Federal Reserve Notes and Federal Reserve Banks

Factual Questions
1

Have you ever noticed that every United States Federal Reserve Note purports to be issued by one of the twelve individual federal reserve banks? It used to be obvious on all of the notes. Just look at the black seal with a letter in the center on the left side of the obverse of any modern one dollar or two dollar note. The seal will state the name of a particular federal bank. It is less obvious on the modern designs for notes in denominations greater than two dollars but it is still there. It appears as a black letter a number just below the green serial number on the upper left hand side. I pulled a random ten dollar note out of my wallet and it has “K11.” This purports to indicate that it was issued by the Federal Reserve Bank of Dallas, Texas.

I would guess, but I don’t know for certain, that a hundred years ago or so when the federal reserve system was first started that the United States Treasury was very careful to ensure that unissued notes shipped to a particular federal reserve bank to be issued by that bank bore the name of that particular federal reserve bank. I speculate, but really don’t know at all, that in modern times the treasury and the federal reserve banks do not pay much attention to which federal reserve bank is indicated on unissued notes when unissued federal reserve notes are shipped to a federal reserve bank to be issued. Furthermore, there is probably no longer any requirement that the unissued notes have to be physically present at any particular federal reserve bank before being issued. If the treasury and the federal reserve system want to reconcile which federal reserve banks issued new currency and how much, it could all be done with simple electronic bookkeeping entries.

Does anybody know how this actually works in today’s federal reserve system?

2

Notes issued by a particular Federal Reserve bank really are issued by that bank. Which is to say, they order a certain amount of currency from the Bureau of Engraving and Printing and distribute it as needed to the Federal Reserve member banks in their district.

There’s no particular justification for this system – you might as well have a single bank with distribution warehouses in various places – but in 1913 the concept of central banking was extremely controversial. In order to get the Federal Reserve Act passed, it was necessary to set up an overly-complicated compromise with regional Fed banks in charge of regulating member banks in each area and issuing currency.

3

I absolutely agree this is correct. But “issued” might only be a matter of accounting. It could be more of an intangible abstraction than it is a physical act. My question is about the actual physical distribution of new notes.

4

I didn’t want to imply that they don’t pay any attention at all to which bank name is printed on the notes. I’m sure they keep track of which notes went where. But if the Federal Reserve Bank of Kansas City, Missouri suddenly needs fifty pallets of new one dollar notes right away and the treasury doesn’t have any Kansas City notes handy at the moment but it has plenty of one dollar notes that have Federal Reserve Bank of Cleveland, Ohio printed on them then there is no reason they couldn’t ship those Cleveland notes to Kansas City. They may be “issued” by the Cleveland bank but they could still distributed by the Kansas City bank to member banks in the Kansas City district. At the end of some accounting period, the treasury and federal reserve could reconcile all of the notes “issued” and all of the notes distributed and after offsetting everything see if one federal reserve bank owes a little to another federal reserve bank. Then they could settle up somehow. Sort of like a check clearinghouse. I don’t know for sure if this is really what happens but I bet it is.

5

I’ve looked into this further but still do not have an answer. With the possible exception of friedo and me, no one appears to be very interested in this subject.

I looked at the balance sheets for several of the twelve federal reserve banks and, not unexpectedly, each bank lists the amount of Federal Reserve Notes outstanding for that bank. Also, and again not unexpectedly, the amounts outstanding for each bank varied significantly.

To avoid confusion, I think we should discuss exactly what it means when we say a Federal Reserve Note is issued. It is not when the note is tendered from the bank to one of its customers. (The customers of a federal reserve bank are the member commercial banks in its district). This is mere distribution. It is not when it is printed. A newly printed note is merely a piece of paper with ink on it that does not obligate anyone to do anything until it is issued. The aforementioned piece of paper with ink on it only becomes a Federal Reserve Note when a Federal Reserve Agent or an Assistant Federal Reserve Agent declares it to be an outstanding liability on the books of a particular federal reserve bank. This is when it is issued. (Before the nut cases start screaming, it takes more than just this declaration. The federal reserve bank must obligate some of its assets to the U.S. Treasury for the privilege of issuing a note.)

I also found this (The Fed - Chapter 5. Federal Reserve Notes) which did shed some light on the question. Prior to 1977, unissued notes were held at each federal reserve bank and were issued by a local Assistant Federal Reserve Agent. I would guess that prior to 1977, most or all of the unissued notes bore the name of the particular federal reserve bank that held them. After 1977, Federal Reserve Notes are issued by a Federal Reserve Agent or an Assistant Federal Reserve Agent when they are shipped from the printing facility in Washington, D.C. or Fort Worth, Texas.

Since issuing a note is actually an intangible accounting process on the books of the federal reserve banks, why would it matter which bank’s name is printed on a particular note? All issued Federal Reserve Notes are equally accepted by every federal reserve bank and the U.S. treasury regardless of which bank’s name is on the note. As an economist might say, they are fungible. I believe that the only reason the identity of the individual federal reserve banks are still on the notes is because of a legacy statute from the original 1913 Federal Reserve Act as amended. (See 12 U.S.C. § 413).

One might ask how are each federal reserve banks obligations accounted for when notes are withdrawn and destroyed because they are no longer fit for circulation. They are not counted or sorted by the names/numbers of the federal reserve bank written on each note. They are sorted by denomination. After destruction, a particular federal reserve banks reduction in liabilities is calculated using a ratio of the amount of that denomination outstanding for that particular federal reserve bank and the total amount of that denomination outstanding for all federal reserve banks. A small adjustment is made for obsolete notes such as Silver Certificates, U.S. Notes, etc. (Interestingly, denominations greater than $100 are handled differently and are sorted by federal reserve banks. This probably doesn’t happen much.)

All of this brings up another question. What do you think the ordinary person thinks when they hear that the government will just “print more money.”? I believe a lot of people take this literally. It is just a metaphor and a poor one at best. Almost all money is in a form other than currency or coin and creating more money has little or nothing to do with printing currency.

6

If it’s still of any interest, interbank assets and liabilities of the regional Federal Reserve Banks are settled by means of allocating gold certificates. Those gold certificates are a legacy from the days when the dollar was a gold-backed currency, which of course it has not been for a long time. The basic principle is as follows: The U.S. Treasury owns the United States’ gold reserves. These gold reserves are valued at the old historical rate of $42.22 per troy ounce, which is far below the market value of gold.

This gold can be “monetized”, i.e., turned into dollars by the Treasury. The process works by the Treasury announcing this intention to the Federal Reserve System. The corresponding amount in dollars will then be credited to the Treasury’s account with the New York Fed; in return, the Federal Reserve System will receive gold certificates from the Treasury, representing a notional claim on the government’s gold reserves. The physical gold is not moved, and the gold certificates are not actual paper certificates but rather book-entry securities. Conversely, the process can be reversed by means of “demonetization” - the Fed returns the gold certificates to the Treasury, and the corresponding amount will be debited to the Treasury’s Fed account.

These gold certificates are a leftover from the old gold standard days; their total amount is not very high (around $11bn), and they only serve as an accounting tool to settle liabilities of the Federal Reserve Banks towards each other (which are recorded in an account called the “Interdistrict Settlement” account). Essentially, the net amounts arising from new banknote issuances and removal of old banknotes from circulation are settled by reallocating gold certificates from the debtor Federal Reserve Bank to the creditor one. The Federal Reserve Banks report the gold certificates allocated to them as an asset on their balance sheets, but they are legally barred from exercising them, i.e., actually demanding the corresponding gold amounts from the Treasury.

The process is explained here, here and here.

7

The sum of the two statements above is that the balance of currency on each regional FRB’s books is a total fiction. They add real identifiable dollars and subtract assumed undifferentiated dollars. Pretty quickly each regional FRB’s book value will diverge from reality.

Meanwhile the total of all the regional FRBs taken together balances with the total value of currency out in circulation, which is probably all that really matters. [Aside: less the currency that’s lost / destroyed by the public, plus whatever amount of counterfeit is in circulation.]