On Tuesday evening, Prime Minister Narendra Modi made an announcement that 500 and 1000 rupee notes will cease to be legal tender. While the 500 rupee notes were reintroduced with a different design on Thursday, the new 1,000 rupee notes will be issued sometime later.
Let us look at the justifications the government has given for this action and how valid these justifications are.
1. To Combat Terrorism
The government of Pakistan is supposedly using fake notes to fund terrorism, particularly in the Kashmir Valley. By removing high denomination notes, Modi is supposedly making it more difficult for them.
What are the facts? Pakistan gets hundreds of millions of dollars in foreign aid from the US and in larger part from China. There is nothing to prevent them from using that money to legally buy Rupees in the foreign exchange market and funding terrorism.
Douglas French, a brilliant economist, writes how the European Central Bank used this very same excuse to stop printing 500 Euro notes. The real reason was that it would render more transactions cashless, thus helping the Central Bank keep negative interest rates, which would not be possible if cash is used.
Moreover, the real problem is not Pakistan. I had explained in an earlier article, how the Indian government is responsible for the violence in Kashmir due to its bad economic policies, which keep Kashmir economically isolated from the rest of the country.
2. To Fight Corruption and Tax Evasion
This one makes sense on a superficial level. If people have a lot of black money stashed in their homes, it will be rendered worthless by this move. The problem is that a lot of black money is not in the form of cash.
Does Modi honestly believe that people keep thousands of crores of rupees under their mattress? Do politicians physically steal cash when they perform a scam? They do not.
The fact is that large corporations evade taxes by hiring armies of accountants. Some of their methods are legal, and others illegal. But the common thing is that none of the CEOs or shareholders keep piles of cash at home. Far better to close the tax loopholes to fight corporate tax evasion.
Politicians do not use physical cash in scams. They use sophisticated “creative accounting” so that the scam is not discovered until long after the theft is done.
What about low-level corruption? Many people use cash to bribe their way into government colleges or to secure government jobs (remember Vyapam scam), or to get around red tape.
Now the obvious and effective way to deal with that is not to get rid of cash, but to reduce the size of government.
Privatise the colleges and cut down on the bureaucracy. If government officials have no power and authority, there will be no reason to bribe them.
3. Keeping Inflation Under Control
By far the most ridiculous excuse. A government official says that this move will reduce conspicuous consumption, which (according to him) results in inflation. That’s nonsense.
Consumers do not cause inflation. Inflation is made in one place and one place only. It is at the RBI; where money is printed. If printed in excess, it causes inflation.
The Real Reason for the War on Cash
Jaitley says that this move will push India towards being a cashless economy. I agree. But is that a good thing? Will it benefit the economy? I don’t think so. Let me explain why.
This government, like all those before it, is fiscally irresponsible. It spends every single rupee that it collects in tax revenue, plus a bit more.
Now that “bit more” has a limit. It comes from either printing money (which will cause inflation) or borrowing (which is limited by demand for government bonds). Therefore, the deficit cannot be indefinite.
Where and why does government want to spend? It wants to spend on populist schemes like subsidies and freebies, so that it can get re-elected. That is a wasteful use of taxpayer’s money.
A cashless economy would mean that every transaction would go through the banks, and be monitored by the government. This would help it increase tax revenue and, by extension, spending on wasteful populist schemes.
The Implications
Since government would be spending an ever larger portion of our money, it would create a drag on the economy. It would slow down private investment, which would dampen production and job creation.
Numerous studies have shown that economies with a large public sector (and small private sector) grow more slowly.
India was like that before 1991, and we don’t want to return to those circumstances. Russia, Venezuela, Cuba, North Korea; all countries that have poor economic performance have a large share of government spending.
This government control over India’s economy is already too much. The total government spending; central, state and local is around 27% of GDP. This is way higher than the ideal maximum limit of 10% which the great economist Milton Friedman recommended.
Moreover, it is a blatant attack on privacy. I for one do not want the government to know how, when and where I spend my hard earned money.
Preserving Economic Freedom
Now a few questions arise. How do we as people preserve our economic freedom? How do we ensure that as much of our wealth as possible remains in our private hands? How do we ensure economic growth for us and the future generations? How do we ensure that government cannot monitor our transactions and invade our privacy?
One interesting alternative to Rupees is Bitcoin, the famous digital currency. It helps conduct transactions anonymously, the government cannot monitor it.
As a result of this announcement, the price of one Bitcoin jumped to Rs 48,665, up from Rs 46,963 12 hours earlier. People are using Bitcoins to protect their privacy.
In case anyone thinks I am advocating something illegal, I am not. Bitcoin is fully legal. Numerous legal goods and services are sold worldwide everyday using Bitcoins, including India.
Does it help avoid taxes? In a way. You pay taxes on Bitcoin only when you sell it for a profit, since there are capital gains involved. But if you sell some goods for Bitcoin, and use it to buy other goods, there is no tax since government does not recognise it as legal tender.
If the war on cash continues, entrepreneurs will come up with numerous ways to help people avoid taxes, such as alternative currencies, accounting services to find tax loopholes and so on. And that might not be such a bad thing.
It is not a crime to arrange our business in a manner such that we pay as little tax as possible.
Indeed, it is a sacred duty of each and every citizen to ensure that government gets to spend as little as possible, that it stays as small as possible. That is the only way we can preserve our economic freedom and ensure a better life for ourselves, our families, and the future generations.
(Jairaj Devadiga is an economist who looks for simple solutions to the complicated problems that ail our society. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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