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Why India Banned 86% of its Currency

December 4, 2019


This video is sponsored by Brilliant. The first 200 to use the link in the description
get 20% off the annual subscription. On November 8th, 2016 at 8:15 PM, TVs across
India flickered in unison. Dramas, cricket matches, and game shows were
all replaced with the face of Prime Minister Modi. In this unscheduled, surprise address, he
announced the 500 and 1,000 rupee banknotes – worth about 7 and 14 US Dollars, respectively
– would soon lose their status as legal tender. Without any monetary value, they would become
nothing but pieces of paper, useless for any and all transactions. ”Soon” meant in 3 hours and 45 minutes
– effective immediately at midnight. And those 500 and 1,000 rupee bills constituted
no less than 86% of all cash in circulation. It was as if the U.S. president suddenly announced
all 10, and $20 bills were worthless, only with a population 4 times bigger and
far more reliant on cash. The next few months were the result of a fascinating,
unintended experiment, as 1.3 billion people scrambled to replace their cash, the government
rushed to print new bills, and dozens of people died in the process. India runs on cash. It’s estimated that, measured by volume,
90-98% of all transactions in the country involve physical currency. and 85% of workers are paid in cash, while
only about half the population owns a bank account. These are optimal conditions for tax theft,
making it extremely easy and extremely common for earnings to go unreported, and, thus,
unknown and untracked by the government. The informal, underground economy makes up
something like 25 to 40% of the nation’s GDP. While salaried workers have taxes automatically
withheld from their paychecks, they represent only a tenth of all organized workers. Farmers, meanwhile, who make up about half
the nation’s workforce, are largely exempt – protected from politicians by their large
voting power, not unlike seniors in the United States. In 2016, only 37 million Indians filed tax
returns, 10 million of which were exempt, leaving only a tiny 27 million payers in a
country of 1.3 billion. Modi’s solution was simple: force everyone
to report their earnings. From November 9th, Indians had until December
30th to take their 500 and 1,000 rupee notes to the bank. There, they could be deposited for their full
value, or exchanged for other notes at the counter, for a maximum of 4,000 rupees per
person per day, later increased to 4,500 and then reduced to 2,000. Tax avoiders, big and small, now had no choice
but to declare their wealth or lose it all come January. Any strange, large deposits without explanatory
paperwork would be an instant red flag for the government. But here’s where everything went wrong: The central bank couldn’t prepare millions
of new, replacement banknotes in secret. Printing them in advance would therefore attract
attention, potentially cause chaos, and alert the very criminals the policy was meant to
target. For this reason, the Reserve Bank could only
start printing the new 500 and 2,000 rupee notes after the announcement – leaving it
with just under 4 hours to reprint the vast majority of the second-most populous nation’s
currency. Clearly, it was an impossible task. Now, having to bring cash to deposit or exchange
would’ve been disruptive enough for many Indians, but because the new banknotes were in such
short supply, long lines formed outside banks and ATMs for months. On top of that, the replacement bills were
slightly smaller, requiring ATMs to be retrofitted to use them. There were lawsuits, strikes, and protests
against what many saw as an unreasonable interference by the government in daily life. And despite all that, there’s good reason
to be skeptical the policy achieved its intended effects. Broadly speaking, there were two goals of
demonetization: First, to weaken terrorist funding, and second, to target the informal, black
economy. Both of which are hard to measure. Whether terrorist groups suffered any significant
losses as a result of demonetization, no one knows with certainty. And the black market is problematic precisely
because it can’t be measured. What we do know, according to the Reserve
Bank of India itself, is that 99.3% of the demonetized notes were later returned. In other words, the policy removed only a
tiny amount of money from circulation. Experts largely agree black money is mostly
stored in the form of gold, silver, real estate, and overseas bank accounts, not bills worth
7 or 14 US Dollars each. It’s true that demonetization added a record
9 million new taxpayers, but the mass disruption it caused also removed nearly the same amount
– 8.8 million people stopped paying that year, likely as a result of lost income. And while digital payments experienced a significant
spike in usage, there was no lasting effect after the new banknotes were fully distributed. Three years later, the only certain outcome
of demonetization was the immediate chaos it created across the nation: Hours wasted
at the bank, financial uncertainty for those most vulnerable, lost wages, and at least
several innocent lives. Worse, it came out of nowhere, not as a response
to inflation or unrest. So, why, then, given all that we now know,
is the policy still so popular in India, among those who personally paid its costs? Like Xi Jinping’s consolidation of power
in China, Modi successfully sold a story of unfairness, of targeting corruption and criminals,
to ultimately gain political support. Soon after, Modi’s party won the 2017 elections
of its 200-million person, most populous state in India, thanks, in part, to the popular
belief that demonetization was a collective sacrifice necessary to make the rich pay their
fair share. Anyone who protested the policy could easily
be labeled as a criminal trying to hide black money. Rather than turning the population against
the government, demonetization enlisted it, making people feel they were personally doing
their part to help fight crime. Modi’s party could’ve passed just as effective
but less disruptive laws targeting black money and explained them to gain support. Instead, he knew the most effective way to
convey information is by showing people, firsthand. Demonetization achieved its real goal of driving
political support by making a faraway, abstract concept tangible and interactive. Likewise, Brilliant is a math, science, and
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