Submitted by Jayant Bhandari via Acting-Man.com,

India’s Government Makes Banknotes Worthless by Decree Overnight

As I write this in the morning of 9th November 2016, there are huge lines forming outside gold shops in India — and gold traded heavily until late into the night yesterday. Depending on who you ask, the retail price of gold has gone up between 15% and 20% within the last 10 hours.

Gold quotes in India – gold traded for as much as Rs 49,000 per 10 grams or US$ 2,294 per ounce

At some places, it was sold for as much as US$ 2,294 per ounce. That is, if you can actually find physical gold — gold inventories at stores are rapidly depleting. All of this happened well before the international price started to move up because of the election results coming out of the US.

Last night (8th November 2016), India’s government banned the use of Rs 500 (~$7.50) and Rs 1,000 ($15) banknotes. This pretty much made most currency-in-use illegal. Banks and ATMs are closed today. The government believes that doing this will help eradicate corruption and push counterfeit money out of circulation. According to the Indian government, the counterfeit money tends to come from Pakistan and helps finance terrorism.

My first instinct when I heard the news was that people would be on the streets this morning. There would be riots and the Indian Prime Minister, Narendra Modi, would be unceremoniously thrown out. Despite being a huge critic of him, I thought he at least had the spine to take bold action, however erroneous it might have been.

I am sometimes too optimistic about India and expect too much goodness from Indians. And I was wrong.

In the morning no opposition against the government was in sight. But there was some animosity detectable between people. Forgetful that they had lined up until late into the night yesterday trying to get cash out of ATMs before midnight, had fought at gas-stations to get their gas tanks filled, and had suddenly been trapped with unusable currency, people exchanged congratulations on what Modi had done.

Indian prime minister Narendra Modi

What Modi had done — contrary to what I initially thought — wasn’t a bold move. It was a populist move, designed to please the 98% who do not save. While they are really driven by envy, these 98% are putting on a brave face, celebrating the alleged defeat of corruption. To them the fights of yesterday — at gas stations and elsewhere — and the loss of trust in their fellow citizens is merely collateral damage.

Fresh Avenues for Corruption Immediately Open Up

Those who find themselves stuck with high denomination bills today, must accept as little as Rs 700 in usable currency for every Rs 1000 of banned currency.

At least theoretically, people can still use the otherwise banned bills at hospitals, gas stations, pharmaceutical shops, and train stations. As one would expect in India, these places have been converted into corrupt currency-exchange shops as of today. Some well-connected people are prepaying for their medical treatment.

But for most legitimate uses, none of these organizations are accepting the otherwise banned instruments. Why should they, when they can force customers to pay in the still-legal currency and then buy the banned instruments for Rs 700 for every Rs 1000 in face value, making a neat 43% extra profit without doing anything?

In India, a country not driven by morals or reason, almost everyone will exploit an opportunity to make an extra buck, however unethical it might be. Those who look deeper, understand that corruption in public life comes from ingrained corruption in India’s society and culture. If one had to make an effort to remove corruption this is where one should start.

1,000 rupee banknotes – worth 700 rupees each today, available from the newest entrants into the money-changer business. Unfortunately, their business model is fraudulent; it sure seems a strange way to “fight corruption”.

Today, there is utter chaos in the market, with only the spontaneously erupted black market available to bypass the ban — most people simply don’t have anything else but the banned currency bills. Some are booking train tickets for future rides and are subsequently canceling them — they can use the banned currency to buy the tickets and can then get legal currency back after ticket-cancellation charges. This is costing people a lot of time, but it is the only way they can stay afloat and buy food. Others are taking different measures, equally desperate.

By any sane person’s reckoning, corruption has skyrocketed for the moment. So has gold. Those who run businesses have lost whatever remnant of trust in the government they still had. In recent months several businessmen have confessed to me that they are closing down, because the state has become increasingly heavy-handed and bureaucratic. Contrary to what the World Bank and IMF are saying, India is suffering economically. Its institutions are crumbling. And India is on the path to becoming another banana republic.

Within a few days, assuming this issue is handled appropriately — which it won’t be — most people with a certain amount of banned currency will be able to deposit it at banks, although tied to withdrawal limits. The banking system will stay partly frozen. After the banks open tomorrow, I expect to see riot-like scenes outside bank branch offices for a few weeks.

Huge chaos in the Indian economy should be expected to continue — as India’s government is simply incapable of bringing liquidity back any time soon. Businessmen will waste their time dealing with this nonsensical event, instead of investing and creating wealth. India simply continues to do more and more of what makes it an uneconomical and wasteful place to invest in.

Civil servants are already finding ways around the cash shortage problem…

Will the Plan Succeed in Reducing Corruption?

But will this eventually lead to a reduction in corruption? Let us use the gold market as an example to understand how the Indian economy operates. Any import of gold is subject to a cumulative tax of about 11%. The retail price of gold should be around 111% of the international price. Ironically, it mostly sells for 105% of the international price. Putting it simply, any law-abiding businessman must lose this 6% differential, ensuring his bankruptcy.

In reality most of the gold entering India is brought in by smugglers. These smugglers are happy to pass on almost half of their profit to consumers, while at the same time paying bribes to the Indian army, customs officials, other bureaucrats and politicians. If one wants to run a gold business, one must use smuggled gold if one wants to be competitive.

A shop selling gold jewelry in India

Virtually all businesses in India have to be run this way. Without paying bribes, no business has a hope of succeeding in India. Corruption is in the blood of India and is not easy to get rid of, even if by sheer luck India finds good political leaders one day.

Corruption is so omnipresent in India that you don’t really have to look for it. It is always there. What Modi is doing is merely political theater to fool the gullible. His decision to ban cash currency is actually proof that he has utterly failed to achieve any meaningful change in India.

I have yet to meet a public servant in India who does not ask for a bribe. During Modi’s reign, not only corruption has gone up, the state has become extremely heavy-handed. As what is happening today shows that the government’s anti-corruption measures themselves are ironically leading to a huge increase in corruption.

Unsuccessful Google search in India…

Conclusion

Unfortunately, India’s degradation will not stop. Indians have become extremely nationalistic over the last two decades. They are now very easy to herd around. Under the color of nationalism they can be made to accept anything – of course, only as long as the victim is someone else. The currency issue of today affects maybe 2% of the entrepreneurial population of India, so the remaining 98% can claim higher moral ground for themselves. The reality is that without these 2%, India could rapidly become a carbon copy of Idi Amin’s Uganda.

What India needs is not a focus on the removal of corruption, but the removal of regulations and restrictions on wealth-creation. For now the state is doing exactly the opposite, as it has in the past. Most importantly, this poison of totalitarianism comes from the extremely irrational society of India — in which corruption is entrenched.

There is no escape for the Indian economy. And in the negative-yielding economy, those who save have no choice but to buy gold, even at $2,294 per ounce.