What Happened When 1 Country Banned Cash Overnight
What would you do and how would you feel if the government decided you’re no longer allowed to use cash? While many of us use mobile payment systems or debit cards in lieu of paper money these days, we all still use it frequently. You probably have several bills in your wallet or purse right now. So, if the Trump administration (or any other) came out and said it was scrapping cash, you’d probably be angry — and worried.
But mostly, you’d just be confused. Why would the U.S. government, or any government, want to get rid of cash? After all, paper and coin-based money systems have been in place since the dawn of human civilization. Currency helped us grow economies and build modern nations.
Yet, that isn’t stopping one of the world’s largest and most important countries from effectively banning it. India, the second most populous country in the world, has pulled the plug on cash.
We’ll get into the how, why, and when on the following pages and ultimately discuss whether India managed to accomplish what it hoped to. But what you need to know, to start, is this is a largely unprecedented move. Despite our modern reliance on credit, debit, and mobile payment systems, cash is still the king in many respects. You can use cash when the power goes out and to buy things off the street. It’s universal and hard, if not impossible, to track.
So why did Prime Minister Narendra Modi trash India’s cash? And how did it turn out? To give you a hint, it hasn’t been a smooth transition.
India goes ‘cashless’
- India’s 1.3 billion people were told certain paper bills would be worthless come 2017.
Modi’s government’s primary motivation in banning cash was to weed out corruption and tax evasion. The logic was that most skeezy behavior is facilitated through cash transactions. To stamp out that type of behavior, you can remove cash from the equation. Suddenly, things are more transparent, and people will be less inclined to engage in corrupt, criminal behavior.
As such, a new system would need to be put in place.
A revised financial system
- Modi’s plan got rid of 500 and 1,000 rupee bills, worth roughly $7.50 and $15 USD.
Indians were required to go to banks and turn in their old bills so as to not see their wealth evaporate. In place of these bills, a new system was instituted. The market was flooded with bigger, newer, and redesigned bills — worth 500 and 2,000 rupees. So Modi didn’t actually end all cash, just the old 500 and 1,000 rupee bills. This demonetization of government bills happened overnight — literally — when Modi announced it on Nov. 8, 2016. People had to rush to banks to exchange bills, which caused mayhem.
So what was Modi’s main goal in demonetization?
The new system’s goal
- According to the Reserve Bank of India, 86% of the country’s cash has been effectively banned.
As mentioned, the primary motivations behind Modi’s plan were to make currency easier to track. This, in turn, would cut off criminals (who operate with smaller bills), stop financing to terrorists, and root out corruption. But there’s another important piece to Modi’s plan. Above all, Modi wanted to force people to move “black money” — large swaths of untaxed money — back into the system.
As it turns out, banning cash overnight isn’t easy. Who would’ve thought?
Let the great experiment begin
- The demonetization plan was in motion for months, but only 10 people knew about it.
After the new plan was announced, people rushed to banks and ATMs to exchange their bills. Indian stocks crashed. There were severe shortages of cash, and many aspects of the Indian economy were thrown into chaos. Again, this all happened pretty much overnight with no advance warning. Modi himself warned there would be a lot of problems for the following 50 days. That, as it turns out, was an understatement.
Next, we look at the fallout of the cash kibosh.
So, what happened?
- 25 people were killed as a result of demonetization within the first six days.
India’s economy is heavily cash-dependent — much more so than the United States. So, demonetization caused huge problems, especially given that the country is still developing, and many of the nation’s poor don’t have access to mobile payment systems. All told, though, the plan seems to have been at least somewhat successful. Many Indians, even poor ones, have expressed support for Modi’s change, citing the need to widen the tax base and root out corruption.
That’s not to say there weren’t some unexpected consequences though.
The expected and unexpected
- About $15 trillion in demonetized bills have been returned.
There were some definite bumps in the road, but that was expected. For one, ATMs needed to be retrofitted to be able to dispense the new bills. Withdrawal limits also had to be implemented to ensure there were no more cash shortages. All told, however, 97% of the demonetized notes have made it back to banks. It’s hard to say what, exactly, Modi’s government was expecting to happen as a result, but now that we’re many months removed from his proclamation, things seem to be settling down.
But there were some clear victims hit the hardest: the poor. Possibly the biggest unseen outcome is that India’s economic forecast has been downgraded. Previously, it had been growing at more than 7%. This hiccup might have cost the country significant momentum.
Finally, what can be learned from the Indian experiment?
Lessons for the rest of the world
Although it’s hard to imagine the American government — or any other, for that matter — suddenly deciding that 86% of the nation’s cash would be worthless, the world can be unpredictable. Nobody saw Brexit coming, for example, or the election of Donald Trump. Still, India’s “trash the cash” experiment shows what happens when a country takes rather extreme measures to deal with some underlying issues, including untaxed cash hoards, corruption, and money laundering.
At the end of the day, Modi’s experiment might pay off. The Indian government might weed out some issues having to do with corruption and widen the tax base a bit. But the cost was big. People died, and India lost economic momentum.