What Can India Teach Us About Abolishing High-Value Currency?
Ever since Genghis Khan used tree bark as legal tender and backed it up by threatening anyone who didn't use it with death, governments have manipulated paper money to suit their purposes.
When India abolished its highest-value rupee notes last November, it sought to rein in hoarders of big bills who evade tax. However, the move sucked so much cash out of circulation that it destroyed the wages of millions of Indians who earn in cash, and deprived millions more of access to their money.
If it seems radical, it turns out a lot of countries have considered scrapping big bills.
But instead, he says the $100 bill has been growing as a proportion of all U.S. currency in circulation.
"And that's pretty much true across the advanced economies, where there are huge amounts of cash that's been printed but most of it in big bills," he says.
Rogoff is the author of The Curse of Cash, which makes the case for eliminating high-value currencies, including the $100 bill. A former chief economist for the International Monetary Fund, Rogoff says in the United States, more than 80 percent of the value of U.S. currency is in $100 notes, which "amounts to $3,400 for every man, woman, and child."
"We don't know," Rogoff says. "But in every major criminal and tax evasion enterprise, cash plays a big role somewhere down the line simply because it's so liquid, government sanctions it and you can use it anywhere. But there isn't really a centralized database. Most of it's unaccounted for."
Be it human smuggling, drug trafficking or fraud, illegal flows of money are estimated at more than $2 trillion a year, according to the U.N. Office on Drugs and Crime. There is no record of how much of illegal flows are constituted by big bills. But Rogoff says most large cash seizures are almost entirely composed of high denomination notes.
To combat crime, the European Central Bank is gradually phasing out the 500 euro note, nicknamed the "Bin Laden" for its use in the financing of terrorism. The EU says it's preferred by criminals for its high value and easy portability.
Bhaskar Chakravorti of The Fletcher School at Tufts University says most Europeans don't rely on the 500 euro bill to conduct legitimate business any more than Singaporeans depend on their country's S$10,000 bill, which has also been phased out.
"Those denominations are so high that generally, anybody who would have to deal with that value of a transaction would probably use a digital transfer for it," says Chakravorti.
Rogoff says eliminating high-value currency alone won't end crime, but it could disrupt the business model of the "bad guys." He says that in the U.S. it could also increase tax compliance among ordinary citizens. The small businessperson who earns income in cash and doesn't report it to the IRS represents about half the losses the government incurs thru tax evasion. Pushing money to off-shore accounts, barter exchanges and corporate shells also contribute to lost tax revenues.
Rogoff says getting rid of the $100 bill would help reduce the $500 billion that tax evasion costs the U.S. government each year.
In addition, with cash transactions dwindling in advanced economies — in the U.S., less than 10 percent of all transactions are conducted in cash — scrapping big bills results in no real hardship. However, poor countries rely on cash. "If you're a developing economy, don't try this at home," Rogoff says.
But in India, they did try it, and overnight eliminated all 500-rupee and 1,000-rupee notes. Prime Minister Narendra Modi meant this to be a swift strike at untaxed wealth, which some estimates put at $460 billion or 20 percent of GDP. But economist Deepak Nayyar says what Modi got was a nationwide cash crunch, because his gamble removed "86 percent of all cash in circulation in the economy."
Making matters worse, Rogoff says, India pulled bills "out of circulation without having the new notes to replace them." The country "eliminat[ed] their cash, and they did not do it over five to seven years, but overnight," he says.
India did replace its 500-rupee and 1,000-rupee notes with the even larger 2,000 rupee note — but didn't print enough to replace all the bills that had been eliminated. And this was the opposite of moving "in the direction of trying to have smaller notes," Rogoff says.
Moreover, the 500-rupee note that was pulled (it has since been reinstated) is not high value. Worth $7.50, it's used by just about everyone. Removing it from circulation devastated millions of workers paid in cash. It imperiled countless small Indian businesses that conduct transactions in hard currency. University of California Berkeley economist Pranab Bardhan called the exercise a "major assault on the poor."
But six weeks into the new year, a sense of normality is returning. Gone are the long queues at banks, and the acute cash shortage is subsiding. The Reserve Bank of India announced this week that restrictions on cash withdrawals would be completely lifted by mid-March.
At the height of the crisis, some Indians protested the removal of the 500- and 1,000-rupee notes. But most quietly queued for limited withdrawals at banks, willing to bear the hardship if it meant the corrupt would get a comeuppance. And with populist fervor, Modi packaged it precisely that way: He said that forcing people to exchange defunct notes for new ones would flush out the dishonest rich who stockpile "black money," income not reported to the tax authorities.
But Nayyar, the economist, says another flaw with Modi's plan is that only a small fraction of unreported wealth is actually held in cash. "More than 90 percent of such income would be held in the form of gold, real estate, foreign accounts, and so on," he says.
Assuming hoarders of black money did come out from the shadows to deposit their untaxed cash, economist Partha Mukhopadhyay says the banks lack the analytic structures to swiftly identify alleged offenders or levy taxes on their unreported money or have them prosecuted.
Mukhopadhyay, a senior fellow with the Centre for Policy Research in New Delhi, says the government could argue that it "has managed to make black wealth visible." By the same token, he says, "This is going to be a long and hard exercise."
The broad gains are political, Mukhopadhyay says — not economic. That is good news for a prime minister halfway through his term and looking to be re-elected. Modi rose to power promising to end "black money," and the public has connected the scrapping of big bank notes with hurting the corrupt.
"And as long as you can keep [people] believing that, whether it's true or not, you might have picked up very substantial brownie points ... and people might trust you to be the person to actually clean up the system," Mukhopadhyay says. But he adds that elections underway in key states will tell the story.
The government, meanwhile, says any economic impact will be transient. And the government of Australia is reported to be studying India's experiment as Canberra considers eliminating its $100 bill.
But with liquidity sucked out of the Indian market at the end of last year, car and home sales plummeted. Investments shrank. The IMF slashed India's growth rate by a full percentage point. "I just don't know what they were thinking," Rogoff says.
It appears the lesson India offers in removing high value bills is how not to do it.
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