Category Archives: monetary policy

Demonetization on Five Continents

Share Button

Several countries are undergoing “demonetization” or currency reforms in which the government recalls bills of particular denomination that are circulation and replaces them with new notes. Some of these initiatives are going better than others.

India is still reeling from the consequences of Prime Minister Modi’s announcement on November 8 that 500- and 1000-rupee denomination bills, which constitute 86 % of the cash in circulation, could no longer be used and that residents have until the end of December to turn them in. They have been waiting in long lines, only to find in many cases that the banks have not received enough of the new currency to make the exchange. Some businesses are unable to operate. India’s experiment is unique in that it combines mostly benign motives – a crackdown on illegal activities – with an abrupt implementation that has inflicted unnecessarily high costs on the economy.

Demonetizations fall into several widely different categories. The most dramatic and disruptive episodes are usually signposts on the highway to hyperinflation. Venezuela’s President Maduro on December 11 announced a recall of the 100-bolivar note, creating chaos by giving residents only 10 days to make the exchange into new higher-denomination-notes (500-bolivar notes and higher, up to 20,000 bolivars).

Venezuela will almost certainly be in hyperinflation in 2017. Economists generally define hyperinflation as a pattern of price rises that exceed 50% per month. The inflation rate may cross over the line into technical hyperinflation within the next few months. Hyperinflation had become much rarer in the 21st century, compared to the 20th century. Venezuela’s would be the first since Zimbabwe’s hyperinflation in 2008-09 — which exceeded 79,600,000,000 % per month, rendering the Zim dollar worthless long before it was officially demonetized.

The current Venezuelan episode continues in a long tradition of gross mismanagement of their currencies by some governments, especially in Latin America and the former Soviet bloc. They have demonetized as a means of confiscating wealth from the public, in effect, and transferring it to themselves. The fundamental problem is that the government spends way beyond its means, unable to finance the spending by taxation or borrowing, and so relies on debasing the currency. The “currency reform” may be announced in the name of a program to end high inflation. But true macroeconomic reform requires fundamental measures to end the excessive printing of money and its origin in excessive primary budget deficits. Without such a true reform, the exchange of new bills for old is just one more symptom of mismanagement (along with price controls and the rationing of goods).

A very different category of demonetization entails the orderly decommissioning and replacement of bills for technical reasons. The technical reasons can range from the lack of popularity of a particular note, to the desire to honor a national hero, to a re-design of features to block counterfeiting, to more consequential – but still orderly – reforms such as a European country’s switch-over to the euro as the national currency. An example was the announcement in April by US Treasury Secretary Jack Lew that the $5, $10 and $20 bills are to be replaced with new designs that include women and civil rights leaders.

What differentiates this second category is that citizens are given enough time to trade in their old currency for the new unit. The monetary authorities plan ahead, so that they have plenty of new bills available. Nobody needs to lose out or even to wait in long lines at the bank. Lithuania is the most recent country to have joined the euro, having given up their lita in 2015. The currency transition went smoothly, as it had when the Germans traded in their marks for euros in 2002, the French their francs, and so on with the rest of the 19 countries that have joined the eurozone.

The main motive for India‘s demonetization apparently puts it into a third category, which includes what the US did in 1969, when it announced the phasing out of $500 bills and higher denominations, and what the European Central Bank commendably decided to do in May of this year with its decision to phase out the 500-euro note. In each of these cases, most of the high-denomination notes are used in illegal activities, ranging from tax evasion to corruption to drug trafficking and even terrorism. So the government stops issuing the big bills to avoid facilitating these illegal activities. Such prominent observers as Ken Rogoff, Larry Summers and Peter Sands think the US should do the same with its $100 bill.

In these cases, the phase-out period is typically long — in some cases indefinitely long, until all the existing paper notes wear out on their own. If the leaders are brave, they could set a relatively short time period, of less than a year, after which the note in question is no longer valid, and could ask tough questions of anyone trying to cash in a large quantity of the high-denomination notes. The goal would be to go beyond merely phasing out the facilitation of illegal activities in the future and to strike a strong blow against those who acquired stockpiles by engaging in such activities in the past. The need for bravery arises because some citizens would object strongly, probably ranging from survivalists to grandparents who want to give a crisp new $100 bill to a grandchild for a special occasion.

Although the discouragement of illegal activities is a motive to be applauded, the implementation in the case of India has obviously fallen short. The reform did not need be so very sudden and so very secret. Especially because the notes were relatively small (worth approximately $7 and $15, respectively) and widely used by all Indians, not just in illegal activities, the authorities should have allowed enough time to print plenty of the new notes and even to allow businesses to accomplish some of the desired switch-over to non-cash means of payment (checking accounts and electronic funds transfer).

Even with the advance warning time, those who had accumulated large wealth stashes in the form of the bills would still have lost some value – in effect a tax – if they had been unable to demonstrate to a bank that they had valid reasons for having the bills. Yes, they would still have been able to take recourse to an unofficial market in the phased-out bills, but they would have had to sell the bills at a discount. Most importantly, allowing more time would have avoided the serious inconveniencing of ordinary people and disruption to the economy that India has experienced since November.

Given the problems that it has created for ordinary Indians, why did the Modi government feel the need to launch the reform so suddenly, without time to print enough new notes? One theory is that a goal was to disrupt rival parties that use cash heavily in their campaigns, ahead of important elections in early 2017 (in the state of Uttar Pradesh). If the theory is valid, it is hardly an uplifting justification for what is supposed to be a good-government reform.

Western leaders probably do not act with sufficient boldness and bravery when they choose to phase out big bills as gradually as they do. But Prime Minister Modi acted too boldly in ending the use of medium-sized bills so abruptly.

[A shorter version of this column appeared at Project Syndicate. Comments can be posted there or at the Econbrowser site.]

Share Button

What Will the Trump Presidency Look Like?

Share Button

We unexpectedly find ourselves in uncharted territory, in so many ways. The United States has never before had a president without either political or military experience. And Donald Trump is especially unpredictable: he has so often said things that conflict with other things he has said. So it is hard to know what he will do.

But a possible precedent for what economic policy in the Trump presidency may look like sits in plain sight: the George W. Bush presidency. To be fair, the Bush family clearly did not support Trump’s campaign. But a number of parallels suggest themselves:
• The candidate won the presidency while losing the popular vote.
• The new president nonetheless believes he has a mandate for sweeping change.
• The direction of the change and the results it produces will not necessarily be what those who “voted for change” will like.
• Observers are assuming that Mr. Trump will oppose the Fed’s easy monetary policy, because he attacked it during the campaign; but I predict that when he gets into office he will turn dovish, opposing interest rate increases.
• Of his economic policy proposals, the ones that are most likely to be put into law are big tax cuts for the rich and increased spending on the military and on some other items. The result will probably be the same as when Bush enacted similar fiscal policies: a worsening of the income distribution and huge budget deficits.
• A Trump return to the post-1980 trend of increasing income inequality would follow a temporary reversal of that trend that occurred toward the end of the Obama Administration (by such measures as median family income, real wages, and the poverty rate). This is the same thing that happened in the transition from the Clinton Administration to Bush.
• The new president won’t be able to deliver his 4% GDP growth rate.
• He is unlikely to be able to increase the role of exports in the economy.
• He certainly won’t be able to make good on his promise to bring back the manufacturing jobs that have disappeared since the 1950s.
• Most worrisome of all are possible foreign policy disasters. We should fear miscalculations leading to tragedies (analogous to Bush mistakes regarding the 9/11/2001 terrorist attack, the failure to apprehend Osama bin Laden, and the subsequent invasion of Iraq). A loss of US global leadership is likely, especially loss of “soft power,” in the sense that those who live in other countries have in the past looked to the United States as a leader of the international order and as a model domestically of what they hope their own countries could be like. Finally, Trump’s cluelessness on the international stage will likely embolden some traditional adversaries, such as Russia, Syria, and North Korea.

Share Button

The Gold Standard and Trump

Share Button

My preceding post, “The Fed and Inequality,” observed that populists have historically favored easy money and low interest rates.  I mentioned William Jennings Bryan’s campaigns for the presidency in the 1890s as well as the supply-siders in the early 1980s who blamed the failure of Reaganomics to produce sufficient growth on Paul Volcker’s efforts to fight inflation with tight monetary policy.

An interesting dimension concerns gold.  Bryan’s proposed reform for allowing easy money was to take the US off of the gold standard, most famously in his 1896 “cross of gold” speech.  He vowed to lead the people as they confronted “the idle holders of idle capital,” declaring “You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold.”

In the 1980s, the supply siders’ proposal for easier money was to put the US back onto the gold standard.  Some proponents of this viewpoint included Jack Kemp, Lewis Lehrman, Ron Paul, Alan Reynolds and Jude Wanniski.  The Reaganites’ pressure on the Fed for monetary stimulus is typical of Republican presidents since Richard Nixon.

In this election year Donald Trump, following Ted Cruz and other Republican presidential candidates, has said he too would like to go back to the gold standard.  But when Trump and other Republican politicians express admiration for the gold standard these days, they say they want tougher monetary policy.  It is the opposite position from the 19th century populists and the opposite motivation from the Reaganites.

If inflation were high today and had been low in the 1980s, one could reconcile the support for the gold standard then and now by trying to argue that it would bring more price stability.  But inflation was too high in the 1980s (above 4%) and has been very low recently (below 1%).  I can’t see how to reconcile the Republican positions then and now, other than observing that they seem to seek monetary stimulus when they are in the White House and monetary contraction when they are out of office.

[Comments on the preceding post and on this follow-up can be posted at Econbrowser.]

Share Button