That cash in your wallet won't last forever, so what happens to it when it needs to be replaced?
Think about money being created. A furiously spinning printing press might come to mind. Now imagine money being destroyed. Do you think of a three-story shredder, a bonfire, a wide blue recycling bin?
You might have noticed that it's pretty hard to find any cash printed much earlier than the 1990s in circulation. Just as more money is constantly being created, it's also constantly being destroyed. Who are the destroyers of money, and how do they do it?
In order to explain money destruction, we have to define what we mean by money destruction. For example, are we talking about money being eliminated, its very presence disappearing from the economy? Or are we talking about when money is physically destroyed but replaced with newer, crisper currency? Let's consider both questions.
When Money Disappears
You probably know that the Federal Reserve controls the money supply, the technical term for the amount of money in the economy. When the money supply expands, money flows into the financial system. When the money supply contracts, money drains out of the financial system. But how does the money actually disappear?
The Fed expands the money supply through a couple of methods. For simplicity, let's consider "security purchasing." When the Fed wants to expand the money supply, it buys a security -- let's call it Asset A -- from a bank. Then it electronically transfers money to that bank. There is now additional money in the financial system that the bank can use to provide loans.
The nice part about being the Fed is that it doesn't actually need to mail a box of dollar bills to pay for these securities. Instead, it creates a "reserve balance" liability on its balance sheet. The transaction is completely electronic. No hard currency changes hands.
Then, when the Fed is ready to reduce monetary supply, it sells Asset A. This puts the security back into the financial market and reduces money in the system, again electronically. Is that money destroyed?
On the one hand, the money no longer exists in the financial system. On the other hand, it was only there temporarily in the first place. When the Fed gets that money back, it merely reduces the size of its reserve balance liability. In a sense, money is only "created" during an expansionary cycle electronically, through an accounting mechanism. It's then "destroyed" in a similar, but opposite, accounting entry.
When Currency Is Physically Destroyed
Obviously, not all money is electronic. Just look at your wallet. Bills and coins are destroyed every day. There are three destroyers of money, and they're the same ones who create and regulate it.
(1) The Bureau of Engraving and Printing and (2) The U.S. Mint
Banks and individuals will hand over "mutilated" bills and coins to these agencies. They then validate its authenticity and issue a Treasury check in return. The Bureau of Engraving and Printing receives around 25,000 mutilated currency redemption claims annually. Each bill is shredded and sent to waste energy facilities for disposal.
(3) The Federal Reserve
The great regulator of money distributes currency through its 30 Federal Reserve Bank Cash Offices, after receiving it from the Bureau of Engraving and Printing. But it also destroys currency that it wants taken out of circulation and replaced with fresh money.
The Fed is diligent about keeping our currency fit since a torn or mangled bill can't go through an ATM, a vending machine, or another electronic reader. As a result, the average life of each bill is surprisingly short:
- $1 bills: 3.7 years
- $5 bills: 3.4 years
- $10 bills: 3.4 years
- $20 bills: 5.1 years
- $50 bills: 12.6 years
- $100 bills: 8.9 years
Overall the average life for all bills is about five years.The Fed occasionally has some reason for accelerating the rate at which money is taken out of the system, like when a new bill design is introduced. But generally, a banknote's fitness determines how long it remains in the financial system.
So how does the Fed know if a bill is fit for commerce? It processes currency submitted to its Federal Reserve banks by the public to check for fitness. The cash offices uses a sophisticated high-speed sorting machine called the "Banknote processing system 3000," manufactured by German firm Giesecke & Devrient. The BPS 3000 has sophisticated sensors that check bills for authenticity and defects like graffiti, dog ears, tears, excessive soiling, and limpness. If a bill is counterfeit, it is sent to the Secret Service. But if it's merely unfit by the Fed's standards, then the machine shreds it. Those shredded notes are sent to landfills or packaged and provided as souvenirs to the public on Federal Reserve Bank tours.
How much money does the Fed destroy? In 2010, its cash offices destroyed 5.95 billion notes. In 2009, that number was even larger at 6.05 billion notes. A large proportion of those notes were $1 and $20 bills, which are the workhorses of the American economy. In 2010, 2.6 billion $1 bills were destroyed.
Those dollars in your wallet won't last forever. Eventually, they will likely end up shredded and replaced by newer, crisper banknotes. But don't fret: although money is being destroyed on a regular basis, it's being crated even more quickly. Currency grows at a relatively stable rate each year. So the net amount of money out there doesn't generally decline. In that sense, money is really never destroyed.
Image Source: Bureau of Engraving and Printing