by Edward Flaherty (last updated September 5, 2000)

Myth #7: The Federal Reserve charges interest on the currency we use.  

In my experience this particular myth has alarmed more people than any other.  The Federal Reserve is a bank, no?  Banks do not lend money for free, right?  Our currency comes into circulation only when the government borrows currency from the Fed -- at interest -- and then spends it into the economy, right?.  This means we, as citizens, pay interest on the very currency that we use.  Conspiracy theorists believe this is part of the alleged "New World Order" plot to bankrupt the United States.

What is the truth here?  Does the government really pay interest on our paper money, Federal Reserve Notes?  Thomas Schauf of FED-UP, Inc. circulates an information letter in which he writes:

Why pay interest on our currency?  A typical incorrect answer is - the FED profits are returned to the U.S. Treasury.  The truth is, the FED is a private bank in business for profit.  We pay roughly $300 billion in interest on our artificial debt and by special agreement, the U.S. Treasury receives $20 billion in return.  Taxpayers lose $280 billion to the FED banking system per year ... Your local library has these dollar figures.  The numbers don't lie.5
Schauf also argues that the Federal Reserve system is part of an international banking conspiracy, and that President Kennedy might have been assassinated because he allegedly attempted to curb the power of the Federal Reserve (See Myth #9).  This currency interest issue is also raised by other conspiracy theorists.  Television evangelist Pat Robertson in his book The New World Order and Jacques Jaikaran in Debt Virus make identical claims.

How accurate are these claims?   Some of Schauf's statement is correct.  The Treasury Department prints Federal Reserve Notes and then sells them to the Federal Reserve system for an average cost of about 4 cents per bill (see FedPoint #1).  However, the Fed must present as collateral for the currency an amount of Treasury securities that is equivalent in value to the currency purchased.  The Federal Reserve collects interest on all the Treasury securities it owns, including the ones held as collateral.  This is as far into the realm of fact as Schauf's statement can take his reader.

What Schauf doesn't say is that nearly all the Federal Reserve's net earnings are repaid to the Treasury.  This is done per an agreement between the Board of Governors and the Treasury.  Schauf even says this "typical" answer is incorrect.  The table below indicates otherwise.    

1999 Combined Statements of Income of the Federal Reserve Banks (in millions)

    Interest income        Interest on U.S. government securities               $28,216        Interest on foreign securities                           225        Interest on loans to depository institutions              11      Other income                                               688                                                             -------              Total operating income                          29,140

     Operating expenses        Salaries and benefits                                  1,446        Occupancy expense                                        189        Assessments by Board of Governors                        699        Equipment expense                                        242        Other                                                    302                                                             -------              Total operating expenses                         2,878

     Net Income Prior to Distribution                       $26,262

     Distribution of Net Income        Dividends paid to member banks                           374        Transferred to surplus                                   479        Payments to U.S. Treasury                             25,409                                                             -------              Total distribution                              26,262

    Source: 86th Annual Report of the Board of Governors, p.335.    

We can see from the table that the Fed's chief source of income is interest on government bonds.  However, we can also see that 97% of the Fed's net income goes back to the Treasury.

Shauf is barking up the wrong tree when he complains that the Fed's portfolio of government bonds is costly to the Treasury.  The Treasury would have to pay interest on those bonds regardless of who owns them.  At least when the Fed owns a bond, the Treasury is going to get back a substantial portion of the interest.  From the Treasury's point of view, the more bonds the Fed owns, the better.

Moreover, it is unclear how Schauf believes the Fed drains $280 billion from taxpayers every year.  The Fed is entirely self-financed as the data above shows; it receives no outlay from Congress.  Perhaps he thinks the Fed receives all the interest payments on the national debt, which in 1999 summed $353 billion.6  That's not true, either.  The Fed owns only about 8.7% of the total national debt, so the vast bulk of the interest payments are going elsewhere.

Schauf believes the Treasury ought to issue its own currency in the form of United States Notes, a form of currency issued on a few occasions in the past (there are still some in circulation, although the total amount is limited by law).  A 1953 series A note is shown below.

<<SNIP>>

Current paper money has the inscription "Federal Reserve Note" across the top, whereas the bill above has "United States Note."

Schauf and the Coalition argue this would be an "interest-free" form of currency.  However, there is no functional difference between U.S. Notes and the Federal Reserve notes we now use.  Neither impose a net interest burden on the Treasury.  The key difference between the two currencies is who controls the issuance.  The publicly-appointed Board of Governors now controls the emissions of Federal Reserve Notes and can make monetary policy decisions largely independent of political pressure.  The issuance of U.S. Notes, on the other hand, would be controlled by the Treasury Department, an arm of the executive branch and a purely political entity.  Monetary policy, in this economist's view, ought to be based on the needs of the economy, not on the needs of current incumbent political party.

Like many others, this Federal Reserve myth is also incorrect.  Schauf and the Coalition err in the argument by ignoring entirely the funds rebated from the Fed to the Treasury each year.  This key detail essentially means that the bonds held by the Federal Reserve are interest-free loans to the federal government -- the equivalent of printing money.  Federal Reserve Notes do not cost the Treasury any net interest.  Indeed, Mr. Schauf, the numbers do not lie.

References:

2.  Board of Governors of the Federal Reserve System, Annual Report, 1999.

3.  Jaikaran, Jacques (1995), Debt Virus: A Compelling Solution to the World's Debt Problems, Lakewood, Co.: Glenbridge Publishing.

4.  Robertson, Pat (1994), The New World Order, Dallas: Word Publishing.

5.  Schauf, Thomas (1992), The Federal Reserve. Streamwood, IL: FED-UP, Inc.

6. Office of the Public Debt, U.S. Treasury.

7. Ownership of Federal Securities, Treasury Bulletin, June 2000.    

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