2007 New Currency Budget Action Requested Staff requests that the Board approve the proposed 2007 new currency budget. The proposed 2007 budget of $597.8 million is a $109.0 million, or 22.3 percent, increase over 2006 estimated expenses. This increase reflects increases in the Bureau of Engraving and Printing (BEP) billing rates, the number of notes printed, and the proportion of high-denomination notes. The primary drivers of these changes are discussed below. Discussion Under the Board's delegated authority, the director of the Division of Reserve Bank Operations and Payment Systems (RBOPS) submits an annual print order for new currency to the director of the BEP. The BEP reviews the print order and establishes billing rates for new currency that RBOPS staff uses to prepare the annual new currency budget. The Board reviews and approves the budget and subsequently assesses the Federal Reserve Banks through an accounting procedure similar to the one used in assessing the Reserve Banks for the Board's operating expenses. In August 2006, the director of RBOPS forwarded to the BEP a print order for 9.1 billion notes for fiscal year 2007. Because the BEP operates on a fiscal year, which began October 1, 2006, and ends September 30, 2007, staff estimates the Board's calendar year budget for new currency by eliminating the cost of notes that the BEP will produce in the first quarter of its fiscal year and estimating the cost of notes that the BEP will produce in the fourth quarter of the calendar year. Table 1 compares the Board's calendar year 2007 budget with the 2006 budget and 2006 estimate.

a $1 and $2 notes do not include security features in the high-denomination Series-1996 and Series-2004 design notes; $5 notes include watermarks, but not color-shifting ink; Series-1996 $100 notes include watermarks and color-shifting ink; and Series-2004 $10, $20, and $50 notes include watermarks, color-shifting ink, and an additional high-level security feature.. Return to table. b The BEP will not produce any $2 notes in calendar year 2007 because Reserve Banks have sufficient inventories to meet estimated public demand for several years. Return to table. c Volume weighted. Return to table.

The denomination and design-specific BEP billing rates shown in table 2 are higher than the 2006 billing rates. The key factors contributing to the higher 2007 billing rates are (1) the BEP capital plan, (2) a new currency paper contract, and (3) public education expenses. Billing Rate Increase--Capital Plan BEP capital improvements represent $32.1 million of the 2007 currency printing budget. Over the next ten years, the BEP plans major capital improvements at both its Washington, D.C., and Ft. Worth facilities. During the first four years of the plan, the BEP plans to replace production equipment at the Washington, D.C., facility, including intaglio presses and overprinting equipment for some production lines. The new presses will replace fully depreciated presses (at least 26 years old), and will provide more versatility for producing future security features as well as more efficient operations as the new presses use larger sheets of currency paper that will create a 56 percent increase in machine capacity. Billing Rate Increase--Currency Paper Contract and Other Costs The billing rate increase also represents expected increases in currency paper costs resulting from the pending award of a new contract, which will be effective beginning January 2007.3 The BEP is currently in final contract negotiations; it expects paper rates to increase because of rising utility and raw material costs as well as new capital investments at the paper manufacturer. If the final paper rates differ from the ones included in the current billing rates, the BEP will adjust the billing rates accordingly. In addition, increases in ink costs and general administrative and overhead expenses account for another three percent of the increase in billing rates. Billing Rate Increase--Public Education Expenses The billing rate increase also represents expected increases in public education costs resulting from the award of a new public relations contract.4 During 2007, the BEP plans a public education program to support the release of the redesigned $5 note in the first quarter of calendar year 2008 and the redesigned $100 note in 2009. The $100 note, which circulates internationally, requires a world-wide public education campaign for which research and early preparations are anticipated to begin in late 2007. Number and Denomination Mix of Notes Printed Table 3 illustrates the number of notes by denomination that the BEP will print in calendar year 2007 compared with the number of notes printed in 2006.

Table 3 Number of Notes Printed (millions per calendar year)

Denomination	2006 Estimated	2007 Budget	Percent change 2007B/2006E
$1	4,512.0	4,097.8	-9.2
$2	230.4	0.0	-100.0
$5	1,094.4	1,222.8	11.7
$10	648.8	334.0	-51.2
$20	704.0	2,031.5	188.6
$50	201.6	278.5	38.1
$100	1,033.6	1,213.1	17.4
Total	8,460.8	9,177.7	8.5

We estimate an 8.5 percent increase in the overall 2007 calendar year BEP note order compared with the 2006 estimate.5 Staff is working with the BEP to smooth out the currency print orders over the next several years, in anticipation of the large number of notes that we expect will be required in preparation for the release of the new $100 note design in 2009. There are currently 5.5 billion $100 notes in circulation, and staff estimates that we will need to replace approximately 4.5 billion of them during the first two years after the release of the new design. The Reserve Banks will destroy all old-design $100 notes deposited, rather than re-issue them, after the new-design notes enter circulation.6 The circulation pattern is considerably different for the $100 note because many of them circulate outside of the United States, and overseas markets largely demand new-design notes. The large $100 note requirement combined with our projected order for other denominations would exceed the BEP's production capacity in 2009. To reduce the number of notes for the BEP to produce in 2009, it will produce part of the estimated 2008 note order in 2007 and, similarly, part of the 2009 order in 2008. In particular, the 2007 order includes enough $20 notes to satisfy demand during 2007 and half of 2008, and enough $50 notes for both 2007 and 2008. We have used this smoothing process in the past to eliminate large swings in orders from one year to the next.7 We expect print orders to be of similar size through 2009, and that the 2009 budget will be higher than the current year budget because the large number of new-design $100 notes will include the most advanced and costly counterfeit deterrent features.8 The 2007 print budget is also higher than estimated 2006 expenses because it contains a larger share of more-expensive high-denomination notes than did the 2006 note order. $10 through $100 notes comprised 42 percent of the 2007 note order, compared with 31 percent of the 2006 note order. This increase in high-denomination notes heavily reflects the year-in-advance $20 note order discussed above. 2007 Currency Transportation The 2007 currency transportation budget is $16.3 million, which includes the costs of shipping new currency from the BEP to Reserve Banks, of intra-System shipments of fit and unprocessed currency, and of returning currency pallets to the BEP. Of the $16.3 million in the 2007 budget for currency transportation, $11.2 million is for shipments of new currency from the BEP and $5.0 million is for intra-System shipments. These amounts are 10.3 percent and 11.3 percent higher than 2006 estimated expenses, respectively. In 2007, the Board will begin a new two-year contract with armored carriers for BEP currency shipments. Based on the renegotiated contracts, the billing rates will increase an average of 9.2 percent over the previous two-year contract rates. The 2007 budget for BEP shipments also includes an estimated $176.8 thousand associated with shipping the year-in-advance inventory for future year currency orders for storage at the Dallas Reserve Bank. The 2007 budget for intra-System shipments includes $600 thousand for shipments of unprocessed $1 notes between Reserve Banks for a new program to use the System's high-speed processing capacity more effectively. The expected transportation and high-speed processing costs for the unprocessed currency are less than costs associated with printing and shipping new notes from the BEP. Without the cost of this program, the 2007 budget for intra-System shipments would be relatively unchanged from 2006 estimated expenses. The 2007 budget for returning currency pallets from Reserve Banks to the BEP is unchanged from the 2006 estimate of $42 thousand. Counterfeit-Deterrence Research The 2007 budget for counterfeit-deterrence research is $3.4 million, which includes costs associated with the Central Bank Counterfeit Deterrence Group (CBCDG) and the Reprographic Research Center (RRC). The CBCDG operates under the auspices of the G-10 central bank governors to combat digital counterfeiting and includes 27 central banks. The Board's $3.4 million share of the 2007 CBCDG budget comprises 99 percent of the Federal Reserve's counterfeit-deterrence budget and is 2.9 percent more than the 2006 estimate. The RRC payment of $35 thousand represents the remaining one percent of the counterfeit-deterrence research budget. The RRC is a state-of-the-art facility used for adversarial testing of banknote designs and counterfeit deterrent features by 12 member central banks and is hosted by the National Bank of Denmark. The budgeted 2007 payment to the RRC increased by $17 thousand, or 118.8 percent over the 2006 estimate, reflecting additional staffing and additional capital investment. The Executive Committee of the RRC agreed to hire an additional person to support the work of the laboratory and address workload and succession planning concerns of the National Bank of Denmark. Treasury's Office of Currency Standards (OCS) The 2007 budget to reimburse the U.S. Department of the Treasury for OCS expenses is $3.8 million. The OCS develops Reserve Bank standards for cancellation and destruction of unfit currency and for note accountability, and reviews Reserve Bank cash operations for compliance with its standards. As a public service, the OCS also processes claims for the redemption of damaged or mutilated currency. The 4.2 percent OCS budget increase results from higher salary and travel costs.

Data for Chart 1

YEAR	1990	1991	1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006E	2007B
Nominal Cost in millions of dollars	190	260	295	355	368	373	403	367	408	487	456	344	430	514	514	497	489	598
Real Cost (CPI Adjusted) in millions of dollars	190	249	275	321	324	320	336	299	327	382	346	254	312	365	356	333	316	377

Data for Chart 2

YEAR	1990	1991	1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006E	2007B
Billions of notes	7.00	8.02	8.45	8.03	9.33	9.96	9.44	9.58	9.20	10.8	8.97	8.18	7.39	8.39	8.88	8.3	8.5	9.2
Billions of dollars	84.47	107.96	103.19	104.89	128.82	148.24	194.64	142.23	163.26	285.49	67.46	50.20	123.30	126.2	157.0	140.8	144.8	189.4

Data for Chart 3

YEAR	1990	1991	1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006E	2007B
Billions of notes	7.00	8.02	8.45	8.03	9.33	9.96	9.44	9.58	9.20	10.8	8.97	8.18	7.39	8.39	8.89	8.29	8.46	9.18
Cost per 1000 notes	$26	$30	$36	$41	$38	$37	$40	$43	$47	$43	$47	$49	$50	$58	$56	$55	$56	$63