When the feds finally come for your cash

The future of money may be playing out in India. The Indian economy is largely cash-based, making it easier to evade taxes and for criminals to operate. Crime and tax evasion are hardly unique to India, but the Indian government has taken the drastic step of taking their highest denomination notes — 500 rupees and 1,000 rupees — out of circulation. (At current exchange rates, 1,000 rupees is equivalent to 20 Canadian dollars). These notes account for about 86 per cent of the value of currency in circulation, and Indians have until the end of the year to exchange their old notes with new 500 and 2,000 notes.

“Demonetization” — as it’s come to be called — is proving to be far more costly than expected. Although the Indian government’s main targets are holders of large, ill-gotten gains, many poor and rural households without access to the banking system risk losing most of whatever wealth they have managed to set aside. Worse, the transition to the new notes is not going as smoothly as planned, leading to cash shortages and a decline in spending. The contractionary effects of such a large reduction in the money supply are likely to produce a recession in India.

Even so, the idea of drastically cutting back on the amount of currency in circulation, and on high-denomination bills in particular, is gaining traction in other countries. More than $1 trillion of U.S. currency in circulation — almost 80 per cent of the total — is in the form of $US100 notes. That works out to more than US$3,000 per American, and if you think that’s an implausibly large number, you’re quite right: several estimates suggest that roughly half of those $US100 notes are circulating outside the U.S. Many — if not most — of those U.S. banknotes are used to settle payments for illegal drugs, weapons and other contraband. Similar concerns have been raised for the volume of €500 notes circulating outside the euro zone. To a very great extent, the main contribution of maintaining high-denomination USD and euro notes is to ensure the smooth functioning of the underground world economy.

High-denomination Canadian banknotes are of course less important on the international scene, but $C100 notes still account for more than half of the $C75 billion in Canadian banknotes in circulation. Given that so many merchants have long since stopped accepting $C100 notes — or even $C50 notes — it’s not clear what would be lost if they suddenly disappeared from the Canadian economy.