Monday, November 21, 2016

Larry Summers on Indian demonetisation

Larry Summers, a former US Treasury Secretary who missed a possible chairmanship of the Fed because of his politically incorrect statements on female professors, has thought it fit to comment on ongoing demonetisation of Rs.500 and Rs.1,000. [Summers had earlier infamously found "the basic, slightly lead-eyed premise of [Mr. Rajan's] paper to be misguided" with reference to Raghuram Rajan's unique prediction of global downturn. According to Summers, Rajan was a Luddite.]

Larry Summers is patronising enough to call the demonetisation move 'the most sweeping change in currency policy in the world in decades.' When the European Central Bank put an end to Euro 500 Bank notes in May, 2016 , it was widely welcomed by many economists including Summers. Euro 500 note was nicknamed 'Bin Laden' since it was the currency denomination of choice for terrorists and drug peddlers. The modus operandi adopted by ECB was different from what RBI is doing now. Euro 500 will be phased out by the end of 2018. In the meanwhile, whatever notes come back to banks will get withdrawn from circulation. A similar approach by RBI would only have ensured planned failure of its move. Summers is now seeking an end to US$ 100 notes.

Since India is deeply troubled by terrorism and black money accumulators, a long time window for conversion would have been imprudent. Naxalites and terrorists from across the border would have welcomed such a tolerant move.

Summers adds, "We recognize that many of those who hold large quantities of cash in India have come by their wealth in corrupt or illegal ways.  So, the temptation to expropriate is understandable.  After all, as the argument goes, anyone who came by their wealth legally has nothing to fear from coming forward and exchanging old notes for new ones." 
However, he also insists, "Most free societies would rather let several criminals go free than convict an innocent man.  In the same way, for the government to expropriate from even a few innocent victims who, for one reason or another, do not manage to convert their money is highly problematic.  Moreover, the definition of what is illegal or corrupt is open to debate given commercial practices that have prevailed in India for a long time." This is an argument for 'live and let live' policy very pleasing to the ears of the guilty.

It is surprising that Summers assumes that despite a two-month window for exchange of notes (lengthened by a further 3-month period for exchange directly at RBI), some 'innocent' people will lose their money. Ten days of chaotic queues in India are enough to enable the noted economist to conclude:  "We were not enthusiastic previously about the idea of withdrawing existing notes from circulation because we judged the costs to exceed the benefits. The ongoing chaos in India and the resulting loss of trust in government fortify us in this judgement."

Demonetisation is not a narrow economic measure. It has social and ethical underpinnings. If it helps in undermining the anti-social forces, be they terrorists, Maoists or black moneyed politicians and businessmen, withdrawal of high-denomination notes becomes imperative. Hopefully, the government will follow up with more measures to penalise the criminals.

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