My thoughts on today's news:
How will the ban of Rs.500 and
Rs.1000 notes affect you as a common man?
First, people who have a lot of
cash, legally earned, will deposit it in the bank. This will increase bank's
deposits by a huge margin.
This will also increase the lending
activity because banks have a CRR (cash reserve ratio) to maintain and with
more deposits they can do more lending.
Credit (loans) will become easier
and interest rates may come down. More loans given out increases broad money
supply and creates inflation. But this will happen slowly, not over-night.
What will happen over-night is heavy
deflation.
Because people who have illegally
earned this money may be afraid to deposit it in a bank. There are people with
crores of cash, black money, earned through illegal ways, such as corruption,
smuggling etc.
Some of these guys will try to find
this money into a bank, but they have to declare it as income and pay taxes on
it. Then the question arises - how did they make this income in the first
place. Most of these guys will chicken out, count their blessings and just
waste the money they have stashed somewhere in Rs.500 and Rs.1000 notes.
This will reduce the total currency
circulation in the economy - leading to deflation. Deflation increases the
value of money that we have because the total money supply goes down but the
commodities and things available in the market have not gone down.
[Example] If there are 100 widgets
and 100 coins, each widget's value would be Rs.1. If there are 100 widgets and
only 50 coins, each widget would cost Rs.0.50 only. Which means with each coin,
you can buy 2 widgets.
The inflation and deflation will
balance out each other on some level. But it is going to take some time for the
inflation to happen because lending activities do not happen over night.
Deflation will happen first, for the
next 6 months to 1 year. Gold prices will drop, stocks & commodities will
drop. Everyone will get excited and congratulate the government for making this
move.
Then slowly, as lending activity
goes up, the broad money supply will go up and prices of all things would go
up, slowly and steadily.
Now no one can predict the extent of
the deflation and inflation. In an ideal world, if 100% of the people who have
Rs.500 and Rs.1000 notes have it as white money, then we would see only
inflation. If a lot of these are black money and if many people decide to waste
the money instead of depositing it, then we will have deflation in the short
term.
If you see heavy deflation and heavy
drop in prices, then it means that India has a lot of corrupt people who earned
money in illegal ways, too afraid to deposit the money in a bank!
And my gut feeling says that we
would see heavy deflation in the next 6 months. If you bet on this, then buy
gold, stocks of asset-heavy companies.
What about Real estate?
It would crash slowly and recover
quickly. That's because, in real estate, there is no index price like gold and
it is fixed by the market in a demand-supply balance.
Let's say I have a real estate plot
- a 40 x 60 plot which I bought for 1 crore a year back. Let's the say market
value of it until yesterday was 1.5 crores. I would still think that the value
of it would be 1.5 crores and I wouldn't sell it for less than that.
But if I want to sell it because I
need money, I wouldn't get a buyer immediately. Because most buyers in real
estate are doing the transactions in black money. Potential buyers would tell
me that they don't have 1.5 crores in white money, so they will not be able to
buy it.
With less potential buyers in the
market and fewer people having white money, the demand for the land goes down
and drives down its price. If I yield and sell it for 1.2 crores, I am driving
down the market price in the entire locality.
RE crash will happen slowly because
people will yield to the pressure slowly and start selling at lower prices
because suddenly the pool of potential buyers have gone down. I predict that RE
prices would dip to lowest by end of 2017 and then start moving up again as
inflation catches up.
[Disclaimer: Currencies, inflation,
deflation, payments and banking is a very interesting subject for me and I have
read a lot of books on this topic. This is just my opinion, but I am bold
enough to share this in the public domain. However, I may be wrong. Let's see
how this pans out. Today is an iconic day in India's journey. History in the
making. Nov 8th 2016! This would be a day to remember.]
