news

There's no gratitude in debt

With the collapse of the Soviet Union, communism failed. However, all over the West since 2008, capitalism, debt at interest and fractional reserve banking have failed to provide real economic solutions and lift people out of poverty.

One of the last dominos to fall was Greece, the cradle of democracy. No army invaded them, no navy blockaded them and no air force bombed them, but this is surely a proud nation in absolute economic ruins.

Also there was Cyprus, and in some ways, how the European Union dealt with Cyprus was even more shocking than Greece: it was a game-changer.

As part of the 10 billion euro (RM44 billion) Cypriot bailout, the EU required a “bail-in”, which left depositors in Cyprus and elsewhere in the EU living in fear, that a new model was being developed to address bank insolvency.

The “bail-in” involved confiscating 6.75 per cent of the value of bank deposits below 100,000 euros and 9.9 per cent of bank deposits in excess of 100,000 euros.

The depositors were, however, compensated with the equivalent amount in shares in their (largely bankrupt) banks.

Needless to say, the depositors were furious, regarding it as “more interventionist than the Soviet Union”, “totally unfair”, “barbarian”, even regarding the scheme as essentially “stealing”.

On the other hand, the EU argued that it was a “fair” distribution of the bailout burden, since the unsecured bank creditors are ranked after the equity shareholders and before the secured bondholders.

The Cypriot depositors suddenly realised that their deposit money does not belong to them, but it is the bank’s money once deposited in the bank and appears on the bank’s balance sheet as a liability.

Thus, deposits are loans to the bank. The only right that depositors have over this money is the right to demand it back, being “demand deposits”.

So a bank run does not imply a breach of trust, as one would assume, but rather a non-performing unsecured loan. The “bail-in” was a conversion from debt to equity reflecting an insolvency restructure. Essentially, to avoid bankruptcy, the banks forced a haircut on the depositors, by confiscating up to 10 per cent of the value of their deposits.

According to the latest data from the Bank of International Settlements (1Q15), Greece’s total debt-to- gross domestic product ratio is 292 per cent, while Malaysia’s is 188 per cent.

Greece’s private debt is a problem at 129 per cent, but its public debt is worse at 163 per cent, while in Malaysia the concern is not public debt at 53 per cent, but rather private debt at 135 per cent.

Meanwhile, American bail-outs involved the privatisation of profits and the socialisation of losses, since their larger institutions were deemed “too big to fail” and taxpayers had to pay the bill.

In the United Kingdom, the Bank of England’s lender of last resort backfired, as instead of reassuring the public and commercial banks by providing emergency liquidity in times of crisis, it highlighted failing banks, and triggered a bank run, in the case of the Northern Rock bank.

Throughout these incidents across the Western financial landscape, the other safety net for depositors, in the form of available funds from deposit insurance companies, proved to be woefully insufficient.

In terms of Malaysia, the ratio of funds to insured conventional or Islamic deposits is only 0.2 per cent, respectively. That wouldn’t last long.

So what would authorities do to protect banks and their depositors, if a systemic financial crisis hits Asia?

A bailout, a bail-in, leave it to deposit insurance, absorb failing banking institutions with other government agencies that have deeper pockets (actually, that’s a bailout and socialisation of losses), or simply pump money into the system in a similar fashion to the Federal Reserve’s quantitative easing programmes?

Or must we succumb to daunting austerity programmes combined with sales of government assets? There are no easy answers, especially with International Monetary Fund conditionality.

Just ask Indonesia and the infamous photo of former IMF managing director Michel Camdessus standing over former president Suharto with arms folded at the height of the Asian financial crisis.

Prophet Muhammad (peace and blessing be upon him) regularly prayed to God Almighty to seek refuge from being in debt.

This is the problem. We have a fiat currency, which is backed by debt being the assets of the banking system. The monetary balance sheet of the ringgit reveals that it is 0.3 per cent backed by gold and 99.7 per cent backed by debt.

Furthermore, we have a fractional reserve banking system that is growing debt at interest exponentially just to remain solvent. Isn’t that the hallmark of a Ponzi scheme?

And when the system falters, the house of cards comes crashing down and we, the people, have to pay the bill.

Capitalism over-values capital and under-values labour. Socialism is the reverse.

However, the Islamic economic system respects capital and labour, involving participatory profit-and-loss sharing equity finance that imparts justice. This implies a genuine 100 per cent reserve system, with a medium of exchange that retains its value, to achieve price stability.

All nations have experienced an exponential increase in prices, and an equal loss of monetary value, since the collapse of the Bretton Woods gold exchange system in 1971.

This value has been cumulatively transferred. Money supply is increasing at aggregate interest, in relation to demand, the effect of which is higher prices.

We have to lower our standard of living through inflation, so that our wealth is confiscated to pay for interest, which is being transferred to the profit and loss statement of the fractional reserve banking system. This is exactly the opposite of one of the goals of Syariah (maqasid al-Shari’ah), which is to protect wealth (hafiz al-mal).

This is why capitalism is not working and unemployment will only increase when labour is deemed a variable cost and interest is fixed.

Moreover, the interest rate rotates wealth from the poor to the rich, exactly the opposite of the zakat rate, which rotates excess wealth from the rich to the poor.

When we pause to reflect, how can a nation hope to increase its wealth, increase its means of paying others, by charging interest upon itself?

The only entity that gains is the fractional reserve bank, a business model that was established by the Bank of England in 1694, and perfected through the Bank Act of 1844. Why do we have to copy this. England Syariah-compliant?

Another world is possible, but we must be honest with ourselves and diagnose the problem properly.

Just like the great Muslim theologian Al-Ghazali did over 1,000 years ago, we must firmly resist duplicating Western philosophical constructs.

First of all, money is a not a commodity that comes at a price, which can be bought and sold for a profit (interest).

As Al-Ghazali mentioned, the medium of exchange is an instrument of transfer only, a mirror that reflects the value of goods and services.

By redefining the medium of exchange properly, the ability to embark on credit creation and risk-free debt finance at the time-value of money simply disappears.

In the short term, and with regard for the successful development of Asean at a regional level, we should not repeat the mistakes of the Europeans, who designed only a monetary union while forgetting fiscal policy.

Asean could combine monetary with fiscal policy and develop an Asean reference currency that, at the very least, targets monetary value in terms of monetary policy, to genuinely achieve price stability.

This monetary theory of value could alternatively be implemented at a national level, if Asean operates as a common market.

At a national level, by declaring deposits as legal tender, it would take them off the balance sheet of banks. This would not only prevent credit creation, but would protect deposits from the ravages of fractional reserve banking during monetary and financial crises.

At the same time, the issuance of money and the provision of equity finance would be separated.

Banks would be converted into investment or wealth management institutions, where the provision of equity finance would be in the form of profit and loss risk-sharing partnerships.

Indeed, absent of interest, equity finance is more efficient than debt finance at growing an economy, by increasing production and employment.

Otherwise, we will just have to learn the hard way, with more of our wealth being transferred, more credit creation and more financial instability.

Josiah Stamp, a former director of the Bank of England, admitted in 1937 at a public address in Central Hall, Westminster, that: “The modern banking system manufactures money out of nothing… Banking was conceived in iniquity and born in sin… If you want to be slaves of the bankers, and pay the costs of your slavery, then let the bankers create money.”

Dr. Adam Abdullah is an assistant professor at IIUM’s Institute for Islamic Banking and Finance specialising in Islamic economics and finance and a member of the International Council of Islamic Finance Educators

Most Popular
Related Article
Says Stories