What is Demonetization?

As part of monetary reform, the central bank may reform specific monetary policy instruments and abolish the forms and conditions of discount and re-discount lending to commercial banks and government lending, leaving specific payment instruments out of the total money supply. One of the most significant examples of demonetization is the official demonetization of gold as international money at the 1973 International Monetary Fund conference in Jamaica.

What is Demonetization?

Demonetization represents removing the legal tender status of a currency. The denomination(s) of currency in circulation in a country usually happens when currency is retired and declared of no value. For example, the Coinage Act of 1873 is demonetization because the act declared the removal of silver in favor of adopting the gold standard as the legal tender.

Demonetization is a decision made by the government of a country, generally backed by its central bank, to bring a change to the current form(s) of currency in circulation. The country’s government may strip down some or all units of currency (banknotes and coins) as legal tender and replace them with new ones. 

What is the Main Reason for Demonetization?

A general reason for demonetization is to bring down the current currency forms and bring new currency forms into circulation. 

It is a way of making adjustments to the economy by its government. There can be multiple reasons behind demonetization. One of the primary reasons is that the government decides to replace the old currency (notes or coins) with new ones.

Demonetization is a way of stabilizing the currency. If the government fears the increase in the accumulation of black money, which eventually causes inflation, demonetization is a process that can assist the government in resolving such issues. It can also be a way of supporting the trade of a country.

Why is India Demonetized?

The reason behind demonetization in India was to curb the increased black money holdings in the country. It was aimed at bringing the money back into circulation that some tax violators have illegally held. 

In 2016, the Indian Prime Minister declared that higher value banknotes, INR 500 and INR 1,000, were no longer legal tenders. The decision was supported by four primary objectives; to fight corruption and black money, restrict terror funding and solve the issue of fake currency printing, which was being done on a large scale in the country.  

Citizens were given time to deposit their money into their bank accounts in INR 500 and INR 1000 denominations. The decision made everyone holding the higher currency notes, especially people with black money, return it to the banks as they had lost their value. 

What are the Positive and Negative effects of Demonetization?

Demonetization is generally declared when the government has no other choice but to bring stabilization to its economy. Along with the positive adjustments to the economy, it also brings chaos and aftershocks. 

Demonetization is a great tool to stabilize the currency of a country. It helps the government track down the real income of its citizens who have been avoiding tax payments. It brings the money back into circulation and to the financial institutions, which otherwise causes inflation. It imposes a long-term positive impact on the economy, where businesses get exceptional opportunities to grow.

The initial stages of demonetization can affect the economy. Its degree of impact depends upon how the process of demonetization is implemented. If it is not implemented with proper and efficient planning, it can create chaos around the country. Also, the demonetized currency is replaced with a new one, which requires the government to incur printing and minting costs. 

Who Did First Demonetization in India?

The first demonetization in India was implemented by Monarji Desai’s government in 1978, when currency notes with high denominations, 500, 1000, and 10,000 rupees, were eliminated as legal tenders.

This demonetization was declared following the High Denomination Bank Notes (Demonetisation) Act, 1978. The Indian parliament passed this law to restrict the use of currency notes with high denominations. 

The primary aim of this move was to eradicate the use of higher currency notes that were facilitating illegal financial transactions and giving encouragement to black money. Since the currency with high denominations in circulation formed a very small part of the total currency, the economy did not face many issues in the money supply at the time of demonetization.

What is the History of Demonetization?

Demonetization goes long back to 1873 when the United States of America first implemented it. It was then followed by another demonetization in 1969. Ghana later adopted the act in 1982, Myanmar in 1987, the Soviet Union in 1991, the European Union in 2002, and other countries, the latest being the demonetization of India and Venezuela in 2016. 

When demonetization was introduced in the US, it aimed to terminate silver from being a legal tender. It was a decision to support the gold standard and was named the Coinage Act. However, the act had many complications as it brought a massive shortage of money supply that greatly affected the country’s economy. 

Later, when other countries adopted the act as a remedy to bring positive changes to their economies, the decision was met with mixed responses. The 1969 demonetization in the US, where currency above $100 was terminated as legal tender, turned out to be a success. Whereas the 2016 demonetization of India and Venezuela brought many hardships. While the former encountered a significant backlash to the economy, the latter experienced protests, and destruction by its citizens. 

What is the Demonetization Policy?

The central policy of demonetization, adopted by any country, is to declare a specific currency unit, or all in circulation, invalid. 

Demonetization revolves around a general principle to declare the current currency forms of no value. It is the same for every country that adopts the act, no matter the reason behind the decision. The result of this decision is that any person in possession of the currency unit being demonetized has to return it to the banks and get the value of their money in return. The demonetized currency is declared to be of no value, so people can get it exchanged with new currency from the banks. 

Why Would a Country Demonetize?

There are many issues that a country faces while running an economy. There are plenty of ways to bring it back on track if it loses its path. However, a government may find itself in a situation where demonetization seems to be the best remedy.

The significant reasons why a country would choose to demonetize its currency are— to bring stabilization to the foreign trade, currency, and economy. It also helps eradicate illegal activities like black money, financial support for terrorism, and counterfeit currency. Other reasons may include changing the current currency units or forms with new ones, solving hyperinflation, and strengthening the economy. 

A country must create an efficient plan for demonetizing its currency as it can become chaotic if not handled wisely. 
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Igor has been a trader since 2007. Currently, Igor works for several prop trading companies. He is an expert in financial niche, long-term trading, and weekly technical levels. The primary field of Igor's research is the application of machine learning in algorithmic trading. Education: Computer Engineering and Ph.D. in machine learning. Igor regularly publishes trading-related videos on the Fxigor Youtube channel. To contact Igor write on: igor@forex.in.rs

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