Demonetization
The process of depriving a currency unit of its monetary status
What is Demonetization?
Demonetization is the process of depriving a currency unit of its monetary status. It happens when a country partially or wholly replaces its currency with a new form of money.
Sometimes a government may replace it with either new notes or coins of the same kind or a new currency altogether. The specific currency unit could not be used to buy products or services or pay taxes or debts.
It is often considered a drastic intervention in the country's economy as it includes eliminating the lawful delicate status of the money and can influence the everyday business exercises in the economy.
Assuming the process turns out badly, it can cause confusion or a genuine decline in an economy. The possibilities of this incident are much more when it is declared out of nowhere, with no earlier advance notice.
The interaction inverse to demonetization is called remonetization which alludes to the demonstration of reestablishing an installment structure as a legitimate delicacy.
Demonetization is frequently accepted to carry steadiness to a nation's currency and utilized as a device to fight inflation, expand trade, and give the economy superior access to the market.
This will permit it to drive normal monetary exercises that produce direct results and move them away from black markets.
Understanding Demonetization
It occurs when the old money is closed, and the new currency is released. It is made public by the initial announcement and given a period for transitioning where people are allowed to switch old currency units for new currency units.
However, there may be specified limits. It is a rare, dramatic, and often disruptive action. Sometimes it happens because the new payment standard can become the primary currency.
As in our current days, cryptocurrencies are gaining popularity, and maybe in the future, paper currencies would be used less. This hypothetical use of cryptocurrencies instead of paper currencies can be termed the demonetization of paper currency.
Having a well-established currency system is needed for a country's economy to run efficiently.
The purpose of using it by a country is to get the old, worthless currency out of circulation. It occurs when a government declares that a currency no longer has worth.
It will stop further issuance of some or whole of the money it prints. The authorities replace the demonetized currency with either coins or notes of the same currency or a new currency altogether.
These measures can be taken due to events like:
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hyperinflation or monetary devaluation,
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the increased circulation of counterfeit currency,
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tax evasion, or
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the creation of economic and political unions.
Another benefit of the process is to counter the hoarding behavior of individuals towards money because if the money is not pumped back into the economy, it ceases to grow. When people keep a huge amount of money as savings, it acts as a leakage in the money flow.
If such a measure is not used, there is a huge chance of money circulation either by spending it or trying to save it in a bank.
The economic cost of these processes can be huge but there are many concerns regarding it, one of them being the transaction cost at the initial stage of it.
If the transition is longer like the European Union did when the Euro was introduced, the cost can be minimized. But if the period is short like In India, the cost can be higher.
One of the reasons being the majority of the Indian population had kept the money in hand rather than in financial institutions. There was social unrest and a lack of productivity in India, especially in rural areas of India.
Demonetization Example
The Coinage Act of 1873 or Mint Act of 1873 was a general revision of the laws relating to the United States Mint. It ended the right of silver bullion holders to have it coined into standard silver dollars while allowing gold holders to make money, leading this act to controversial results and has been called the "Crime of 73".
In 2002, the cash changeover 2002 was a significant event in Europe's history and a major technical achievement.
On 1 January 2002, euro banknotes and coins were introduced in 12 countries representing 308 million inhabitants in Europe.
It was the world's largest-ever monetary changeover, involving the banking sector, security carriers, retailers, the cash-operated machine industry, and, of course, the general public.
By 3 January, 96% of all cash dispensers in the euro area were issuing euro banknotes. At that time, more than 6 billion banknotes and nearly 30 billion national coins had been withdrawn.
In 2016, Indians had a surprise announcement that the larger denominations of 500 and 1000 had lost their legal tender.
This move was made to end corruption and fight the flow of black money. And new notes of 500 and 2000 were introduced, and the government promoted the use of cashless transactions in the economy.
The Reserve Bank of India 2017 delivered its report on demonetization; it said the vast majority of the restricted notes returned into the financial framework, which throws out all allegations of black money and counterfeit currency.
With close to 99 percent cash back in the framework, the disappointment hints at two things:
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The black money held in real money was extremely low, or
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The public authority neglected to carry out the demonetization productively. All the black money was held in Rs. 500 and Rs. 1000 certified receipts washed back to the financial institutions.
The demonetization of 2016 on the Venezuelan economy for achieving economic, monetary, and price stability, eliminating the smuggling of banknotes, achieving a higher level of efficiency and quality in government management, and eliminating the laundering of bolívares was brutal.
This policy's main effect was the shortage of cash because of the outflow of 77% of the circulating money in the country.
Another effect was the reduction in consumption due to the shortage of cash. Sectors such as transport and marketing of agricultural products and food saw a decline in sales in the initial days of the exit of 100 notes.
Advantages of Demonetization
There are several advantages when a country demonetizes its currency. A few of the merits are:
1. Increased Savings in Financial Institutions
As a result, people started to save more and deposit it at the bank rather than keeping it by hand. Saving it in a bank or financial institution can create transparency and accountability for the money.
1. Better economy
When there are more cash flows, the economy grows. The people move their cash to banks and other financial institutions, and the flow of money is increased, leading to a better economy.
There would be more taxes to be paid, and the government would be able to fund more development using these projects, leading to an effective economy.
2. Lower lending rates
When the money is demonetized, and the flow of cash is increased, it leads to a better economy and decreased lending rates. These lower lending rates are because of the lower cost of funds.
While everything is constant, the country's money supply and interest rate are inversely related, making it more expensive to borrow or less expensive, which states that more cash flow with less rate of interest and vice-versa.
3. Curbing anti-social activities
Most anti-social activities are conducted through cash because it is difficult to trace them back to their origin.
One of the main reasons for India's demonetization is to curb black money and counterfeited money. So by these processes, most illegal activities try to get rid of the unaccountable cash, leading to a better economy.
4. Promote digital transaction
One of the best ways to help the government for more visibility of transactions is to use digital transactions. So the tax evasion and use of unaccounted money can be more transparent.
Disadvantages of Demonetization
On the other hand, the main disadvantages are:
1. Inconvenient for common people
It can make a significant burden on individuals in a country. If such an event occurs anytime the public authority decides to eliminate banknotes from cash yet keep the others, it may be tough and burdensome for people.
Assume that when more modest coins are being taken out from the money course, and banks neglect to give little changes, it can bother the vast majority to store or trade cash in many banks.
The monetary development in a nation can confront a time of all-out gridlock because of unsettling business influences or any such issues, to some extent in the initial period after the execution of the process.
Monetary development will encounter a time of respite because of business interruptions, to some extent for the short term.
2. Disruption and Difficulty in bill payment
Assuming somebody has sent some banknotes in the post to take care of a bill, or on the other hand, there is any significant delay, and demonetization hits, meanwhile, the cash put away to cover the bill can become invalid.
This is more normal than you could think in exceptionally administrative frameworks.
The typical exchanging exercises might be disturbed by this cycle since it requires investment for purchasers and providers to conform to the new financial approach.
3. Short-term economic crisis for the poor
Assuming that the recent transformation failed to accomplish its points, it will bring about a monetary crisis for the poor in the country.
Minute changes in the condition of ordinary things or disarray about the legitimacy of the ongoing cash can represent a ton of difficulties and frenzy among the unfortunate residents in the country.
Assuming that individuals take on other cash and this money is certainly not effective, then, at that point, it can cause a monetary emergency for every individual involved.
Indeed, even a slight change in the worth of ordinary things or even a limited quantity of disarray about whether money is legitimate can mean a great deal of difficulty.
In that capacity, demonetization can increment and compound imbalances inside the society for the time being.
4. Costly to print more money and circulate it.
The expenses associated with producing new banknotes and coins and ending the use of old money are some of the early downsides.
The Government needs to modify all the ways that make the recently embraced monetary standards accessible to individuals. It will bring about additional expenses for banks and inconvenience bank clients.
ATMs must be re-adjusted to oblige to the new monetary standards. As a result, it will bring about extra expenses for banks and other clients.
Conclusion
This is an old practice in the world; governments around the world have been making these decisions for ages.
However, the demonetized currency may vary. The objective is to combat inflation, and black money, curb illegal activities, get fake currency out of the economy, and get a clear picture of money for taxation.
The decision to make it work would have been difficult for the nation's common people, but it was necessary. It is a simple process to fight back against several key points even though it has some demerits that may seem unfavorable in various ways.
However, before any process that can affect the economy is carried out, it should be carefully thought through, and its impact on the common people and below poverty line citizens should be considered.
In this way, it can be a chance for a fresh new start, or it can be something that causes a burden for a country.
Though illegal cash hoarding constitutes only a small fraction of black money as compared to other forms of real estate & gold, if such a step is taken by the Government, it should be well-planned initially.
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