Monday, 21 November 2016

Why Narendra Modi’s demonetisation move is unprecedented

Historically, ‘demonetisations’ or radical recalls/replacements/redenominations of currencies by governments have been in response to hyperinflations. We know of many such cases of outright withdrawal of notes from circulation being resorted to, when normal means to suck up excess liquidity in the system have failed. The underlying purpose has always been to control runaway inflation and the accompanying loss of faith in the domestic currency, both among investors and the larger public.

The best example here is of Germany under the Weimar Republic, which, on November 20, 1923, introduced a new currency — the rentenmark — and declared all old reichsmark notes to be no longer legal tender. This happened as domestic prices, already 14 times their 1913 levels in mid-1921 and 1,475 times towards end-1922, had skyrocketed to 1,422,900,000,000 times by November next year. As the currency lost value by the minute, people rushed to spend their wages the very moment they received them, fuelling further inflation and necessitating more printing of notes to pay 250 billion reichsmarks for a kilo of butter or 15 billion for a short ride on a Berlin streetcar. The only way to deal with this situation was demonetisation: purging the system of all existing notes and launching a new currency backed by solid assets — in this case, land belonging to the state. With credibility restored, inflation fell and the run on the currency, too, ended.


No comments:

Post a Comment