Demonetization

Demonetization, in layman’s terms, is the eviction of a particular currency/tender present in the economy from circulation and thus replacing the same with a new currency which may aim for several outcomes like the corruption-free economy, black money removal, controlling inflation, stopping funding of illegal activity, etc.

Demonetization is a radical and positive step a government takes to improve the economy/country. However, it should also be appropriately implemented and planned to avoid hassles to the common public and severe economic harm.

• Demonetization involves the removal of specific currency or tender from circulation and replacing it with a new currency, often aimed at achieving goals like a corruption-free economy, curbing black money, controlling inflation, and disrupting illegal funding activities.
• The primary focus of demonetization is to target black money in circulation, leaving those who hold such wealth in other assets like gold, real estate, or land relatively unaffected by the policy.
• While demonetization can be a comprehensive and positive government measure to boost the economy, it requires careful planning and implementation to avoid inconveniencing the general public and causing severe economic disruptions.

Currency demonetization refers to the process in which the old notes and coins being used for a currency in an economy is replaced by new ones. Sometimes a country may also replace the currency entirely with a new one. No doubt is initially creates a lot of disturbance and deterioration in the economy, but in the long run people accept it.

In the long run, it brings tranparancy in the market, helps in controlling inflation and any illegal financial activity.  The main result is measured by how the common person or the general people look at it and adapt to it.

However, it is generally seen that governments or leaders from all over the world who have tried demonetization failed to see their big dream concretely. In a process to punish the part of the society involved in illegal activities, the government ended up causing trouble or inconveniences to people who were compliant thoroughly. Saying so also doesn’t mean there were no positive impacts. A similar scenario was observed with the recent demonetization India faced.  But problem and chaos is a part of the process since the actual medium of exchange is being affected suddenly. However, it does not mean there is a demonetization failure because it has quite a number of positive effects in the long run.

Example #1

The U.S. demonetized all notes above $100 on July 14, 1969, which positively affected the economy. It was primarily aimed at eradicating the black money present in the system, and all highly acclaimed the move. However, this decision can sometimes be also linked to the evolution of the U.S. Banking system.

Example #2

Considering the recent currency demonetization in India, the country's central bank or reserve bank of India stated that though it was announced where tenders of 500 and 1000 were declared as banned and were asked to get it exchanged by new tenders, it was not as beneficial as almost all the old tenders were deposited or either exchanged with the new tenders. Therefore, the estimated figure is 99%, or around $238.7 billion.

It meant that corrupt individuals and people in business who held the illicit wealth managed to safeguard it. The only benefits of demonetization was the investigation of close to 1.8 million bank accounts involving a sudden huge volume of transactions and numerous individuals who were questioned to identify and tax the black money.

• This policy aims to make the country corruption-free. The individuals who are used to taking bribes to limit their activity as they are scared to justify the unaccounted cash and can easily come under the limelight of taxation authorities.
• It helps the country's government track the source of black money. In addition, it will help them to tax the person for unaccounted income. In India, for example, PAN (Permanent Account Number) is mandatory for any high-value deposits made. Thus, this income tax authority can easily get hold of a person exchanging or depositing a lot of cash during demonetization.
• This policy also stops funding illegal activities like terrorism, human trafficking, money laundering, etc. These illegal activities survive on unaccounted money, and bringing about such radical monetary policies will halt them. This ultimately makes the society become safer, more transparent and helps in easy detection and prevention of fraud.
• The maximum positive effect of demonetization can be seen in the stoppage of the circulation of fake currencies. Most of the fake currencies usually exist in the form of high-value tenders, and this takes the biggest hit.
• The reasons for demonetization also includes bringing about a habit of going cashless and adopting digital forms of payment which are very demanding these days. It reducing the burden of carrying and paying using cash, which saves time and increases efficiency.  
• Banks offer lower lending rates because the money flows from public hands to banks. As a result, they are better positioned to manage the liquidity, which means lower cost of funds and thus lower lending rates.
• It also brings about savings as people tend to deposit the money in their bank account rather than keeping it in physical form.

Let us understand the benefits of demonetization.

• When people consider the short-term benefit of such policies, they are really in scarcity, but on the contrary, when one analyzes the long-term impact, they are in plenty. Generally, industrial sectors like FMCG, real estate, constructions, etc., which are greatly dependent on cash, initially take the hit. Still, parallelly, increased government spending and enhanced financial inclusion will boost the economy over a prolonged time.
• The reasons for demonetization is more directed to the removal of black money in circulation. Thus, people holding the same in other forms of assets like gold, real estate, land, etc., are generally not victims of this policy and get away with it.
• Terrorist activities come down drastically. This positively impacts the country.
• The country has taxed several unaccounted cash holders and audited numerous bank accounts, which ultimately ended up for the boon of the country. It is up to the people to understand this trade-off positively or vice versa

• Abolishing old currency notes and replacing them with newer ones increased printing costs. It is generally borne by the government of a particular country or economy.
• The initial chaos that it creates is massive. The entire nation has to reach the bank, which is limited in number to handle the population, thus resulting in long queues, wastage of productive hours, and temporary losses to small businesses.
• Many people have to suffer from issues like non-payment of wages or timely payment because even companies struggle to manage their daily required cash for operations. . It leads to discontent, problem meeting daily needs and chaos among daily wage earners.
• At times, the overall economy may face cash crunch or liquidity problems because people speculate that there may be no cash in the market and thus start holding it back with themselves.
• Spending power comes down during such phases, and people tend to spend less, and businesses suffer losses. All people cannot get hold of the new physical money within a very short time or switch to cashless payment, reducing spending.
• The cashless facility may not always work since not all vendors are equipped with the right technology and infrastructure, thus creating many problems even in buying simple consumables. Small retailers or shops may not have the online facility and sudden change in payment system affect their small business.
• It slows down the economy as black money plays a big role in inflating GDP. Thus, due to sudden withdrawal of the black money, the actual GDP figure, which might be quite less, comes into light and the economy growth slows down.

Such disadvantages may lead to demonetization failure if a nation implements it and does not have proper and efficient control system in place to manage the situation.

This has been a guide to Demonetization and its meaning. We explain its impact, advantages and disadvantages along with examples. You can learn more about financing from the following articles –

• Neutrality of Money
• Fiat Money Definition
• Quantity Theory of Money
• Formula of Money Multiplier