Author:Luther, William J.

ON THE EVENING of November 2016, Indian Prime Minister Narendra Modi announced that 500-rupee notes (valued at about $8) and 1,000-rupee notes would become "worthless pieces of paper" at midnight, no longer recognized as legal tender. The stated goal of his demonetization plan: to catch criminals. The government offered a brief window in which old notes could be swapped for new ones, with the idea that everyone from human traffickers to tax cheats would have to show up at banks with vast sums of money and confess their sins or lose the value of their cash holdings altogether.

The costs of this scheme were large. At the time of the announcement, demonetized notes accounted for 86 percent of all currency in circulation. As George Mason economist Lawrence H. White has written, "A serious currency shortage immediately arose, with predictable consequences. Honest wage laborers in the huge cash economy went unpaid, honest construction projects came to a standstill, honest shopkeepers saw sales dry up, and honest businesses failed. Honest people wasted billions of hours waiting in queues to exchange old notes for the trickle of new notes."

Growth in the country's gross domestic product fell from an annualized rate of 7.37 percent in the quarter prior to the announcement to an average annualized rate of 6.06 percent in the first three quarters of 2017.

What's more, the program utterly failed to impose a levy on those conducting business in the underground economy. Lawbreakers did not find themselves stuck with worthless notes. Instead, the Reserve Bank of India reports that 98.96 percent of all demonetized notes were turned in during the months following the announcement. That is on par with redemption rates in Italy (99.15 percent) and France (98.77 percent) following the introduction of the euro--and in those cases users were given 10 years to convert their old money.

The Indian experiment was a failure. Yet a group of politicians, academics, and do-gooders continues to dream about a cashless world where black markets would shrink and tax coffers would grow.


IN HIS 2016 book The Curse of Cash (Princeton), Harvard economist Kenneth S. Rogoff makes what is arguably the best case for demonetization in America. He estimates that more than a third of all U.S. currency in circulation is used by criminals and tax cheats in the domestic economy and suggests the proportion is even higher for large denomination notes. Rogoff concedes that "crime will continue with or without cash, but for very good reasons, cash is a medium of exchange highly favored by the underground economy, and the underground economy accounts for a significant share of the demand for cash."

Rogoff proposes eliminating $100 and $50 bills immediately. He claims few people use such large denominations in the domestic legal economy. As long as those who do are able to switch to lower denominations at little cost--and he says they would be--such a policy would be minimally disruptive.

But it doesn't stop there: In Rogoffs scheme, most lower denomination notes also must go. This would take place over a much longer period, a decade or more. To promote the transition, the government might subsidize deposit accounts--perhaps through rebates to customers or direct payments to financial institutions--or require all paychecks to come via direct deposits. The smallest denomination notes could be left in circulation or, better still, replaced with coins--which are much heavier and hence less convenient for large transactions--to leave some limited scope for financial privacy.

This proposal promises to deliver significant gains from reducing crime and tax evasion while imposing few costs on those operating in the legal domestic economy. Who wouldn't want that? Indeed, the idea has launched a formidable coalition in the Better Than Cash Alliance, with the...

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