Tuesday, November 29, 2016

Demonetization does nothing to end "Black Money"

I know that demonetization has been projected as a moral project that seeks to "clean up" Indian society and cure its addiction to "Black Money" but this demonetization plan does exactly nothing towards that apparently noble purpose.

Leaving aside my libertarian leanings (which prompt me to say "why should a poor Indian who works her/is ass off and gets next to nothing from her/is government directly pay taxes or bank fees so that the GoI can track their income etc...")  - we all have to accept that even in its most awesome ideal form - the demonetization does exactly nothing to prevent the accrual of "Black Money".

People are still going to break laws. This defiance is rooted in India's deeply libertarian social thought. Unlike the American Libertarian consciousness which is largely a vehicle for certain members of the billionaires club to seduce useful idiots - the Indian libertarian ideology is the byproduct of centuries of mistrust of government.

One of my early mentors in the ACRE labs at IITB - Dr. Venkatramani once said something that has stuck with me for my entire life. He said to me -

"Look at people at a road crossing in India and in Germany or US. In US or Germany - if the crossing light is red - the people will stand there until they become skeletons. In India - people will cross even if the crossing light is red and the traffic is flowing at 100 kph. You could say we are just fundamentally different from these other nations. We do not like rules or to follow laws." 

In honor of its creator - I call this "Venkatramani's Postulate".

As long as Indians remain like that - they will break the rules and laws of the land.

As long as they break the rules and laws of the land - they will need to bribe the enforcement agencies to prevent accountability.

That is where the bribery will kick back in. If you change the notes - the denominations of the bribe will change, it will not go away.

A much better way to think about the demonetization (instead of this moral project bullshit) is to compare it to an interest rate hike in a credit based economy like the US.

When the Federal Reserve wants to dampen speculation in the markets, it raises the interest rates. This deflates speculatory impulses in critical markets like commodities, bonds etc... The Fed does not have a choice in this matter (despite what you hear on YouTube about a Rothschild conspiracy). If the Fed does not do this - you will see major fluctuations in the price of critical commodities and you will risk a collapse of the foundational elements of the economy itself.

In a similar fashion - we need to acknowledge some key facts about India's current situation.

Given the unusually large amount of money that Indian expats are sending back to the "home country" - we are seeing a massive speculation bubble in India's real estate sector. This bubble is driven by people who want to buy housing in  India, never occupy it and keep it as a means of wealth storage in a time when everyone agrees that developed world economies are heading for a major depression. The debt crisis in the developed world is so severe, no rational Indian expat wants to plough any real money into these markets. The ROI on a subterranean real estate investment in India is far in excess of anything that even "Value Investing" can bring in the US or UK or Europe.

As this speculative bubble inflates it puts the Indian economy at grave risk of a collapse. When it collapses (and it will given time) unless the GoI is in a position to support people with credit to make up the cash short falls that will inevitably occur with such an event. The Indian economy will suffer the onset of conditions similar to those that led to the Bengal Famine.

The key thing from an economic security perspective is to keep the speculative bubble in India's real estate sector at a manageable level. The size of the bubble has to be kept as small as possible, and in the event it bursts - one should make sure that resources available are able to provide credit to people who lose cash in the process.

Demonetization is one of the tools that one can use to achieve that end. It is an extremely blunt tool. It will do more harm than good.

A much more precise tool would target the specific means by which expats drop money into real estate in India. A simple system of increased fees on real estate purchases by non-residents would lead to significant inflow into the GoI coffers.

Another technique is to declare a certain day of the month as a tax holiday where specific sums of money below a certain cap can be dropped into bank accounts with no questions asked and no back taxes owed. Once deposited the amount will generate interest income that will be taxed appropriately but the depositor will not be asked how they earned the money or if they paid taxes on it earlier.

Carrying out demonetization without appropriate consultation with the relevant departments - specifically without reading the Agriculture Ministry into the process is just wrong.

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