What is demonetization?
Demonetization is the removal of a legal tender status from a monetary unit. It happens every time there is a change in national currency: the current form or forms of money are withdrawn from circulation and withdrawn, often to be replaced by new notes or coins. Sometimes a country completely replaces the old currency with a new currency.
The opposite of demonetization is remonetization, in which a form of payment is restored as legal tender.
What would you do with $ 10,000?
Removing the legal tender status from a monetary unit is a drastic intervention in an economy because it directly affects the medium of exchange used in all economic transactions. It can help stabilize existing problems or cause chaos in an economy, especially if it is undertaken suddenly or without warning. That said, demonetization is undertaken by nations for a number of reasons.
Key points to remember
- Demonetization is a drastic intervention in the economy which involves the removal of the legal tender status of a currency.
- Demonetization can cause chaos or a serious downturn in the economy if it turns bad.
- Demonetization has been used as a tool to stabilize a currency and fight inflation, to facilitate trade and market access, and to push informal economic activity towards more transparency and away from the black and gray markets.
Demonetization has been used to stabilize the value of a currency or fight inflation. The Coinage Act of 1873 demonetized money as the legal tender of the United States, in favor of the full adoption of the gold standard, in order to avoid disruptive inflation, as new large deposits of silver were discovered in the American West. Several coins, including a two-cent coin, a three-cent coin and a half-penny, were abandoned. Withdrawing money from the economy led to a contraction in the money supply, which contributed to a nationwide recession. In response to the recession and political pressure from farmers and silver miners and refiners, the Bland-Allison Act remonetized money as legal tender in 1878.
In a more modern example, the Zimbabwean government demonetized its dollar in 2020 as a way to fight the country’s hyperinflation, which was recorded at 231,000,000%. The three-month process involved expelling the Zimbabwean dollar from the country’s financial system and solidifying the US dollar, the Botswana pula and the South African rand as the country’s legal currency in an effort to stabilize the economy.
Some countries have demonetized currencies to facilitate trade or form monetary unions. An example of demonetization for commercial purposes occurred when the nations of the European Union officially started using the euro as their standard currency in 2002. When the physical euro banknotes and coins were introduced, the old currencies such as the German mark, the French franc and the Italian lira have been demonetized. However, these various currencies remained convertible into euros at fixed exchange rates for some time to ensure a smooth transition.
Finally, demonetization has been attempted as a tool to modernize a developing economy dependent on cash and to fight corruption and crime (counterfeiting, tax evasion). In 2020, the Indian government decided to demonetize the 500 and 1,000 rupee notes, the two biggest cuts in its monetary system; these notes represented 86% of the cash in circulation in the country. With little warning, Indian Prime Minister Narendra Modi announced to citizens on November 8, 2020 that these tickets were worthless, effective immediately – and they had until the end of the year to deposit or exchange them for 2000 rupees and 500 rupees newly introduced. bills.
Chaos ensued in the cash-dependent economy (about 78% of all transactions with Indian customers are in cash) as long, meandering lines formed outside of ATMs and banks , which had to close for a day. The new rupee notes have different specifications, including size and thickness, requiring recalibration of ATMs: only 60% of the country’s 200,000 ATMs were operational. Even those who were distributing lower denomination bills faced shortages. The government-imposed restriction on daily withdrawal amounts added to the misery, although an exemption from transaction fees helped somewhat.
Small businesses and households have struggled to find cash, and reports of daily wages not surfacing have surfaced. The rupee has fallen sharply against the dollar.
The government’s objective (and the justification for this abrupt announcement) was to fight India’s thriving underground economy on several fronts: eradicate counterfeit money, fight tax evasion (only 1% of the population pays taxes), eliminate black money from money laundering and terrorism. fundraising and promoting a cashless economy. Individuals and entities with huge amounts of black money obtained from alternative payment systems were forced to take their high-value notes to a bank, which was legally required to obtain tax information about them. If the owner could not provide proof of payment of cash taxes, a penalty of 200% of the amount due was imposed.