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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