Why India's War on Cash Is a Warning to the U.S. - TheStreet

India's economy crumbled in just weeks, all because of a misguided war on cash. This should be a lesson to anyone pushing for a cashless society.

While Americans were going to the polls on Nov. 8, India's Prime Minister Modi made an announcement that all existing large-denomination bills would need to be deposited in banks in exchange for new bills. The bills in question accounted for almost all the cash in the economy.

The request was startling. The result: India's economy ground to a halt.

"PMI data for December indicated that the rupee demonetisation [sic] took a toll on manufacturing performance," states a recent report from IHS Markit.

The same report says the Nikkei India Manufacturing PMI, roughly equivalent to the ISM Manufacturing Index, fell below 50 for the first time in 2016. Indicating a contraction, it fell to 49.6 in December from 52.3 the previous month.

"They [the Indian government] took a huge amount of money out of circulation: Most people there don't have bank accounts or credit cards," says Steve Hanke, professor of applied economics at the Johns Hopkins University.

The lack of people with bank accounts meant many folks could not switch existing large bills for new ones. They were just left with worthless old currency.

"The economic impact was a big crunch in the money supply, and as a result, the economy is going into recession," says Hanke.

In short, the collapsing money supply squeezed the mojo out of an economy that was hopping along just a few months ago, though the government's chief economic adviser said in a January report that the pullback has begun to ease.

The motivation for Modi's cash grab was to stamp out corruption and other criminality.

That's pretty much the stated reason that people in the U.S say they want to eliminate hundred-dollar bills. They want to crack down on illegal activity. I wrote about the matter last year.

Will the U.S. have more success than India? Possibly, but the move, if it comes, will not be without consequences.

The U.S. won't suffer the same economic problems that Modi has inflicted on India. That's in large part because most people can get a bank account and large transactions can get handled electronically.

But in some ways, the U.S. is the same as India, because it scrapping certain notes will have unintended consequences.

The Law of Unintended Consequences

Currency that you are free to use for whatever purpose you choose, illegal or legal, has more value than money that has restrictions.

Take the Swiss franc, for instance. It has consistently rallied against the dollar.

In 1971, 1 USD would fetch 4.3 Swiss francs, vs. around one franc now. It's also worth noting, the Swiss still use cash for large transactions. When you understand that using cash to buy a new car in the U.S., the government would be all over you, it's easy to see the attraction of the Swissy vs. the greenback.

So what would happen if the U.S. scrapped the C-note?

"You'll see one or more players step into the market and supply a medium of exchange," says Robert E. Wright, professor of political economy at Augustana University. "It's the convenience of the thing."

In the simplest terms, private money will be created that suits the market place better than government-controlled money that lacks privacy.

We've already seen the growth of so-called Crypto-currencies such as Bitcoin. Scrapping the hundred-dollar bill would give such currencies a boost.

For investors, any move toward banning large bills would likely lift prices for Bitcoin Investment Trust (GBTC) , which holds bitcoin, and similar alternative currencies. Likewise, expect gold prices to rise, too, so watch the SPDR Gold Shares (GLD) - Get Report exchange-traded fund, which holds bars of solid bullion.

The author is an independent contributor. He owns none of the securities mentioned in this story.