Vivek Dehejia, Resident Senior Fellow at IDFC Institute, examines whether demonetisation threatens the trust that people have in the legal tender. 

"...over the course of history, trust in fiat currency has most often been weakened by erratic and high inflation, and shattered after episodes of hyperinflation. This is a much bigger problem than the one-time wealth effect on holders of black money due to demonetisation...

The question that arises, therefore, is whether this non-system is a sensible way both for national fiat currencies to set their monetary policies and for such currencies to be linked together through exchange rates? In a world of fiat currency, there is of necessity the imperative to select a nominal anchor, given that it is no longer the price of gold or some other commodity. Before the great financial crisis, and even for some time following it, the consensus fixed on inflation targeting, which we are also now practising in India. Thus, the anchor of monetary policy is the rate of consumer price index (CPI) inflation, which is stipulated to fall within a band...

The cost of [unconventional monetary policies (UMPs)] has been to distort seriously the structure of the economy, with zero or negative interest rates penalizing savers and rewarding those who can park large amounts of idle cash in bubbly assets, whether property, vintage cars, or old master artworks. Asset price bubbles have been created, and they will be pricked in one way or another—painlessly, perhaps, or more likely, by inflicting pain on the real economy, as in the great crisis we have lived through...

...there is the opportunity to engage in a serious debate, at long last, on whether the US, and by extension other economies that wish to fix to the dollar, is ready to embrace sound money and cast aside the fragile and ephemeral trust in a non-commodity based fiat currency as at present...

Before partisans wheel out the old John Maynard Keynes chestnut that gold has been rendered a “barbarous relic”, one might hasten to point out that a modern commodity-based currency need not reproduce the classical gold standard, but be based on a weighted basket of commodities. The idea would be that the stock of money would grow and contract as a function of a broad measure of the world’s stock of resources and not be a function of the whim of a particular central banker in thrall to today’s fads and fashions..."

Read the full article published in Livemint here.