Blog Post - Views on the Economy and the World

Demonetization on Five Continents

| Feb. 10, 2017

Several countries are undergoing “demonetization” or currency reforms in which the government recalls bills of particular denomination that are circulation and replaces them with new notes. Some of these initiatives are going better than others.

India is still reeling from the consequences of Prime Minister Modi’s announcement on November 8 that 500- and 1000-rupee denomination bills, which constitute 86 % of the cash in circulation, could no longer be used and that residents have until the end of December to turn them in. They have been waiting in long lines, only to find in many cases that the banks have not received enough of the new currency to make the exchange. Some businesses are unable to operate. India’s experiment is unique in that it combines mostly benign motives – a crackdown on illegal activities – with an abrupt implementation that has inflicted unnecessarily high costs on the economy.

Demonetizations fall into several widely different categories. The most dramatic and disruptive episodes are usually signposts on the highway to hyperinflation. Venezuela’s President Maduro on December 11 announced a recall of the 100-bolivar note, creating chaos by giving residents only 10 days to make the exchange into new higher-denomination-notes (500-bolivar notes and higher, up to 20,000 bolivars).

Venezuela will almost certainly be in hyperinflation in 2017. Economists generally define hyperinflation as a pattern of price rises that exceed 50% per month. The inflation rate may cross over the line into technical hyperinflation within the next few months. Hyperinflation had become much rarer in the 21st century, compared to the 20th century. Venezuela’s would be the first since Zimbabwe’s hyperinflation in 2008-09 — which exceeded 79,600,000,000 % per month, rendering the Zim dollar worthless long before it was officially demonetized.

The current Venezuelan episode continues in a long tradition of gross mismanagement of their currencies by some governments, especially in Latin America and the former Soviet bloc. They have demonetized as a means of confiscating wealth from the public, in effect, and transferring it to themselves. The fundamental problem is that the government spends way beyond its means, unable to finance the spending by taxation or borrowing, and so relies on debasing the currency. The “currency reform” may be announced in the name of a program to end high inflation. But true macroeconomic reform requires fundamental measures to end the excessive printing of money and its origin in excessive primary budget deficits. Without such a true reform, the exchange of new bills for old is just one more symptom of mismanagement (along with price controls and the rationing of goods).

A very different category of demonetization entails the orderly decommissioning and replacement of bills for technical reasons. The technical reasons can range from the lack of popularity of a particular note, to the desire to honor a national hero, to a re-design of features to block counterfeiting, to more consequential – but still orderly – reforms such as a European country’s switch-over to the euro as the national currency. An example was the announcement in April by US Treasury Secretary Jack Lew that the $5, $10 and $20 bills are to be replaced with new designs that include women and civil rights leaders.

What differentiates this second category is that citizens are given enough time to trade in their old currency for the new unit. The monetary authorities plan ahead, so that they have plenty of new bills available. Nobody needs to lose out or even to wait in long lines at the bank. Lithuania is the most recent country to have joined the euro, having given up their lita in 2015. The currency transition went smoothly, as it had when the Germans traded in their marks for euros in 2002, the French their francs, and so on with the rest of the 19 countries that have joined the eurozone.

The main motive for India‘s demonetization apparently puts it into a third category, which includes what the US did in 1969, when it announced the phasing out of $500 bills and higher denominations, and what the European Central Bank commendably decided to do in May of this year with its decision to phase out the 500-euro note. In each of these cases, most of the high-denomination notes are used in illegal activities, ranging from tax evasion to corruption to drug trafficking and even terrorism. So the government stops issuing the big bills to avoid facilitating these illegal activities. Such prominent observers as Ken Rogoff, Larry Summers and Peter Sands think the US should do the same with its $100 bill.

In these cases, the phase-out period is typically long — in some cases indefinitely long, until all the existing paper notes wear out on their own. If the leaders are brave, they could set a relatively short time period, of less than a year, after which the note in question is no longer valid, and could ask tough questions of anyone trying to cash in a large quantity of the high-denomination notes. The goal would be to go beyond merely phasing out the facilitation of illegal activities in the future and to strike a strong blow against those who acquired stockpiles by engaging in such activities in the past. The need for bravery arises because some citizens would object strongly, probably ranging from survivalists to grandparents who want to give a crisp new $100 bill to a grandchild for a special occasion.

Although the discouragement of illegal activities is a motive to be applauded, the implementation in the case of India has obviously fallen short. The reform did not need be so very sudden and so very secret. Especially because the notes were relatively small (worth approximately $7 and $15, respectively) and widely used by all Indians, not just in illegal activities, the authorities should have allowed enough time to print plenty of the new notes and even to allow businesses to accomplish some of the desired switch-over to non-cash means of payment (checking accounts and electronic funds transfer).

Even with the advance warning time, those who had accumulated large wealth stashes in the form of the bills would still have lost some value – in effect a tax – if they had been unable to demonstrate to a bank that they had valid reasons for having the bills. Yes, they would still have been able to take recourse to an unofficial market in the phased-out bills, but they would have had to sell the bills at a discount. Most importantly, allowing more time would have avoided the serious inconveniencing of ordinary people and disruption to the economy that India has experienced since November.

Given the problems that it has created for ordinary Indians, why did the Modi government feel the need to launch the reform so suddenly, without time to print enough new notes? One theory is that a goal was to disrupt rival parties that use cash heavily in their campaigns, ahead of important elections in early 2017 (in the state of Uttar Pradesh). If the theory is valid, it is hardly an uplifting justification for what is supposed to be a good-government reform.

Western leaders probably do not act with sufficient boldness and bravery when they choose to phase out big bills as gradually as they do. But Prime Minister Modi acted too boldly in ending the use of medium-sized bills so abruptly.

For more information on this publication: Please contact the Belfer Communications Office
For Academic Citation: Frankel, Jeffrey.Demonetization on Five Continents.” Views on the Economy and the World, February 10, 2017,