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U.S. Currency: Printing of Flawed Redesigned $50 Notes (Testimony, 10/01/97, GAO/T-GGD-98-8).


GAO discussed issues related to the Treasury's recent production of
flawed, newly redesigned $50 notes.

GAO noted that: (1) neither the Bureau of Engraving and Printing (BEP)
nor the Federal Reserve know specifically how many flawed notes are
among the 217.6 million redesigned notes produced before September 8,
1996; (2) BEP views the problem as a start-up issue to be expected with
production of a completely new note design; and (3) Federal Reserve
officials have not decided what to do with the flawed notes, but have
identified three options: (a) destroy all 217.6 redesigned notes and
replace them; (b) inspect the 217.6 million notes and destroy and
replace only those notes that are found to be flawed; or (c) circulate
the 217.6 million notes after the higher quality new notes have been in
circulation for a few years.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD-98-8
     TITLE:  U.S. Currency: Printing of Flawed Redesigned $50 Notes
      DATE:  10/01/97
   SUBJECT:  Federal reserve banks
             Currency and coinage
             Internal controls
             Crime prevention
             Forgery
             Money supply

             
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Cover
================================================================ COVER


Before the Subcommittee on Domestic and International Monetary
Policy, Committee on Banking and Financial Services, House of
Representatives

For Release
on Delivery
Expected at
1:00 p.m.  EDT
Wednesday
October 1, 1997

U.S.  CURRENCY - PRINTING OF
FLAWED REDESIGNED $50 NOTES

Statement of Bernard L.  Ungar, Director
Government Business Operations Issues
General Government Division

GAO/T-GGD-98-8

GAO/GGD-98-8t


(240275)


Abbreviations
=============================================================== ABBREV

  BEP -

U.S.  CURRENCY:  PRINTING OF
FLAWED REDESIGNED $50 NOTES
==================================================== Chapter STATEMENT

Mr.  Chairman and Members of the Subcommittee: 

I am pleased to be here today to address issues you raised about the
Department of the Treasury's recent production of flawed, newly
redesigned $50 notes.  This flaw was reported in the media during the
week of September 22, 1997.  As you know, the newly redesigned $50
bill is part of a broader effort by the Treasury and the Federal
Reserve to redesign the nation's currency to deter counterfeiting. 

Today, I will address each of the specific questions you raised: 

  -- How many flawed notes were produced? 

  -- How did the production of flawed notes come about? 

  -- What actions are planned about the flawed notes, and what are
     the costs associated with these notes? 

  -- Have any lessons been learned from this experience that could be
     applied to the future production of redesigned currency? 

To address the questions you raised, we interviewed officials and
reviewed relevant documents at the Department of the Treasury,
including the Bureau of Engraving and Printing (BEP), which designs
and produces the nation's currency; the Secret Service, which
conducts investigations of counterfeiting activities; and the Federal
Reserve, which distributes U.  S.  currency and ensures its physical
integrity.  We also performed a limited inspection of the newly
designed $50 notes stored at BEP in Washington, D.C., and at Federal
Reserve banks in Philadelphia, Pennsylvania; and Richmond, Virginia. 
These two banks were among 16 Federal Reserve banks that received the
flawed notes.  We chose them because of their proximity to
Washington, D.C.  We also interviewed officials at these two banks. 
Other than the limited inspections we performed, we did not
independently verify the information provided by BEP, the Secret
Service, or the Federal Reserve.  We did our work between September
26, 1997, and October 1, 1997. 


   BACKGROUND
-------------------------------------------------- Chapter STATEMENT:1

The introduction of significantly redesigned currency began in March
1996, with the introduction into circulation of the newly designed
$100 note.  Redesigned lower denomination notes were expected to be
introduced into circulation at subsequent 9- to 12-month intervals,
but the introduction of the $50 note has been delayed because of
efforts to make the denomination easier to read by the visually
impaired.  The note is now expected to be introduced later this
month. 

The redesigned currency includes several new security features.  Some
of these features are overt; that is, they are designed to be
recognized by the public.  The other features are covert; that is,
they are intended to be used by the banking system.  One of the overt
security features on the $50 note is concentric fine lines printed in
the oval shape that is behind Ulysses S.  Grant's portrait on the
front of the note.  During the initial production of the newly
designed $50 notes, BEP detected flaws in some of the notes,
specifically a gap, or white space, between some of the concentric
lines surrounding Grant's portrait. 


   HOW MANY FLAWED NOTES WERE
   PRODUCED? 
-------------------------------------------------- Chapter STATEMENT:2

Neither BEP nor the Federal Reserve know specifically how many flawed
notes are among the 217.6 million redesigned notes produced before
September 8, 1997.  Although both BEP and the Federal Reserve have
done some inspections to identify flawed notes, neither has done a
complete count or a statistically projectable sample.  BEP said it is
not prepared to estimate the number of flawed notes without more
thorough sampling, which it plans to do.  In Philadelphia, Federal
Reserve officials looked at 200 of the $50 notes and estimated that
50 to 60 percent were flawed. 

On September 30, 1997, we and Federal Reserve officials jointly
reviewed judgmentally selected samples of newly redesigned $50 notes
that had been shipped to the Philadelphia and Richmond Federal
Reserve banks.  We jointly determined that 56 percent of the 1,200
notes we reviewed that were produced before September 8, 1997, and
were shipped to Philadelphia did not meet the Federal Reserve's
standards for circulation concerning the clarity of the concentric
lines surrounding President Grant's portrait.  At Richmond, we
jointly inspected 1,000 $50 notes produced before September 8, 1997,
and found that 45 percent contained similar flaws.  We also jointly
inspected 1,000 $50 notes at Richmond that were printed after
September 7, 1997, and found that 2 percent were flawed.  On
September 30, 1997, we independently inspected 1,664 $50 notes at BEP
headquarters that were printed after September 7, 1997, and found
that 12 percent were flawed.  A better estimate of the number of
flawed notes at BEP and the Federal Reserve banks cannot be made
until more rigorous and scientific sampling procedures are used for
the note inspections. 


   HOW DID THE PRODUCTION OF
   FLAWED NOTES COME ABOUT? 
-------------------------------------------------- Chapter STATEMENT:3

BEP began producing the new $50 note in June 1997.  BEP officials
said they noted problems in the initial production runs with the
concentric fine lines that form the background surrounding the
portrait of Ulysses S.  Grant.  Specifically, they noticed gaps in
the lines, which were caused by one or more lines not printing
completely.  These gaps were inconsistently distributed throughout
the notes, thus making them difficult to correct.  BEP viewed the
problem as a start-up issue to be expected with production of a
completely new note design.  BEP officials told us that although they
viewed the new notes as acceptable for distribution to the Federal
Reserve and for circulation, they believed that the quality of the
concentric lines needed to be improved.  Accordingly, they made a
number of changes in their production, including adjustments to
printing presses, changes in the ink, and changes to the printing
plates used to create the face of the new note.  For example, BEP
made modifications to the printing plates by cutting small horizontal
grooves into the concentric lines, called dams, that permit ink to be
deposited more successfully on the paper.  According to BEP, these
changes reduced, but did not eliminate the concentric line gaps in
some of the $50 notes. 

In September, Federal Reserve and BEP officials, at a regularly
scheduled meeting, discussed the importance of note quality. 
Immediately after that meeting, BEP invited the Federal Reserve to
view some of the new $50 notes that it had produced to get its
customer's input on the quality of the notes.  According to Federal
Reserve officials, this was the first time they were informed of the
problems with the concentric lines surrounding President Grant's
portrait.  BEP officials said they did not tell the Federal Reserve
about the problem earlier because they believed the notes were of
acceptable quality and that the production problems were typical of
those that could be expected in producing a newly designed note. 

According to Federal Reserve and BEP officials, the printing problems
with the concentric lines did not appear in test notes that BEP
supplied to the Federal Reserve prior to full scale production of the
notes.  BEP officials stated that printing difficulties often appear
only in the production process.  They said that test currency is
produced under more carefully controlled conditions and is not
produced at the same press speeds and volumes. 

When Federal Reserve officials inspected the production notes in
early September 1997, they considered the quality of the concentric
lines in many of the notes to be unacceptable for circulation, in
part because of the public education campaign, which specifically
identified the concentric line's clarity as a security feature that
should be examined when determining if a note was genuine.  For
example, educational brochures on the note produced by Treasury and
the Federal Reserve, which are now available, advise the public to
look at the very fine concentric lines behind the portrait to be
certain that they are clear.  In mid-September, Federal Reserve
officials met with BEP, U.S.  Secret Service, and other Treasury
representatives who agreed with the Federal Reserve's concerns and
also agreed on quality standards for determining note acceptability. 
These standards were then programmed into BEP's automated currency
inspection equipment. 

BEP and the Federal Reserve refer to notes produced before the dams
were cut as phase I notes, and those produced after the dams were cut
as phase II notes.  They refer to notes produced after BEP's currency
inspection devices were recalibrated as phase III notes.  BEP and
Federal Reserve officials believe phase II notes are of higher
quality than phase I notes, and that the quality of phase III notes
is higher than that of both phase I and II notes.  Beginning in June
1997, BEP produced a total of 160 million phase I notes, of which
about 59.5 million were shipped to 16 Federal Reserve banks and 100.5
million are stored at BEP headquarters.  Beginning around August 1,
1997, BEP produced 57.6 million phase II notes, all of which are
stored at BEP.  Production of phase III notes began around September
8, 1997, and as of September 24, 1997, BEP reported having shipped
about 11.7 million of the phase III notes to Federal Reserve banks
and storing about 4.3 million of the phase III $50 notes in its
inventory. 

Secret Service, Federal Reserve, and BEP officials said the flaws in
the notes did not increase the risk of counterfeiting or further
delay the notes' introduction.  According to a Secret Service
official, issuing the flawed notes would not make them more
susceptible to counterfeiting or impede counterfeiting detection. 
However, the official noted that the flaw in the concentric lines
could result in increased public questions about the note's
authenticity.  Federal Reserve officials voiced similar concerns,
particularly in regard to foreign countries where U.S.  currency is
often more closely scrutinized.  Much of their concern stemmed from
the emphasis given to the concentric lines in the promotional
material being disseminated on the new $50 note.  Federal Reserve and
BEP officials stated that the flawed notes would not cause a further
delay in the issuance of the new note to the public because the $50
note represents a relatively small portion of BEP's total production,
and it does not take long for it to make enough notes to meet the
public demand. 


   WHAT ACTIONS ARE PLANNED ABOUT
   THE FLAWED NOTES, AND WHAT ARE
   THE COSTS ASSOCIATED WITH THESE
   NOTES? 
-------------------------------------------------- Chapter STATEMENT:4

As of September 29, 1997, Federal Reserve officials told us that they
had not decided what to do with the flawed notes but expect to decide
by the end of the year.  According to Federal Reserve officials,
there is no need to rush to make a decision because the newly
designed $50 notes are not scheduled to be released for circulation
until October 27, 1997, and they believe that they will have enough
of the good notes to put into circulation.  The Federal Reserve has
identified three options that it is considering: 

  -- destroy all 217.6 million phase I and phase II $50 notes and
     replace them;

  -- inspect the 217.6 million phase I and phase II $50 notes and
     destroy and replace only those notes that are found to be
     flawed; or

  -- circulate the 217.6 million phase I and phase II $50 notes after
     the higher quality new notes have been in circulation for a few
     years. 

Before decisions can be made on which option to select, Federal
Reserve officials described several steps that they planned to take. 
First, they said they would determine costs of developing and
installing sensors on their currency processing equipment to inspect
the phase I and phase II $50 notes.  The Federal Reserve said that
although its equipment--normally used to inspect recirculating
notes--has the capability to check certain aspects of individual
notes, it does not have the sensors needed to detect the gaps in the
background of the portrait.  According to BEP, its equipment can
detect the gaps in the background of the portrait but only in its
normal production format--that is, in sheets of 32 notes.  Since all
the phase I and phase II notes have been cut into individual notes,
BEP's detection equipment cannot be used for such an inspection. 
Thus, sensors that have the capability to detect such gaps would need
to be developed by a vendor and then purchased by the Federal
Reserve. 

The second planned step would be to determine how much it would cost
to identify the acceptable notes and reprint only those that were
unacceptable.  The third planned step would entail the Federal
Reserve and BEP conducting scientific samples of the entire inventory
to identify what portion is acceptable and unacceptable.  Finally,
the fourth step would be to use the data obtained in the first three
steps to determine the most cost beneficial option between destroying
and replacing all the notes or identifying and destroying and
replacing only the flawed notes.  According to Federal Reserve
officials, they do not believe that there is a high probability that
they would choose the third option of distributing all 217.6 million
phase I and phase II notes at a later time. 

The Federal Reserve has not estimated the complete costs of
reproducing the flawed $50 notes.  As an example to provide
perspective on the costs of the options under consideration,
according to BEP and Federal Reserve officials, if the Federal
Reserve were to decide to destroy all 217.6 million of the $50 notes
and replace them, it would cost approximately $7.2 million for
printing replacement notes plus an additional $360,000 to destroy the
notes at the Federal Reserve banks and BEP and to ship the
replacement notes.  This amount is about $1 million less than the
$8.7 million the Federal Reserve initially paid for the phase I and
phase II $50 notes because the replacement production costs do not
include charges for capital equipment and fixed costs that were
already included in the charges for the original production runs. 

The Federal Reserve was not able to estimate the costs associated
with option two because the costs of obtaining and installing the
sensor equipment are not known at this time; nor does it yet know
what proportion of the 217.6 million notes are acceptable or what the
costs of inspecting them would be.  According to the Federal Reserve,
the costs associated with the third option would probably be minimal
and would be mostly storage costs.  All costs incurred by the Federal
Reserve due to the replacement of the flawed notes would result in a
reduction in the amount of money the Federal Reserve returns to the
Department of the Treasury after it subtracts its operating expenses
from its revenues.\1


--------------------
\1 For additional information on the Federal Reserve's operations and
returns of revenue to the Treasury, see Federal Reserve System: 
Current and Future Challenges Require Systemwide Attention,
GAO/GGD-96-128, June 1996. 


   HAVE ANY LESSONS BEEN LEARNED
   FROM THIS EXPERIENCE THAT COULD
   BE APPLIED TO THE FUTURE
   PRODUCTION OF REDESIGNED
   CURRENCY? 
-------------------------------------------------- Chapter STATEMENT:5

Mr.  Chairman, while our review of this matter has not been
extensive, we have made two observations that should prove useful in
the future production of redesigned currency.  These observations
relate to (1) the Federal Reserve's and other stakeholder involvement
in inspecting BEP production and limiting the number of notes
produced until production problems are resolved and (2) resolving the
problems with printing fine concentric lines before new denominations
are produced. 

The experience gained from the redesigned $50 note showed that it
would be useful to have the Federal Reserve, Secret Service, and
other Treasury officials involved early in the production process to
inspect the quality of note production.  In this instance, although
the Federal Reserve inspected test notes, it did not inspect
production run notes until a substantial number of notes had been
produced and shipped.  According to the Federal Reserve, it has not
historically been involved in inspecting currency production,
primarily because BEP has generally produced high quality currency;
the currency designs have not significantly changed for many years;
and BEP experienced no major problems with the printing of the newly
designed $100 note last year.  Federal Reserve officials said that
they are now reassessing their approach to monitoring the quality of
currency production. 

Both BEP and Federal Reserve officials said that they agree that
early inspection of BEP production would be worthwhile after the
experience with the production of the newly designed $50 note, but
said they have not yet agreed on the specifics of the Federal
Reserve's early involvement.  Once BEP and the Federal Reserve reach
agreement on the details, we believe it would be helpful for them to
formalize their agreement in writing.  In addition, BEP and the
Federal Reserve may wish to include Secret Service and other Treasury
officials in their discussions and agreements.  Based on the problems
encountered with the newly designed $50 note, the BEP and Federal
Reserve might also want to limit the production of newly designed
currency until all production problems are resolved and to include
such a limitation in their written agreement. 

Our second observation deals with the resolution of problems in
printing concentric fine lines surrounding the portrait on
denominations lower than the $50 note, which the Treasury Department
and the Federal Reserve plan to introduce at 9- to 12- month
intervals following the introduction of the $50 note.  According to
BEP, the fine concentric line design on the face of the new $50 note
poses particularly difficult challenges to print clearly, and the
fine concentric lines will be somewhat different for each
denomination because the configuration of the portraits will vary. 
For example, BEP officials said that printing the fine concentric
lines on the newly designed $100 note, which has a portrait of
Benjamin Franklin with long hair taking up a large area of the oval
surrounding Franklin's portrait, has not been as difficult as
printing the lines on the newly designed $50 note, which has a
portrait of Ulysses S.  Grant with relatively shorter hair taking up
a smaller area of the surrounding oval.  It may prove helpful for BEP
to explore whether design changes would lessen the chances of
production problems for future denominations. 

In this regard, we noted that while BEP has improved the quality of
the new $50 notes after making production modifications to the
engraved plates and adjusting the tolerances of its inspection
equipment, BEP officials acknowledged that some imperfect notes still
are produced and are likely to continue to be produced, although at a
much lower frequency.  In our very limited observations of $50 note
production this week, we observed some imperfect concentric line
backgrounds, but it is important to note that our sampling was not
statistically representative and we cannot make any projections on
the overall rate of imperfection. 


   RECOMMENDATIONS
-------------------------------------------------- Chapter STATEMENT:6

In view of the experience with the early production of the redesigned
$50 note, we recommend that the Secretary of the Treasury and the
Board of Governors of the Federal Reserve: 

  -- Formalize an agreement to have Federal Reserve, BEP, Secret
     Service, and other relevant Treasury officials involved early in
     the currency production process for future redesigned notes to
     inspect production and agree on an acceptable level of quality;

  -- Limit initial production of newly designed currency to the
     number that would be necessary to provide reasonable assurance
     that all production problems are resolved, and include such a
     limitation in their written agreement; and

  -- Explore the feasibility of design changes that might lessen the
     potential for production problems for future redesigned
     denominations. 


------------------------------------------------ Chapter STATEMENT:6.1

Mr.  Chairman, that concludes my prepared statement and I will be
happy to answer any questions that the Subcommittee may have. 


*** End of document. ***