Is all reserve currency necessarily physical cash?

Hi,
Is all reserve currency (e.g. China’s) necessarily physical cash? Are the interest payments the US pays on its debts converted into actual physical cash dollars which the recipient countries then use to pay for OPEC oil or foreign investments? I know that China controls/limits the influx of physical dollars into its economy.

I look forward to your feedback
davidmich

Short answer: No.

Slightly longer answer: No, since cash payments are not necessarily (and not usually) the way international transactions are made. In the case of China, for instance, the Chinese central bank (the People’s Bank of China, PBC), which holds vast amounts of U.S. dollar reserves, holds these typically in the form of Treasury bonds. Interest payments on these Treasury bonds are done by the U.S. Treasury in fundamentally the same way as to other bondholders, i.e., cashless. The PBC maintains dollar-denominated accounts (so-called correspondence accounts) in the U.S., either with the Federal Reserve (it’s actually quite common for central banks to maintain correspondence accounts with each other) or one or more commercial banks, to conduct dollar transactions. No cash hauling is required there.

Thanks Schnitte. Just to go off topic a little.When I go to any Asian bank outside of the US, I can get spanking new dollar bills. How does that come about? Is there a special transaction between the federal reserve/Treasury and these banks to get brand new dollar bills? How does that work? How are these bills supplied?
davidmich

The Fed, like other central banks in other countries, operates a network of cash-processing facilities, which in the present day often are pretty much assembly line-style, industrial-scale facilities where commercial banks can conduct cash transactions with the central bank: Commercial banks can bring in cash in large quantities, where it is counted, checked for authenticity (counterfeit notes are removed from circulation and destroyed), checked for quality of the notes (worn and torn ones are, again, removed from circulation), credited to the paying bank’s Fed account, and stored in Fed vaults. Likewise, commercial banks which need cash can obtain it in large quantities from such facilities, with the amount withdrawn charged to the bank’s Fed account. These cash facilities do recycle cash in the sense that the lion’s share of what they pay out comes from the vaults and thus from notes paid in by someone else, but they also inject a continuous influx of freshly printed cash into the system, for two reasons: Firstly, to replace the worn and torn ones that are removed from circulation, and secondly, because the total amount of cash circulation has a rising tendency over the long run simply due to inflation and real economic growth. It’s pretty much a cycle, with the same bill being paid in and out over and over again, until it’s so old it gets retired. Not all cash handling is done by the Fed - some banks or umbrella organisations of banks operate their own cash facilities -, but the Fed-run places play an important role in the cycle. The Cleveland Fed has a website describing the whole thing in some more detail. I work in central banking myself, and have been to such facilities (outside the U.S.) - it’s actually quite impressive to see millions and billions in cash being hauled around on pallets and forklifts in a factory- and warehouse-like environment.

Against this background, I wouldn’t day that non-U.S. banks have “special” transactions with the Fed in the sense that they get preferential treatment - they participate in the cash cycle on the same principles as U.S. banks. But they are “special” in the sense that for them, the cycle is more of a one-way: Whereas U.S. banks have a continuous flow of bills going out and coming in, for non-U.S. banks it’s often one of the two directions outweighing the other (e.g., they pay out a lot of dollar cash to customers, but don’t get in much of it), so they have to constantly replenish their dollar cash supply from the Fed, much of it will be done in crisp new bills.

Thank you Schnitte for that very useful;summary of the process.
davidmich

Hi Schnitte,
I found this post by a commenter on straight dope. Can you verify this for me please?
davidmich

“The Mint doesn’t make Federal Reserve notes. The Bureau of Engraving and Printing does, and it sells them at the cost of production to the Federal Reserve, not at face value to banks. (The Fed pays face value for coins, but not its own notes.)”

You can verify a lot of this yourself on the internet.

From the Federal Reserve:

On the same page, the fact that the US Mint produces all the circulating coins, which are bought by the Federal Reserve for distribution.

The Fed is legally the issuer of the notes, but the BEP does the technical production process. This does not, however, make the BEP the issuer of the bills; the Fed (or, more precisely, the Feds - all twelve regional Feds issue banknotes in their own name, and the bills bear a seal clearly indicating which Fed issued it; “Federal Reserve System” notes issued by the system at large rather than an individual Federal Reserve Bank also exist, however) merely commissions the BEP to make the bills and deliver them to the Fed. It’s essentially an outsourcing of the printing process.