India’s government may have initiated the biggest economic change in decades while the world’s attention was diverted by the American presidential circus. On November 8, 2016, Prime Minister Narenda Modi announced that all 500 and 1,000 rupee bills would be withdrawn from circulation at midnight.
This marks a paradigm shift in India’s economy because it is essentially an effort to force Indians to adopt the kind of electronic currency already widely used in the United States and Europe. The bills withdrawn were the largest denomination banknotes issued in India.
Yanking the bills is designed to reduce tax evasion, corruption and the black market. It is also an attempt to limit terrorism and organized crime because large bills are widely used to fund those activities. They are also easy to counterfeit, which is a major problem in India.
Dragging India into the Digital Age
Another reason for the shift is to force Indians into the modern banking system whether they want to join it or not. Many middle class Indians conduct all their business in cash, and use gold or jewelry hidden in a safe as their “retirement plan.”
The Prime Minister hopes to get that money into the stock or bond markets where it can fuel the economy, or into bank accounts where it can be taxed. The idea behind Modi’s action is that forcing people to use smaller bills will drive them to use electronic payments.
Modi is trying to drag India into the 21st Century and the digital age. He wants to make integration with the global economy easier and to facilitate the development of trading markets. Such drastic actions are needed because the average Indian makes $4.09 a day.
Bitcoin Proves Modi’s Strategy is partially working
Mr. Modi’s strategy may backfire by driving educated Indians to turn to bitcoin and other digital currencies. Online searches for information about bitcoin in India increased by 20% to 30% after Modi’s announcement, The Hindustan Times reported.
Around 100,000 people in India also downloaded the bitcoin exchange app Zebpay to their smartphones, CNBC reported. That means Modi is succeeding in his efforts to get Indians to embrace electronic money transfer. The only problem is that they may bypass the banking system and move straight to cryptocurrency.
That might create a real problem in India by creating a two tiered economy in which the poor – the vast majority of the people are stuck with the government currency. Meanwhile the rich; and increasingly the middle class, use bitcoin and shut the common man out of the economy. That sounds like a recipe for class warfare and luddite reactions to me.
The War on Cash has begun
Mr. Modi’s action is putting a popular idea in modern economic thought to real world test. Proposals to abolish paper money and replace it with some sort of digital currency are common in modern economic thought.
Former International Monetary Fund Chief Economist Kenneth S. Rogoff recently published a book called The Curse of Cash in which he recommended that governments abolish paper money. Rogoff’s thesis sounds a great deal like the arguments Modi put forward when he announced the demise of the 500 and 1,000 rupee notes.
Rogoff argued the paper currency should be abolished because it facilitates organized crime, drug smuggling, tax evasion, prostitution, counterfeiting and other nefarious activities. On November 8, Modi did much the same thing and even wrapped his argument in the flag by noting that Islamic terrorists attacking India finance their activities with counterfeiting.
Whether Modi plans to implement all of Rogoff’s is unclear at this point. Rogoff wants governments to slowly phase out cash beginning with large bills and replace all small bills with coins.
Will America Abolish Cash?
The response to Modi’s action will show us whether the abolition of paper currency is politically viable. If the action does not hurt Modi’s Bharatiya Janata Party (BJP) at the polls expect politicians in other countries, including our friend Mr. Trump to follow suit.
Modi is probably the closest individual to Trump politically among the world’s leaders. His BJP promotes a radical nationalist ideology reminiscent of Trump’s that emphasizes economic growth. That means there is a strong possibility Trump may follow suit and try to scrap the $100, $50, and $20 bills in the United States at some point.
My guess is that law enforcement organizations like the Drug Enforcement Agency (DEA); and tax collectors the IRS,would like to get rid of $100 and $50 bills because it would make their jobs a lot easier. Few $100 or $50 bills circulate in the United States; instead most of them go outside the country where they end up in gangster’s safes or in mattresses.
Trump would find political support for any effort to abolish cash from law enforcement and police unions some of which endorsed his presidential bid. Whether such support would enable him to get such a measure passed by Congress is unclear at this point. Nor do we know what public reaction would be, even though most Americans rarely see large bills, the idea of cash is popular.
How should Investors React to the Demise of Cash
Whether Modi’s action is the beginning of a slow phase out of cash, remains to be seen. Yet it looks like part of a trend that includes at least other major economy.
The European Union has stopped printing the €500 note which has long been a favorite medium of exchange among bad guys. The Union is still printing €100 and €200 notes; so large denomination currency will be part of the continent’s landscape for a longtime to come.
The best way for investors to cash in on the end of cash is to invest in Bitcoins and other cryptocurrencies. As talk of scrapping cash spreads, more money will spread into such mediums and increase their value. Digital currency will be the perfect hedge against moves to scrap cash.
Another interesting investment might be bank issued digital currencies like Citigroup’s (NYSE: C) proposed Citcoin and Goldman Sachs’ (NYSE: GS) SETLCoin. There’s also ICAP, a digital currency UBS, Deutsche Bank (NYSE: DB), Santander and BNY Mellon plan to roll out in 2018.
One investment I would be leery of is gold, Modi’s move should produce a short lived increased in demand for the metal. Yet it might lead to a long term fall in demand, because India is the world’s largest market for gold. If large numbers of Indians start putting their cash in Bitcoin the demand for gold might fall.
Investors need to pay close attention to what’s happening in India, because it might mark the beginning of the biggest paradigm shift in money since paper currency appeared. Those who pay close attention will profit, many others will be caught off guard; and find themselves stuck with a mattress full of worthless paper.