The Indian government last week demonetized its 500- and 1000-rupee notes. Overnight, the 500-rupee ($7.36) note and the 1000-rupee ($14.73) note were banned from use in commerce. Those holding the notes were allowed to exchange their notes for smaller denominations, but only to a total sum of Rs 4000, and only one time. That sum has now been reduced to Rs 2000. The alleged reason for the demonetization of the notes was to crack down on corruption, tax evasion, and black markets. The results of the demonetization, as should have been easily predicted, were horrendous.
ATMs throughout India began running out of cash, tourists found themselves stranded, and long lines formed at banks around the country. Many Indians turned their notes in to black market currency traders or purchased gold so as not to have to deal with the banks or with the authorities. More than 85 percent of the bills in circulation in the country were Rs 500 and Rs 1000 notes, so the effects of this demonetization are widespread. Although the government has introduced new Rs 500 and Rs 2000 notes to replace the demonetized notes, that doesn’t do much good for those who may have had significant amounts of savings held in cash, and the delays in provision of the new notes have caused further difficulties.
There are many reasons that people choose to hold cash. The Indian government alleged that cash holdings allowed for corruption and tax evasion, therefore the attempt to sweep cash holdings into the financial system. It is true that cash can help aid tax evasion and corruption in many societies. The solution, however, is not to ban cash, but to get rid of the grounds for tax evasion, bribery, and black markets. If tax burdens were lower there would be a diminished incentive to evade tax payments. If government officials didn’t wield inordinate amounts of power over people then there would be no incentive to bribe them for favors, special treatment, or exemptions from regulation. And if regulations were not so stringent and the free market were allowed to flourish unhindered, there would be no black markets to bring out into the open. But it’s far easier for government to place blame on nebulous corrupt figures or on black market smugglers than it is to point fingers at itself and credit government actions with creating that corruption and those black markets in the first place.
This isn’t the first monetary boondoggle in which the Indian government has engaged. Remember that India is one of the largest consumers of gold on the planet, particularly during the wedding season. Indians have traditionally held much of their wealth in the form of gold and the cultural ties to gold endure. Many temples in India sit on treasures of gold donated by pilgrims, vast amounts of gold accumulated over hundreds of years of temple visits. The sums number in the billions of dollars, which the Indian government would love to get its hands on.
An outright confiscation of that gold from temples would likely result in a massive public outcry, so the government has sought to coax that gold into government coffers through a series of gold monetization schemes, most notably one introduced last year. The plan sought to entice holders of gold to bank their gold with the government, in exchange for regular interest payments and an eventual repayment of principal. That repayment however, was in most cases going to be in rupees rather than gold, and the interest payments were abysmally low. At the same time, the government hoped to use its newfound gold holdings to mint an Indian gold coin which it could then sell. Needless to say, the details of the scheme were so sorry that not much gold was turned in.
That scheme followed previous attempts by the government to get its hands on gold holdings, as well as increased tariffs on imports of gold to try to suppress gold ownership and force people into holding rupees rather than gold. The thinking was that by replacing gold ownership with rupee holdings, India’s central bank would be able to engage in more effective monetary policy to stimulate the economy. Widespread gold ownership and distrust of the rupee was seen as hampering the central bank’s efficacy. None of these attempts at curbing gold holdings have been able to make much headway, as the cultural legacy of gold ownership is so ingrained in India that government fiat cannot eradicate it. No matter how strong the government’s attempts to force the people to do what it wants, the people have minds of their own.
The crisis in India also demonstrates another possible effect of government control over the monetary system, one in which the ruling party benefits politically from its control over the monetary system. It has been reported that the government’s cash crackdown may harm opposition parties who rely on cash donations to fund their operations, so there may have been another ulterior motive to the demonetization. That shouldn’t be surprising. Governments aren’t disinterested parties concerned only with the common good, they are organizations staffed by individuals, each of whom has his own self-interest at heart. Allowing governments control over the monetary system allows those individuals to manipulate the monetary system to their own advantage.
In the West with the system of central banking that has established itself in most countries, that government control has manifested itself in a persistent stream of loose monetary policy punctuated by intermittent bouts of only modest relative tightening. The result has been a steady rise in prices, a diminished standard of living, and a transfer of wealth from the poor and the middle class to the ultra-rich debtors who benefit from inflation. Governments have grown ever more bloated as they rely on inflation to allow them to repay their exorbitant debts with devalued money.
The solution to all of the problems brought about by government intervention in the monetary system is of course to force governments to relinquish control over money issuance. Just as with any other good or service, money can be provided by markets, and indeed it has been over the course of history. It has been done in the United States and elsewhere. Where commerce is desired, a monetary unit spontaneously emerges from human interaction to supply markets with a medium of exchange. It is only due to the consistent efforts of governments to monopolize issuance of currency and to erase any memory of market provision of money from popular memory that so many people are unaware of alternatives to the current government monopoly over money. The only good thing about the situation in India is that it shows those of us in the West who are paying attention what might eventually transpire here. The negative effects of the cash crackdown will hopefully serve as a wakeup call that government control over the monetary system and governments’ continuing war on cash are destructive and foolhardy endeavors.