Demonetization, Mr. Market and Me

On the 8th of November 2016, the PM of India announced that the Rs 500 and Rs 1000 notes would no longer be legal tenders. This announcement was followed by an unprecedented media coverage of the common man and his problems due to the demonetization, and a range of emotions from the media, the political parties, the experts and the public- frenzy, panic, anxiety, frustration, anger, happiness and sadness. I know someday, we will be able to say, whether this was a stroke of genius or madness- but not today, not now! That’s because, the economy is a complex system and in a complex system, one can never be sure of what will cause what reaction or what chains of reaction! Yet, we cling on to experts to guide us through these times. I for one, hope to never forget these times!

Here are a few thoughts of mine on what I think of this. Most of my thoughts are disjointed, but I will try to present a cohesive point of view.

  • A majority of the predictions wont work, including mine. There are simple systems and complex systems. A simple system has a limited range of inputs and a limited range of outcomes and over time we as humans, have learnt what inputs would cause what outcomes. Take for example, boiling water in a kettle.We know how much heat and time would be needed to boil the water. We also know that to boil water faster, we could provide more heat or reduce the water or both. Likewise, we also know what part to repair or tweak to improve the performance of a car or a washing machine. But an economy is a complex system. The range of inputs are wide and varied, the number of sub-systems and entities in it millions and billions, which makes it difficult to predict the outcome/ outcomes. Secondly, in complex systems, there can be consequences and consequences of those consequences. For example, when the economy was opened up in 1991, we had a range of emotions, like we do now. It was hard to predict back then as it is now on how exactly things will shape up. 25 years since then, we can say it was a stroke of genius on the part of Rao and Dr. Singh to open up the economy. 25 years from today, will it still be a masterstroke-  I don’t know. As Taleb says, the most wise answer to a question on complex systems, would be a -‘I don’t know’. So will demonetization clean up India, stop terror funding, bring real estate within reach or make India a developed country- I don’t know. And neither do you, or Indian Express or NDTV or The Hindu or an economist with double PHD know how exactly things will shape up. So why are they predicting how things will shape up? If you do indeed want to predict, predict using the incentives and disincentives of the system.
  • As humans our behaviors will be shaped by the incentives and disincentives of the system. Take traffic on the road, for example. In places, where the traffic police actively checks, levies heavy fines for breaking the rule, where there are cameras taking pictures of lawbreakers, traffic usually tends to be more orderly. Likewise, a place that a huge tolerance for all kinds of lawbreakers, usually tends to have the worst traffic management. So if, the government does make it difficult to deal in cash, we will tend to go with cashless or digital options. If the government makes it difficult to keep accepting bribes, we will have transactions that require lesser or no bribes. If the government punishes the corrupt and the lawbreakers, then we will have more honest and law abiding citizens. So you see, the incentives and disincentives that the government places in the system will determine how we shape up as a society. So if the PM does indeed create more disincentives to be corrupt (demonetization being one of them), then the society will respond accordingly. And while we are talking about, incentives and disincentives, we must talk about Kantian Fairness as well.
  • Kantian Fairness. Say you accepted a bribe the first time and are caught and made an example out of it. Is that fair? Say you accepted a bribe, but it was due to a genuine need for money; does the punishment meted to you fair? Say it was a sick child and you needed urgent money for treatment and hence you resorted to bribe taking and was subsequently caught. Are the consequences fair? Should the system pardon you because it was your first time or your genuine need? I can go on making this question more and more difficult for you and ideally your answer shouldn’t change at all. If the system that you create, causes problems for a few but on the whole is good for the society in the long run, then the system is good. So just because there is pain or short term pain, does not mean its not good for the society. In the long term, we have a remarkable ability to adapt. We lived for 44 years without economic liberalization and only 25 years with it. Almost twice as many! Yes- thinking back now, it must’ve been painful with lack of growth and limited choices before 1991, but life went on. Likewise, life will go on as we adapt to the incentives and disincentives in the new system.
  • The Indian Economy. The Indian economy, is robust, in my limited opinion. We as a nation are now consuming more products and services ourselves in addition to exports. We are a young nation (I think the youngest by average age), and are likely to aspire for more, consume more, innovate more. If the government does really create incentives to innovate and is business friendly and does punish the lawbreakers, then the economy is going to do even better. On the other hand, if the government tolerates corruption in its own party, then it creates incentives for others to indulge in the same. On the whole, I think our economy is strong and robust and is likely to rebound from this shock and grow.
  • And what about Mr. Market?
    • Mr. Market watches the news 24×7.
    • Mr. Market believes the experts.
    • Mr. Market is short termist.
    • Mr. Market is prone to pangs of emotions.
    • Mr. Market does not think in terms of systems, processes and outcomes.
  • And finally, a couple of notes to myself.
    • To beat Mr. Market, do the opposite. (see above)
    • Have a Buy List ready. You never know, when Mr. Market will panic.
    • Stay Calm. This too shall pass.
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