While the rest of the world was focused on the US Presidential Election last week, Indian Prime Minister Narendra Modi suddenly declared that he was voiding about 86% of the rupees in circulation.

Immediately.

“Oh, yes, and by the way, the banks and ATMs won’t be working for at least the next two days.” 

Some numbers:

1. According to the Reserve Bank of India, there are 16,500,000,000 actual ₹500 notes in circulation, and 6,700,000,000 ₹1,000 notes.
2. Each ₹500 is worth around $7, and each ₹1,000 note is worth slightly less than $15.
3. In case you’re wondering, in total, those bills were worth about $216 billion – which is equivalent to about 80% of the entire South African economy.
4. That’s also equivalent in value to almost a sixth of the Indian economy.
5. Also (and I’ll come back to this), about 68% of all transactions in India are cash-based (compare that to the US at 20%, or the UK at 11%).

And while we’re here, just consider that the Indian economy is about five times the size of South Africa’s – but they have about 27 times the amount of actual cash in circulation.

To be honest – one of the most impressive parts of this story is that Mr Modi managed to have a ‘surprise’ at all. We’re talking about a country of almost 1.2 billion people: someone should have leaked it out.

In practice, this meant that no logistical planning could take place. My favourite quote:

The government deliberately didn’t reconfigure the more than 200,000 cash machines beforehand to help keep the announcement a secret. The machines are being re-calibrated so that they can dispense new 500 and 2,000 rupee notes, which do not fit into the existing cash trays in the ATMs.

Un. Real.

Why is this happening?

Well, the official story is that this is trying to root out ‘black money’ and reduce corruption. Essentially though, this is about tax collection. Two things to point out:

1. Cash is almost entirely anonymous.
2. Bank transfers are never anonymous.

When 68% of transactions are cash-based, the job of a tax collector is difficult. They have to rely on in-depth lifestyle audits and tax raids.

But in a cash-less economy, the tax collector just asks to see your bank statement.

And in a more cashless economy, the cashlessness is self-reinforcing. If everyone uses cash, then it’s easy to fall off the radar – but if everyone uses bank transfers, then it’s quite challenging to be the only tax-evader in the room using cash. Eventually, somewhere down the line, you’re going to want to buy a house or a car or some kind of asset with all your untaxed wealth – and if you throw cash on the table, someone is going to ask a question.

So even if the Indian government says that it’s going to replace the notes with new notes:

1. There are apparently going to be limits on how many new ₹2,000 notes are printed;
2. Anyone depositing large numbers of rupee cash bundles has to justify where their money came from; and
3. How keen do you think the Indian people will be to keep all their cash savings in new ₹2,000 notes, now that the Indian government has proved that it can and will just declare them worthless?

What this says about money

This is exactly the kind of thing that gets anti-fiat-money folks riled up. Governments create this paper, declare it to be legal tender by ‘fiat’, and then they can just as quickly illegally-tenderise it by:

1. Money printing that leads to hyperinflation; and/or
2. Skipping the money printing entirely, and simply declaring bank notes to no longer be bank notes.

For me, it’s a reminder that cash is not a risk-free investment. If you want to hold cash, then there’s a risk that the governing-protector of that cash could do political things with it.

It’s also a reminder that governments have increasingly strong incentives to discourage the use of bank notes. After all, the easiest and cheapest money to print is the electronic money that lives as a few bytes of binary code in a bank ledger. It’s also the easiest to tax.

And who cares if all the poor, who can’t afford the fees associated with bank charges, and who don’t have proofs of address and proper IDs and all that KYC documentation that the global banking regulators demand, are quietly restricted from the business of living?

For more:

• 45 Years off the gold standard (this post involved burning retired currency and turning it into art – I’m quite proud of it).
• “How long will this Fiat monetary system hold up?”
• Money: no longer a store of value, really

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.