What it means
Nearly all of the paper money in circulation is made up of Federal Reserve Notes, in denominations from one dollar to one hundred dollars. The notes are printed by a government printing bureau, and the Federal Reserve Banks pay for the printing and then issue the notes into circulation when commercial banks ask for cash.
A seal on the face of each note, with a letter, identifies which regional bank issued it. Accounting for the notes is unusual.
A Federal Reserve Note appears as a liability on the balance sheet of the issuing Reserve Bank, because the note is a claim on the central bank. Each Reserve Bank must hold collateral, such as government securities, at least equal to the value of the notes it has issued.
The notes are "legal tender", which means they must be accepted for payment of debts, although a business is not obliged to accept cash for a sale if it states its policy in advance. Notes are different from coins, which are issued by the Treasury.
Together they make up the physical part of the money supply. When a bank needs cash for its customers, it asks its regional Reserve Bank, which sends notes and reduces the bank's reserve account by the same amount.
Worn or damaged notes are returned to the Reserve Banks and destroyed. For a business, the practical impact is on cash handling, security, and the cost of moving and counting cash.
A nuance is that cash is only a small part of the total money supply. Most money exists as electronic balances in bank accounts, so the amount of notes in circulation tells us little about the amount of spending power in the economy.
A second nuance is that a large share of United States notes are held outside the country, which matters when the central bank considers how much to print. From an accounting viewpoint, the central bank earns interest on the securities it holds against the notes, while paying nothing to the holders of the notes.
That difference, known as seigniorage, is a major source of the central bank's income, and most of it is paid over to the Treasury after costs. This is why the issue of paper money is not just a convenience but a profitable activity for the public sector.
In practice
Real-world examples.
Example
A supermarket chain deposits $400,000 of notes from its tills at its bank each day. The bank passes surplus notes to its Reserve Bank, which credits the bank's reserve account. The finance team pays a fee for armoured cash transport, which is one of its largest cash handling costs.
Example
A foreign trading company holds $5,000,000 in $100 notes in its own vault in another country as a store of value. The notes are still liabilities of the Reserve Banks, even though they never return to the United States. The company's treasurer watches the cost of insuring and storing such a large pile of cash.
Example
A bakery owner finds a torn $20 bill in her takings. Her bank accepts it, and sends it to the Reserve Bank for replacement. She gets full credit if enough of the note remains, and the bank handles the paperwork for her.
Formula
Calculation
Collateral coverage ratio = collateral held / Federal Reserve Notes outstanding
Suppose an illustrative Reserve Bank has issued $1,000,000,000 of notes and holds $1,050,000,000 of government securities as collateral for them. Coverage ratio = 1,050,000,000 / 1,000,000,000 = 1.05, or 105%. The excess collateral = 1,050,000,000 - 1,000,000,000 = $50,000,000. The bank meets its requirement because collateral is at least 100% of the notes issued.Case study
Seen in the real world.
Marlow Retail Group is an illustrative, fictional chain of convenience stores that handles around $9,000,000 in cash a year. The finance director wants to know the real cost of cash.
She adds up the armoured transport at $54,000, bank cash handling fees at $27,000, till shortages at $18,000, and staff time counting cash at $41,000. The total is 54,000 + 27,000 + 18,000 + 41,000 = $140,000, or about 1.6% of cash sales.
Armed with this figure, the group offers a small discount for card payments and installs smart safes. In this illustrative case, cash handling costs fall by about $35,000 a year, and the lesson is that although a Federal Reserve Note looks free, handling it is not.
Watch out
Common mistakes.
- Thinking Federal Reserve Notes are backed by gold, when they are backed by collateral held by the Reserve Banks, mostly government securities.
- Believing the Treasury issues the paper money, when the notes are issued by the Federal Reserve Banks and printed by a government bureau.
- Assuming a business must accept cash for every sale, when legal tender only means the notes can be used to settle debts.
Questions
People also ask.
What does the seal on a note tell you?
A letter in the seal identifies the regional Federal Reserve Bank that issued the note.
Who prints the notes?
A government printing bureau prints them, and the Federal Reserve Banks pay for the printing.
Are coins Federal Reserve Notes?
No, coins are issued by the Treasury and are a different part of the money supply.
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