When at about 8 PM on the 8th of last November, Prime Minister Narendra Modi declared that all Rs 500 and Rs 1,000 denomination currency notes in circulation would, from midnight onwards, “become just worthless pieces of paper”, it launched a new word — demonetisation or simply notebandi — into our popular lexicon. But it also made many of us think, both practically and philosophically, about what money really is and has been.
How could mere paper become money, to start with, and how did 2,402.3 crore notes in this case — whose combined value of Rs 15.44 lakh crore constituted nearly 86 per cent of the total currency with the public and in bank vaults — turn into worthless kaagaz ke tukde overnight, that too, because of one man deciding so?
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Well, money’s basic function is as a medium that enables purchase and sale of goods and services. It’s something you as a seller would accept from me as a buyer. Further, it’s something others, too, are willing to take when you seek to purchase from them. And, since buying and selling is what generates output, jobs and incomes — for every purchase we make, a part of our income is transferred to somebody else, who, in turn, spends it and which, then, becomes some other’s income — money is the vital lubricant that keeps an economy going and contributes to its gross domestic product.
Since money’s essence is its acceptability as a medium of exchange, this could initially only have been a thing that was solid, durable and possessing intrinsic value. Besides, it had to have portability, malleability and divisibility, allowing for it to be easily carried around even in one’s little pocket and being melted and reshaped into homogenous units of lower or higher denominations.
It was natural, therefore, that most money originally was silver, copper or gold. Although other stuff such as cattle, liquor, tobacco, salt, dried cod and shells, too, were tried out, they failed the bulk of the tests of an ideal currency material. The precious metals, by contrast, could be made into coins of predetermined weight corresponding to different face values. Trust and faith in a currency came from its being issued by the sovereign; stamping his head on the coin was seen to serve as a guarantee of the weight and fineness of the metal used.
Coins, however, were also amenable to debasement through reducing their gold or silver content. By clipping or shaving a few micromilligrams and mixing brass, tin and other base metals in their place, the same amount of precious metal could be used to produce more coins. The rulers, unfortunately, were the most frequent offenders — their proclivity to wage wars always demanded extra-budgetary resource-raising. Even during the third-century Roman Emperor Aurelian’s time, the basic silver coin actually had 95 per cent copper.
The Indian rupee, right since the East India Company’s adoption of a uniform system of coinage across its possessions in 1835, was a silver coin containing a tola (0.375 troy ounces) of the metal of 91.67 per cent fineness. But during World War I, when world silver prices soared from around 22 pence to 78 pence per ounce between November 1914 and December 1919, the cost of the metal in a one-rupee silver coin, at 29.25 pence, far exceeded the latter’s fixed exchange rate of 16 pence (or Rs 15 per pound, as 240 pence made a pound). It left the authorities, therefore, with no option but to allow the rupee to appreciate to a level of 28 pence or Rs 8.57 per pound by December 1919. Not doing so would have led to large-scale redeeming of pounds in rupees at government treasuries and the resultant silver coins (as many as 15 for every pound) being diverted to jewellers for melting and meeting their bullion requirements.
No sovereign would want his power to issue currency trammelled by the availability of gold or silver, more so if there weren’t any local sources of bullion that had to necessarily, then, be imported. Such rulers were obviously more prone to monetary experimentation, which extended from debasing their own currencies to searching for alternatives to precious metal. These rulers were also the progenitors of paper money.
Paper money was supposedly invented in China back in the early 11th century, but the man instrumental in its spread as currency across his vast contiguous Mongol Empire was Genghis Khan (1162-1227). The use of paper currency — derived from the bark of mulberry trees — so fascinated the Venetian merchant Marco Polo that a chapter in his famous 13th-century travelogue on China was appropriately titled ‘How the Great Kaan Causeth the Bark of Trees, Made into Something Like Paper, to Pass for Money Over All His Country’.
The issue of paper money was initially accompanied by the promise to pay the equivalent value of gold or silver from the public treasury. While the issuances were, accordingly, backed by bullion, a point was reached, though, where the face value of the outstanding notes significantly surpassed that of the underlying metal. The public seemingly did not mind. So long as the supply of metal reserves was adequate and not everyone exercised the right to redemption at once — a rare possibility — the notes did their job of passing from hand to hand, simply to make payments for goods and services. It reinforced what money ultimately was: A mere medium of exchange that people accepted as payment. Such acceptability rested more on faith, trust and convenience of use, than whether that medium was gold or paper.
The stage was set for fiat money. This was pure paper money backed by nothing of tangible value. Unlike previous paper money that entitled its holder to redeem it for a specified quantity of gold or silver, the note now presented at the treasury/central bank could only be exchanged for, well, another note of the same denomination. Genghis Khan’s paper currency was fiat money, in every sense, forced on his subjects. Since he expropriated everybody’s gold and silver and made rejecting the paper money issued by him a capital offence, they had no choice but to use this for transactions.
Modern fiat money declared to be legal tender by governments owes its existence far less to intimidation. It is, instead, backed solely by the credibility of the issuer — faith that the monetary authority would observe self-restraint in not printing too much currency, which when chasing the same quantity of goods and services, will stoke inflation. Faith is, indeed, central to most money — and which needn’t be confined only to the notes issued by governments and central banks. What matters is whether the issuer, public or private, is considered creditworthy enough.
The best example from history to cite here is the hundi. This age-old financial instrument was basically an IOU written by the buyer of a good, promising to pay the seller at a future date. If the seller resided in some other place, the hundi could be an order directing the drawer’s agent (drawee) there to make the payment to the former. In the process, the hundi served as a pure remittance facility. But it could be more. In the event the drawer was a reputed merchant, the hundi could be used by the seller to raise a loan by transferring it through endorsement to the lender. The latter would extend the loan at a discount to the value of the hundi, and, subsequently, encash it at par. The hundi, thus, became a negotiable instrument. Being freely transferable through successive endorsements before it was finally presented to the drawee also made the hundi a source of mobile credit.
There is evidence to suggest that it was the hundi, rather than gold mohurs or banknotes, which greased the wheels of commerce in India right from medieval times, if not earlier. It was the integration tool by which money moved seamlessly across the length and breadth of the subcontinent, enabling Multani bankers to remit funds from their headquarters at Shikarpur in Sindh to Madurai in the Tamil heartland, just as their Marwari counterparts did so from the desert towns of Rajasthan to the Brahmaputra Valley.
The issuers of hundis were private parties, not the Reserve Bank or Government of India. Their IOUs weren’t ordinary contracts between buyers (drawers) and sellers (the original payees), but obligations that even third parties were willing to accept as payment. Such transferable debt was nothing but money.
It brings us to what money is at the end of day. It is debt that can be passed around from person to person. If the debtor is someone with impeachable reputation for honouring obligations, his IOU might even circulate freely without ever being redeemed. The only difference between such transferable private debt and fiat currency issued by the sovereign is that the latter cannot legally be redeemed. Yes, currency is a liability of the central bank (“I promise to pay the bearer the sum of five hundred rupees”). But go to the Reserve Bank of India and ask it to discharge its Rs 500 “liability” to you. All you will get in return is another, maybe crispier, Rs 500 note.
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We began this essay with demonetisation. What happened when those 2,402.3 crore pieces of “specified bank notes” ceased to be legal tender? It resulted in Rs 15.44 lakh crore-worth of transferable debt suddenly being removed from the system. Bereft of lubricant, the economic machine naturally slowed down. It did not stall, because people replaced currency, which was transferable or tradable debt, with simple non-negotiable credit. I had no money to give, yet you continued supplying me goods on credit. But this was purely an arrangement of trust, based on our knowing each other well.
You wouldn’t have supplied similarly on credit to unknown or not-so-known persons. Prior to demonetisation, you didn’t have to really know your customer, provided he paid in cash. What notebandi did was to restrict business only to those whom you knew and trusted.
There was a historical precedent again — something that took place in Ireland almost five decades ago. On May 1, 1970, all banks in the country shut down, following a pay settlement dispute with employees. It lasted till November 17 and during this period no bank transactions could be conducted. So, how did people manage? They wrote cheques that, in the normal course, would have involved transfer of money from the buyers’ bank accounts to those of the sellers. But since banks were shut and no one knew at that point when they would reopen, it meant that the sellers were accepting cheques purely on trust. As the cheques weren’t being cleared, they could only have hoped these would not bounce.
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The Irish economy then, just as India after notebandi, did not collapse. But the cost of disintegration of established monetary systems wasn’t small. There was, after all, a limit to how much an economy could function based on assessing the creditworthiness of individuals paying by un-clearable cheques, which were effectively no more than kaagaz ke tukde. A month after the banks closed, livestock markets in Ireland announced that they would no longer accept private cheques. In July, a farmer convicted of smuggling seven pigs into the Irish Republic was reportedly unable to pay the £309 fine handed down to him, for want of ready cash.
We saw and heard many such stories — and more — here as well afterNovember 8, 2016.
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