Monetisation of paper money is done simply by passing an order by the monetary authority. A central bank, which issues currencies, says that such and such notes are monetised or carry money value in such and such denominations. For example, in Bangladesh, what we see in Tk. 500 and Tk.1000 notes are all given a monetary value by the Bangladesh Bank (BB). We all trust what the BB says about the value of the currencies it issues. Winning of trust of its users is the main factor in keeping the value of a currency. Normally, the issuing authority does not do anything which may erode the trust of the currency users. Currencies are used mainly against buys and these are also used as the store of value. As a store of value, currencies also act as an element in the wealth basket of the people. The value of a currency goes up and down depending on its demand and supply or what it can purchase in the marketplace. Currencies' values are known by its purchasing power and also when these are traded against other currencies issued by other countries.
In some countries, currencies of other countries are not easily inter-changeable. Various foreign exchange regulations are there in the way of free exchange or free convertibility of currencies. But most of the emerging or developing countries made their currencies convertible, at least partly, over the last few decades. For example, Bangladesh made its currency 'Taka' convertible in the current account at the beginning of the current century. Bangladesh, like many other developing countries, is still hesitant to make its 'Taka' convertible in the capital account, apprehending that the step will prompt a capital flight.
Some big economies like China and India are trying to internationalise their currencies. China's success in this case is quite noticeable, as its Yuan has already become a currency for inclusion in the IMF's Special Drawing Rights (SDRs). This means, Chinese Yuan is henceforth being treated as one of the international reserve currencies alongside the US Dollar and Europe's Euro.
But India is lagging far behind in this respect though it also has a few hundred billion dollar reserves in its foreign exchange accounts. Rupees are not still fully convertible in the capital account. What India did is easing its capital account for repatriation of Rupees in foreign exchange in bigger amounts by the Indian nationals. Whether a currency is to be held by foreign nationals depends on trust. International recognition of a currency as a reserve currency is important, but trust in the concerned currency is also important in case of whether demand for a currency will go up or remain stable globally.
Why do most of the individual users want US Dollar to be the major part of their cash holding while they travel aboard? Because, people or travellers trust the US Dollar more than other internationally recognised currencies. Still, more than half of the global transactions is carried out in the US Dollar. This has given the United States a unique position in the global financial market. This has also helped the United States to issue more of debt instruments to the subscribers, many of whom are of foreign origin.
But what will happen if the US monetary authority suddenly announces that their high-value 100 Dollar notes are no longer recognised notes? A mad run across the globe will take place. Those who hold the US Dollar in cash and those who collected them from informal markets will be the worst losers. Hundreds of billions of US Dollar are floating around the globe. All the dollar bills outside the US are not in the accounts of the central banks of the world; a huge amount is with individuals and with unrecognised money changers or dealers in cash form. God forbids, if the US, for some reason or other, say tomorrow that its 100 Dollar notes are hereby being demonetised, if people want, they can change them against other small denominated notes issued by the US Federal Reserve. This type of announcement will simply lead to a breakdown of the global financial system and many people around the globe will curse the US for such an action.
The Indian currency Rupee is not yet global, but India seems to be an aspirant in this respect. What India did in the name of demonetisation of its high-value currencies like Rs 1000 and Rs 500 notes will simply pour more water on such an aspiration. India found demonetisation of its high-value currencies as the better way of fighting tax evasion and black economy perpetrators. But the question is, why did India allow its black economy grow so big so long? Lack of good governance and politics of black money took India to a situation wherefrom a turnaround is not that easy. What India did by declaring its high-value currencies demonetised will bite the Indian economy severely from many sides in the foreseeable future. Economic transactions will go down sharply leading to fall in the growth rate of the Indian gross domestic product (GDP).
Internationally, Indian Rupee will no longer be acceptable even on a limited scale. Poor Indian people, who do transact mostly in cash, will suffer more than the rich Indians. Rich Indians and tax evaders will quickly bring a change in their portfolio holdings. The Indians, who amassed wealth abroad using the holes of the Indian system, will remain out of touch. How judicious the decision of the present Indian government of whitening the black economy in this way will be tested more closely in the coming days and even this step of demonetisation may lead the Indian government to repent. Demonetisation is done only in special circumstances like wars. We did not hear any other country demonetising its currency in peace time. This step will speed up cashless transaction in India. But how far this will go in curbing the black economy will remain under a big question mark. Black money is the product of many restrictions India imposed on economic transactions since long. Without cleaning the Indian politics of black money, simple demonetisation will not work for the purpose it has been undertaken.
The writer is Professor of Economics at the University of Dhaka.