Introduction
We live in exceptional times. The financial panic in the USA
What has happened to financial markets in recent months is without precedent in the history of recent times. The same bourgeois economists who previously denied the possibility of a slump are now talking about the most serious crisis for sixty years. Alan Greenspan, former chairman of the US Federal Reserve, has described the current financial crisis as "probably a once-in-a-century event".
They actually mean 79 years, since there was no crisis at all in 1948. But economists are superstitious people and are afraid to mention 1929, just as the ancient Israelites were afraid to mention the name of their god, in case something unpleasant were to occur. They are all worried about confidence in the markets, since they all fervently believe that it is confidence (or the lack of it) that is the real cause of booms and slumps. In reality, however, booms and slumps are rooted in objective conditions. The rise and fall of confidence reflects actual conditions, although it can then itself become part of these conditions, helping to drive the market up - or, as in this case, down.
In the last few months AIG, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers and Merrill Lynch, companies that were thought to be too big to fail, have all either filed for bankruptcy, been "bailed out" by the government, or been nationalized. As the seriousness of the economic crisis begins to dawn on people, a mood is being prepared in society the like of which has not been seen for many years. This morning (September 26) came the news of the collapse yet another US bank, Washington Mutual, which was closed by the US
The estimates of the economists are constantly being revised downwards. Six months ago the International Monetary Fund estimated more than $1,000bn (€691bn, £546bn) in financial sector losses and predicted a sharp slowdown in the global economy. Most economists criticized this for being too pessimistic. Now they are singing a different
The price of oil has acquired a feverish character, with wild swings up and down. As the dollar fell, stocks tumbled and the price of oil jumped again after the previous steep fall. A 17 per cent increase on Monday, September 22, was the biggest daily price rise ever, and larger even than during the invasion of Iraq
As a result of the economic and social convulsions, many people are beginning to question the nature of an economic system that could produce such abominations. When the capitalist state itself is compelled to nationalize financial institutions, the idea will gradually become generalized: why do we need private bankers and capitalists at all? For this reason, the politicians avoid the word nationalization as the devil avoids holy water. At all costs they seek to find ways in which the state can provide capital to banks in ways that do not imply nationalization. They struggle to invent forms of capital that leave ownership and control in private hands. But in the end, they are compelled against their will to take over the ailing banks to prevent them from collapsing. This is a damning indictment of private ownership of a key sector of the economy.
Although it would appear a paradox, it is no coincidence that the country where politicians are shouting most loudly against the sins of the market and the greed of the financiers is precisely the United States
Is it not grotesque that bosses at defunct Bear Stearns were amassing fortunes while pursuing reckless business strategies that led to the collapse? And why should the American taxpayers, most of who are not well off, foot the bill for $700 billion to bail out the big financial institutions? As of September 30, 2007 the federal government was in a $53,000bn dollar fiscal hole, equal to $455,000 per household and $175,000 per person. This burden is rising every year by $6,600-$9,900 per American. Medicare represents $34,000bn of this deficit and the related Medicare trust fund is set to run out of money within 10 years. The Social Security program is projected to have negative cash flow within about 10 years. Whoever wins the presidential election and whoever controls Congress will have to preside over deep cuts in living standards? The same capitalists who have taken billions from the government and the Federal Reserve are demanding tough budget controls, cuts in federal spending, a comprehensive reform (read reduction) of entitlement to healthcare.
Whatever they do now will be wrong. If they sign the deal, they will earn the hatred of millions of ordinary Americans. One woman, interviewed last night on British television, when asked what she thought of the proposed bail-out, answered bitterly: "I have just come off an eleven hour shift and I work 60 hours a week. Now they want to take $2,300 off my pay to give to the bankers!" This must be typical of the attitude of millions of ordinary people in the USA USA
The bourgeoisie suffers from periodic bouts of manic depression, passing rapidly from extreme optimism to the depths of despair. On both sides of the Atlantic , where previously there was "irrational exuberance", now there is gloom and doom. It was ever thus: the bourgeoisie always sways between the two extremes of manic depression. One minute the party is in full swing and vast fortunes are being made; the next, the whole thing is deflated and misery abounds. When the collapse finally arrives it is like the morning after a wild party. The night before, people were happily inebriated with not a care in the world. Now, in the cold light of morning it is a very different story. Men and women are painfully aware of the excesses of the night before. They solemnly swear that they will never touch strong drink again, and they are quite sincere - until the next party.
"The Great Depression began less than 80 years ago but, then again, we are in a different century. Whether or not this will be the worst such upheaval the world has to face between now and 2099, the fact that nothing as bad as the Depression occurred between the 1930s and now is in itself remarkable." This comment is interesting on two counts: the same people who for years have been denying that there was any possibility of a repeat of 1929 and the Great Depression now, without blinking an eyelid, say that it is not only possible, but that it is remarkable that it has not happened - yet.
The fall in prices during a crisis merely balances out their earlier inflation. In that sense one can speak of a "correction". However, we pointed out long ago how the bourgeois economists have repeatedly changed the terminology describing an economic slump in order to make it appear less serious than it is. At one time they used the word panic, then slump, then depression, then recession, until now they have finally arrived at correction. After all, if we accept the miraculous healing powers of the market, which by art of magic regulates itself without any conscious human involvement, how can we object to the market "correcting" itself?
Our epoch is the epoch of monopoly capitalism. One of the features of this is the complete domination of finance capital. This domination has gone further in the USA and Britain Britain Britain Britain is being dragged towards recession following the USA
Birth of the crisis in the form of time line & events
Defined as "a severe shortage of money or credit", the start of the phenomenon has been pinpointed as 9 August 2007 when bad news from French bank BNP Paribas triggered sharp rise in the cost of credit, and made the financial world realise how serious the situation was.
The problems, however, started much earlier.
GROWING SUB-PRIME PROBLEMS
After a two year period between 2004 and 2006 when US interest rates rose from 1% to 5.35%, the US
APRIL-AUGUST 2007: SUB-PRIME CONTAGION
April
New Century Financial, which specialises in sub-prime mortgages, files for Chapter 11 bankruptcy protection and cuts half of its workforce.
As it sold on many of its debts to other banks, the collapse in the sub-prime market begins to have an impact at banks around the world.
July
Investment bank Bear Stearns tells investors they will get little, if any, of the money invested in two of its hedge funds after rival banks refuse to help it bail them out.
Federal Reserve chairman Ben Bernanke follows the news with a warning that the US sub-prime crisis could cost up to $100bn (£50bn).
AUGUST 2007: SCALE OF THE CREDIT CRISIS EMERGES
9 August 2007
Investment bank BNP Paribas tells investors they will not be able to take money out of two of its funds because it cannot value the assets in them, owing to a "complete evaporation of liquidity" in the market. It is the clearest sign yet that banks are refusing to do business with each other.
The European Central Bank pumps 95bn euros (£63bn) into the banking market to try to improve liquidity. It adds a further 108.7bn euros over the next few days. The US Federal Reserve, the Bank of Canada and the Bank of Japan also begin to intervene.
17 August
The Fed cuts the rate at which it lends to banks by half of a percentage point to 5.75%, warning the credit crunch could be a risk to economic growth.
21 August
28 August
German regional bank Sachsen Landesbank faces collapse after investing in the sub-prime market; it is sold to larger rival Landesbank Baden-Wuerttemberg.
SEPTEMBER 2007: A RUN ON A BANK
3 September
German corporate lender IKB announces a $1bn loss on investments linked to the US sub-prime market.
4 September
The rate at which banks lend to each other rises to its highest level since December 1998.
The so-called Libor rate is 6.7975%, way above the Bank of England's 5.75% base rate; banks either worry whether other banks will survive, or urgently need the money themselves.
13 September
The BBC reveals Northern Rock has asked for and been granted emergency financial support from the Bank of England, in the latter's role as lender of last resort. Northern Rock relied heavily on the markets, rather than savers' deposits, to fund its mortgage lending. The onset of the credit crunch has dried up its funding.
A day later depositors withdraw £1bn in what is the biggest run on a British bank for more than a century. They continue to take out their money until the government steps in to guarantee their savings.
18 September
The US Federal Reserve cuts its main interest rate by half a percentage point to 4.75%.
19 September
After previously refusing to inject any funding into the markets, the Bank of England announces that it will auction £10bn.
OCTOBER 2007: MAJOR LOSSES BEGIN TO EMERGE
1 October
Swiss bank UBS is the world's first top-flight bank to announce losses - $3.4bn - from sub-prime related investments. The chairman and chief executive of the bank step down. Later, banking giant Citigroup unveils a sub-prime related loss of $3.1bn. A fortnight on Citigroup is forced to write down a further $5.9bn. Within six months, its stated losses amount to $40bn.
30 October
Merrill Lynch's chief resigns after the investment bank unveils a $7.9bn exposure to bad debt.
NOVEMBER 2007: UK
29 November
The Bank of England reveals the number of mortgage approvals has fallen to a near three-year low.
30 November
The Council for Mortgage Lenders (CML) issues the starkest warning yet of the impact of the credit crunch on the mortgage market, saying that without more funding available on financial markets, mortgage lenders will not be able to offer as many mortgages.
DECEMBER 2007: HELP IS AT HAND
6 December
13 December
The US Federal Reserve co-ordinates an unprecedented action by five leading central banks around the world to offer billions of dollars in loans to banks. The Bank of England calls it an attempt to "forestall any prospective sharp tightening of credit conditions". The move succeeds in temporarily lowering the rate at which banks lend to each other.
17 December
The central banks continue to make more funding available.
There is a $20bn auction from the US Federal Reserve and, the following day, $500bn from the European Central Bank to help commercial banks over the Christmas period.
NEXT UP: THE BOND INSURERS
19 December
Ratings agency Standard and Poor's downgrades its investment rating of a number of so-called monoline insurers, which specialise in insuring bonds. They guarantee to repay the loans if the issuer goes bust. There is concern that insurers will not be able to pay out, forcing banks to announce another big round of losses.
9 January 2008
The World Bank predicts that global economic growth will slow in 2008, as the credit crunch hits the richest nations.
18 January
A rush to withdraw money from its commercial property funds forces Scottish Equitable to introduce delays of up to 12 months for investors wanting to take their money out.
It blames the rush of withdrawals on concerns about the US
21 January
Global stock markets, including London
22 January
The US Fed cuts rates by three quarters of a percentage point to 3.5% - its biggest cut in 25 years - to try and prevent the economy from slumping into recession. It is the first emergency cut in rates since 2001. Stock markets around the world recover the previous day's heavy losses.
31 January
A major bond insurer MBIA, announces a loss of $2.3bn - its biggest to date for a three-month period -blaming its exposure to the US
FEBRUARY - MARCH 2008: BIG NAME CASUALTIES
7 February
US Federal Reserve boss Ben Bernanke adds his voice to concerns about monoline insurers, saying he is closely monitoring developments "given the adverse effects that problems of financial guarantors can have on financial markets and the economy". The Bank of England cuts interest rates by a quarter of one percent to 5.25%.
8 February
In the UK , the latest CML figures show the number of homes repossessed in the UK rose to 27,100 in 2007, its highest level since 1999.
10 February
Leaders from the G7 group of industrialised nations say worldwide losses stemming from the collapse of the US
17 February
After considering a number of private sector rescue proposals, including from Richard Branson's Virgin Group, the government announces that struggling Northern Rock is to be nationalised for a temporary period.
7 March
In its biggest intervention yet, the Federal Reserve makes $200bn of funds available to banks and other institutions to try to improve liquidity in the markets.
17 March
Wall Street's fifth-largest bank, Bear Stearns, is acquired by larger rival JP Morgan Chase for $240m in a deal backed by $30bn of central bank loans.
A year earlier, Bear Stearns had been worth £18bn.
28 March
Nationwide predicts UK house prices will fall by the end of the year, revising its previous forecast of no change in prices.
APRIL 2008: THE 100% MORTGAGE IS CONSIGNED TO HISTORY
2 April
Moneyfacts, which monitors financial products, says 20% of mortgage products have been withdrawn from the UK market in the previous seven days. Five days later the 100% mortgage disappears when Abbey withdraws the last home loan available without a deposit.
8 April
The International Monetary Fund (IMF), which oversees the global economy, warns that potential losses from the credit crunch could reach $1 trillion and may be even higher. It says the effects are spreading from sub-prime mortgage assets to other sectors, such as commercial property, consumer credit, and company debt.
10 April
The Bank of England cuts interest rates by a quarter of one percent to 5%.
11 April
A warning is issued by the CML that the amount of funding available for mortgages in the UK
15 April
Confidence in the UK
But it does add that the situation is good news for buyers with large deposits who can buy property that was previously out of reach.
21 April
The Bank of England announces details of an ambitious £50bn plan designed to help credit-squeezed banks by allowing them to swap potentially risky mortgage debts for secure government bonds.
APRIL - JUNE 2008: BANKS PASS
22 April
Royal Bank of Scotland announces a plan to raise money from its shareholders with a £12bn rights issue - the biggest in UK
25 April
Persimmon becomes the first UK house builder to announce major cutbacks, citing the lack of affordable mortgages and a fall in consumer confidence. It adds sales have fallen by a quarter since the beginning of the year.
29 April
The CML says the number of new mortgages approved in March slipped 44% to 64, the lowest monthly number since records began in 1999.
30 April
The first annual fall in house prices for 12 years is recorded by Nationwide. Prices were 1% lower in April compared to a year earlier after a "steep decline" in home buying over the previous six months. Later in the week, figures from the UK
2 May
More than 850 companies went into administration between January and March, government figures show, a rise of 54% on the previous year. Retail and construction firms are hardest hit.
22 May
Swiss bank UBS, one of the worst affected by the credit crunch, launches a $15.5bn rights issue to cover some of the $37bn it lost on assets linked to US
19 June
There are significant developments in two major credit crunch-related investigations in the US
25 June
Barclays announces plans to raise £4.5bn in a share issue to bolster its balance sheet.
The Qatar Investment Authority, the state-owned investment arm of the Gulf state, will invest £1.7bn in the British bank, giving it a 7.7% share in the business. A number of other foreign investors increase their existing holdings.
JULY 2008: MAJOR LENDERS ON THE EDGE
8 July
The gloomy findings of a survey of its members prompt the British Chambers of Commerce (BCC) to suggest that the UK is facing a serious risk of recession within months. Meanwhile, the FTSE 100 stock index briefly dips into a "bear market", in which the market suffers a 20% fall from its recent highs.
13 July
US mortgage lender IndyMac collapses - the second-biggest bank in US
14 July
Financial authorities step in to assist America's two largest lenders, Fannie Mae and Freddie Mac. As owners or guarantors of $5 trillion worth of home loans, they are crucial to the US
21 July
Just 8% of HBOS investors agree to take up the new shares offered in its £4bn rights issue, because they are priced higher than existing shares are trading on the stock market. But HBOS still gets the £4bn it wanted, as the unsold new shares are bought by the issue's underwriters.
31 July
AUGUST - SEPTEMBER 2008: GIANTS SUFFER
4 August
Global banking giant HSBC warned that conditions in financial markets are at their toughest "for several decades" after suffering a 28% fall in half-year profits. Of Europe's top banks, HSBC has among the heaviest exposure to the troubled US
22 August
The bad news continues with revised figures from the ONS revealing that the UK
28 August
Nationwide reveals that UK
A day later Bradford and Bingley posts losses of £26.7m for the first half of 2008, blaming surging mortgage arrears for a rise in impairment.
Looking ahead, it warned it expected arrears to remain at high levels for the rest of the year.
30 August
Chancellor Alistair Darling warns that the economy is facing its worst crisis for 60 years in an interview with the Guardian newspaper, saying the current downturn would be more "profound and long-lasting" than most had feared.
1 September
Official figures from the Bank of England show a slump in approved mortgages for July.
Meanwhile, while the pound falls to record lows of 81.21 pence against the euro and two-year lows of $1.80.
2 September
In an effort to kick-start the UK UK
4 September
The Bank of England leaves rates on hold at 5% while the latest figures from the Halifax show that house prices in England and Wales
5 September
A raft of negative news from around the world sees the FTSE notch up its steepest weekly decline since July 2002. The US
6 September
The Halifax US
7 September
Mortgage lenders Fannie Mae and Freddie Mac - which account for nearly half of the outstanding mortgages in the US - are rescued by the US government in one of the largest bailouts in US history. Treasury Secretary Henry Paulson says the two firms' debt levels posed a "systemic risk" to financial stability and that, without action, the situation would get worse. At the same time, in the UK
9 September
More bad news emerges for the UK UK
10 September
Wall Street bank Lehman Brothers posts a loss of $3.9bn for the three months to August.
The announcement comes against a background of further dire economic warnings from the European Commission, which warned that the UK, Germany and Spain will go into recession by the end of the year.
15 September
After days of searching frantically for a buyer, Lehman Brothers files for Chapter 11 bankruptcy protection, becoming the first major bank to collapse since the start of the credit crisis. Former Federal Reserve chief Alan Greenspan dubs failure as "probably a once in a century type of event" and warns that other major firms will also go bust. Meanwhile fellow US
16 September
The US Federal Reserve announces an $85bn rescue package for AIG, the country's biggest insurance company, to save it from bankruptcy. AIG gets the loan in return for an 80% public stake in the firm.
17 September
25 September
In the largest bank failure yet in the United States
The group was hit by mortgage defaults the collapse of the US
28 September
The credit crunch hits Europe 's banking sector as the European banking and insurance giant Fortis is partly nationalised to ensure its survival. It is seen as too big a European bank to be allowed to go under. Authorities in the Netherlands , Belgium and Luxembourg US
29 September
In Britain Spain 's Santander
Wachovia, the fourth-largest US bank, is bought by its larger rival Citigroup in a rescue deal backed by the US US
It opens up new uncertainties about how banks will deal with their exposure to toxic loans and how credit markets can begin to operate more normally. Wall Street shares plunge, with the Dow Jones index slumping 7% or 770 points, a record one-day point fall.
30 September
Dexia becomes the latest European bank to be bailed out as the deepening credit crisis continues to shake the banking sector. After all-night talks the Belgian, French and Luxembourg
Separately, the Irish government says it will guarantee all deposits in the country's main banks for two years. In the UK
OCTOBER-NOVEMBER 2008: THE FIGHTBACK
1 October
Stock markets stabilise ahead of a vote in the Senate, which eventually approves an amended $700bn financial rescue bill. Market confidence that Lloyds TSB's takeover of HBOS will not be derailed by stock market volatility sees HBOS shares rise 20%.
A report says that French Finance Finister Christine Lagarde calls for an emergency EU bail-out fund for banks threatened with failure. The EU says it is looking at whether Ireland
3 October
The US House of Representatives passes a $700bn (£394bn) government plan to rescue the US financial sector.
The 263-171 vote was the second in a week, following its shock rejection of an earlier version on Monday. The UK
6 October
The deal to save Hypo Real Estate, reached with private banks, is worth 15bn euros more than the first rescue attempt, which fell apart a day earlier. World stock markets react badly to the ongoing turmoil. The German government says it will not pass new legislation to provide extra protection for savers. Chancellor Angela Merkel had earlier said that no German savers would lose any money. But it emerges that this was a was a political pledge, rather than one which would see it change laws on banking deposits. However Denmark had already responded by giving a 100% guarantee on savings, while Sweden
7 October
The Icelandic government takes control of Landsbanki, the country's second largest bank, which owns Icesave in the UK
8 October
10 October
Amid widespread fears of a global recession, Asian, European and US
11 October
Finance ministers from leading industrialised nations pledge action to tackle the financial crisis. The G7 nations issue a five-point plan of "decisive action" to unfreeze credit markets, after a meeting in Washington
13 October
The UK government announces plans to pump billions of pounds of taxpayers' money into three UK banks in one of the UK's biggest nationalisations. Royal Bank of Scotland (RBS), Lloyds TSB and HBOS will have a total of £37bn injected into them.
14 October
The US US
15 October
The number of people out of work in the UK US US
17 October
French savings bank Caisse d'Epargne announces a loss of 600m euros (£466m) in a "trading incident" which the bank said was triggered by what it called "extreme market volatility" amid the market crash during the week of 6 October.
19 October
20 October
24 October
In Denmark
The UK
28 October
30 October
The Federal Reserve cuts its key interest rate from 1.5% to 1% in a widely expected move, as it aims to avoid a possible US US
3 November
French bank Societe Generale sees net profit slump by 84% in the third quarter, hit by the credit crisis. Net profits in the three months to the end of September fell to 183m euros ($235m; £145m) from 1.12bn euros in the same period a year before.
6 November
The International Monetary Fund (IMF) approves $16.4bn Ukraine loan to bolster its economy, shaken by global financial turmoil. The Bank of England slashes interest rates unexpectedly from 4.5% to 3% - the lowest level since 1955. The European Central Bank lowers eurozone rates to 3.25% from 3.75% in an attempt to prevent a recession.
9 November
12 November
US Treasury Secretary Henry Paulson says the government abandoned plans to use some of the $700bn bail-out money to buy up banks' bad debts and decided instead to concentrate on improving the flow of credit for the US
14 November
The eurozone officially slips into recession after EU figures show that the economy shrank by 0.2% in the third quarter. Leaders of the G20 developed and emerging economies gather in Washington
17 November
Two separate studies put the US economy firmly "in recession" after preliminary data shows GDP contracted 0.3% in the third quarter.
20 November
The International Monetary Fund (IMF) approves a $2.1bn (£1.4bn) loan for Iceland, after the country's banking system collapsed in October. It is the first IMF loan for a Western European nation since 1976.
23 November
The US
24 November
The UK UK
25 November
The International Monetary Fund (IMF) approves a $7.6bn (£5.1bn) loan for Pakistan to shore up the country's economy. Pakistan
26 November
The European Commission unveils an economic recovery plan worth 200bn euros which it hopes will save millions of European jobs. The scheme aims to stimulate spending and boost consumer confidence.
1 December
The US recession is confirmed by the National Bureau of Economic Research, a leading panel including economists from Stanford, Harvard and MIT. The committee concludes that the US
4 December
French President Nicolas Sarkozy unveils a 26bn euro stimulus plan to help France Denmark
Impact on real economy
THE global financial crisis of September-October 2008 is a major ongoing financial crisis, the worst of its kind since the Great Depression of 1930s. It became prominently visible in September, 2008 with the failure, merger or conservatorship of several large United States-based financial institutions. The underlying causes leading to the crisis have been reported in business journals for many months before September with commentaries about the financial stability of the leading US and European investment banks, insurance companies and mortgage banks consequent to the sub-prime mortgage crisis.
Beginning with failures of large financial institutions in theUnited States United States and Europe , which further accelerated the liquidity crisis. Political leaders and ministers of finance and central bank governors of the leading nations of the world have coordinated their efforts to reduce fears, but the crisis is persisting and undergoing changes in varying magnitudes and directions. The crisis has its roots in the sub prime mortgage crisis and can now be looked upon as an acute phase of the financial crisis of 2007-2008.
The present scribe thinks the key reason for the global financial crisis, which is blamed on the subprime mortgage crisis, is partially true. Because, theUS
The economy of a country cannot stand on a sustainable level, if t its public life remains debt-oriented instead of savings-dependent. Over and above, with the surge of inflation, especially for food and fuel, the cost of living has shot up throwing them out of liquidity and thereby triggering failures in settlement of debt installments one after another. Under such circumstances, theUS
Now, we will discuss the impact of this global crisis on our economy.
Apparently, the export sector, especially the RMG and remittance will feel the first pinch as the galvanizing effect of the global financial meltdown. The projected havoc will consequently create unemployment in society and reduce the purchasing power of the general masses.
However, this writer differs with the above assumption. According to him, the global crisis originating in the developed world will create new opportunity for our export products as the buyers of those countries will be compelled to buy low-cost RMG products raising the demand for our apparels. On the other hand, the Bangladesh RMG is enjoying a competitive edge overChina and Vietnam
This scribe will now focus on remittance issue. The ongoing global crisis will largely hit heavy and hi-tech industries absorbing white color job holders and skilled laborers whereBangladesh
On the other hand, the continuous price fall of oil will help the international entrepreneurs to undertake new business efforts creating fresh employment opportunities which will ultimately save our remittance flow.
The price of per barrel of oil declined to US $ 65 from that of $ 147 and it is expected that the oil price will hover between $ 80 and $ 90 per barrel in the years to come.
It is also apparently clear that the flow of foreign aid and donation in our annual budget will decline because of the global crisis.
But our national priority should be to reduce the dependency on foreign aid. We have to ensure our self-esteem in the world as a self-dependent nation. We must create food safety net and energy safety net right now to ensure our national growth to withstand the challenges.
The food safety net should be created through enhancing domestic production, meeting shortfall through import in time, adopting stringent program and ensuring adequate supply.
On the other hand, the energy safety net should be created as the pace of development of any nation is intimately linked to its level of energy consumption.Bangladesh
The first benefit with the implementation of food safety net and energy safety net will be in the field of price stability which will directly create new entrepreneurship. New entrepreneurship will lead to generating new employment opportunities, which in turn will create effective demand in the economy through increasing the purchasing power of commonpeople.
Beginning with failures of large financial institutions in the
The present scribe thinks the key reason for the global financial crisis, which is blamed on the subprime mortgage crisis, is partially true. Because, the
The economy of a country cannot stand on a sustainable level, if t its public life remains debt-oriented instead of savings-dependent. Over and above, with the surge of inflation, especially for food and fuel, the cost of living has shot up throwing them out of liquidity and thereby triggering failures in settlement of debt installments one after another. Under such circumstances, the
Now, we will discuss the impact of this global crisis on our economy.
Apparently, the export sector, especially the RMG and remittance will feel the first pinch as the galvanizing effect of the global financial meltdown. The projected havoc will consequently create unemployment in society and reduce the purchasing power of the general masses.
However, this writer differs with the above assumption. According to him, the global crisis originating in the developed world will create new opportunity for our export products as the buyers of those countries will be compelled to buy low-cost RMG products raising the demand for our apparels. On the other hand, the Bangladesh RMG is enjoying a competitive edge over
This scribe will now focus on remittance issue. The ongoing global crisis will largely hit heavy and hi-tech industries absorbing white color job holders and skilled laborers where
On the other hand, the continuous price fall of oil will help the international entrepreneurs to undertake new business efforts creating fresh employment opportunities which will ultimately save our remittance flow.
The price of per barrel of oil declined to US $ 65 from that of $ 147 and it is expected that the oil price will hover between $ 80 and $ 90 per barrel in the years to come.
It is also apparently clear that the flow of foreign aid and donation in our annual budget will decline because of the global crisis.
But our national priority should be to reduce the dependency on foreign aid. We have to ensure our self-esteem in the world as a self-dependent nation. We must create food safety net and energy safety net right now to ensure our national growth to withstand the challenges.
The food safety net should be created through enhancing domestic production, meeting shortfall through import in time, adopting stringent program and ensuring adequate supply.
On the other hand, the energy safety net should be created as the pace of development of any nation is intimately linked to its level of energy consumption.
The first benefit with the implementation of food safety net and energy safety net will be in the field of price stability which will directly create new entrepreneurship. New entrepreneurship will lead to generating new employment opportunities, which in turn will create effective demand in the economy through increasing the purchasing power of commonpeople.
The true reasons
The role of financial markets & their operation process
Over-reliance on self-regulatory capability of the markets is the actual cause for the current breakdown.
Letting the banks do what they want
The stage for the present crisis was set decades ago. Stock trading commissions were deregulated in the 1970s. The Glass-Steagall Act of 1933, which defined the distinction between investment and commercial banks, was repealed in 1999. This deregulation allowed other financial institutions to enter the territory of investment banks by trading stocks. Investment banks also sought refuge in the riskier business of securitization and high leverage (borrowed money). The Securities and Exchange Commission further relaxed the rules for investment banks in 2004, leaving them to essentially regulate them.
House prices never fall
Lower interest rates led to recovery from the 2001 recession, but the Federal Reserve kept interest rates too low for far too long, even when insiders started complaining. The generous credit environment prompted high levels of home equity borrowing funded by a new generation of “creative” mortgage companies. These companies function like hedge funds and exist beyond the regulatory radar. This fueled a speculative spree in the housing market with consumers understanding little of the risk involved in these mortgages. With low interest rates and a lack of regulation, loans began to be offered to subprime borrowers (less credit worthy borrowers) at a higher rate. To lure borrowers, the lenders offered teaser rates, which are lower in the beginning but grow rapidly.
The bubble bursts
The confidence in the housing market did not endure so housing prices began to fall. The position of homeowners became untenable. Borrowers were now defaulting not only due to their inability to pay but also their unwillingness to pay, as their houses were worth less than their mortgage. Appearance of a large number of houses for foreclosure caused housing prices to tumble further. With delinquent loans and houses worth far less, the lenders’ assets deteriorated. By now the subprime mortgage-backed securities were held globally. Investors started withdrawing from lenders. The banks started incurring losses in the derivatives market on their CDS, which existed to provide hedge protection. Banks in U.S. , Europe and Asia collapsed. The two remaining investment banks in the U.S., Goldman Sachs and Morgan Stanley, converted to commercial banks, a status subject to more regulation but with readier access to capital. Wall Street, as was formerly understood, is practically dead.
But Main Street
The failure of the Invisible Hand
The policies of little regulatory oversight were based on the premise that the mortgage companies and investment banks will act in their self interest to protect their shareholders. However, the short-term interests of the managers in mortgage companies were to give out more sub-prime loans quickly. With the instrument of securitization the burden was shifted to other investors, which prompted the lenders to take more risks. It was believed that the investment banks would act in a disciplined way for self-preservation and responsibility and not borrow excessively. But self-regulation rarely works this way.
Financial derivatives evolved as a mechanism to limit risk, but they only helped transfer the risk. Even those who were not willing to take risk are now affected, as it spread throughout the financial system. Experts like Warren Buffet and Felix Rohatyn were always wary of derivatives, equating them to bombs. However, former Federal Reserve Chairman Alan Greenspan, in power during much of the deregulatory period, fiercely opposed tighter regulation of derivatives whenever they came under scrutiny. Greenspan himself admitted in testimony to Congress on October 23 that more regulation is needed to prevent further disaster. Yet, his realization comes much too late. Without adequate institutional regulation the market will fail to curb the “opportunism” of the players. Even if the market does affect self-correction, it might take too long. As we are seeing, a crisis has already precipitated.
Mortgage market and mortgage backed securities
The mortgage market
Subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of residences, to borrowers who do not meet the usual criteria for borrowing at the lowest prevailing market interest rate. These criteria pertain to the down payment and the borrowing household's income level, both as a fraction of the amount borrowed, and to the borrowing household's employment status and credit history. If a borrower is delinquent in making timely mortgage payments to the loan servicer (a bank or other financial firm), the lender can take possession of the residence acquired using the proceeds from the mortgage, in a process called foreclosure.
The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system.
| | Subprime | Alt-A | Jumbo | Agency | ||||||||
| Year | O[1] | I[2] | R[3] | O | I | R | O | I | R | O | I | R |
| 2001 | 190.00 | 87.10 | 46 | 60.00 | 11.40 | 19 | 430.00 | 142.20 | 33 | 1,433.00 | 1,087.60 | 76 |
| 2002 | 231.00 | 122.70 | 53 | 68.00 | 53.50 | 79 | 576.00 | 171.50 | 30 | 1,898.00 | 1,442.60 | 76 |
| 2003 | 335.00 | 195.00 | 58 | 85.00 | 74.10 | 87 | 655.00 | 237.50 | 36 | 2,690.00 | 2,130.90 | 79 |
| 2004 | 540.00 | 362.63 | 67 | 200.00 | 158.60 | 79 | 515.00 | 233.40 | 45 | 1.345.00 | 1,018.60 | 76 |
| 2005 | 625.00 | 465.00 | 74 | 380.00 | 332.30 | 87 | 570.00 | 280.70 | 49 | 1,80.00 | 964.80 | 82 |
| 2006 | 600.00 | 448.60 | 75 | 400.00 | 365.70 | 91 | 480.00 | 219.00 | 46 | 1,040.00 | 904.60 | 87 |
Source: Inside Mortgage Finance (2007). Data cited in Ashcraft and Schuerman, 2008, p. 2. Agency origination refers to conventional loans that conform to standards set by Government Sponsored Enterprises such as Freddie Mac and Fennie Mae.
[1] Origination (in dollars)
[2] Issuance (in dollars)
[3] Ratio (percentage)
The role of interest based banking system
Although financial crises such as that currently underway tend to be seen as surprising and unusual when they occur, in fact they are common events, particularly in the period since 1970. For example, Demirgüc Kunt and Detragiache (2005) use a sample of 77 systemic crises over the period 1980–2002 in their research. Over 1970–2002, Caprio et al. (2005) found 117 episodes of systemic banking crises (with much or all of bank capital being exhausted) in 93 countries. They also found 51 episodes of borderline and non-systemic banking crisis in 45 countries over the same period. As Davis and Karim (2008) detail, seven systemic crises took place between 1980 and 2000 in advanced OECD countries, with minor crises in the US , Portugal and Italy
| | Date | Duration | direct cost to taxpayers* | output loss (% of GDP) |
| | 1991-2001 | 10 years | 14.0 | 71.7 |
| | 1989-1992 | 4 years | 3.4 | 27.1 |
| | 1991-1994 | 4 years | 2.1 | 3.8 |
| | 1991-1994 | 4 years | 10.0 | 44.9 |
* Per cent of annual GDP at end of episode Source: Barrell and Hurst
The Nordic crises were sharp and had a significant effect on output, and they were associated with rapid and poorly designed financial deregulation that led to excessive consumer and commercial real estate borrowing and housing market and commercial property bubbles. The collapse of consumption spending and commercial real estate companies that came with the pricking of asset bubbles was a factor behind large-scale losses in the banking sectors, as were exposed positions in foreign exchange dealings. Real house prices fell 30 per cent in Finland between 1991 and 1993, whilst they fell by 25 per cent in Sweden
The Japanese crisis also followed from ill-judged deregulation and an expansion of borrowing but involved fewer failures. The crisis lasted for a significantly longer period and the cumulated output loss appears to have been large. The economy was also trapped in a period with zero interest rates, making monetary policy essentially ineffective. It was driven as much by falling commercial property prices after an extreme bubble and by corporate sector over-indebtedness as by personal sector problems, and it led to a re-evaluation of risk premia in Japan
Precursors of the crisis
The structural background in the period 2000–7 was one of low global interest rates, arising in turn from high levels of global liquidity as countries such as China
This pattern of innovation also fostered an accelerating shift of banks from holding loans on balance sheet to relying on securitizations (which in turn reduced the incentive to monitor loans). They profited from origination fees without having to suffer from capital requirements or a need to raise liabilities to cover the assets. Banks also held increasingly low levels of on-balance- sheet liquid assets, given low interest rates, and they undertook aggressive wholesale liability management to maintain funding levels. Furthermore, banks shifted risk to off-balance-sheet conduits and special investment vehicles (SIVs) in order to save capital under Basel
Lending to households grew at unprecedented rates, as we can see from figure 2, especially in Spain , the US and the UK US , and to a lesser extent in the UK UK and the US Spain and France , and perhaps a little less so in the US
Figure 2 Personal sector borrowing as a proportion of disposable incomes
The asset price bubble in the years up to 2007 was perhaps most noticeable in real estate, but real equity prices also looked strong, albeit buoyed by a high profit share as well as by low real interest rates. As can be seen from figure 4, the value of the stock market as compared to nominal GDP in the US and the UK France and Spain UK and France Spain and the US
Figure 3 Real House Prices
At a deeper level, it can be argued that the pattern of asset price bubbles also reflected policy errors. One aspect is the monetary policies, notably in the US United States UK
Moreover, there were failures of regulation. As noted in Davis and Karim (2008) many central banks have developed ‘macroprudential surveillance’ in recent years, with teams of analysts producing financial stability reviews. These in turn have often highlighted the risks of high leverage by home owners, accompanied by house prices above sustainable levels. They also, albeit to a lesser extent, saw the risks of opaque financial innovations and the risk of a liquidity crisis in the financial markets as in 1998 (the Russia-LTCM episode). The problem is that beyond speeches by Central Bank Governors (moral suasion), there were no effective policy instruments for macroprudential action in the hands of these central banks beyond the interest rate, which was devoted to price stability. They could, as in the case of Sweden , have ‘leaned against the wind’ in the context of inflation targeting, as Wadhwani (2008) suggests, but that was not considered appropriate in the UK or the US UK US US
The situation was arguably aggravated by the fragmentation of micro prudential regulation in the US , its separation from the Central Bank in the UK Basel Europe , and it has been the major user of the ECB’s short-term facilities. Hence its business model, which was similar to that of Northern Rock, was not robust to a crisis where inter-bank interest rates rose.
Looking more closely at European issues, over the past decade or so the European Commission has created a Single Market in financial services, and has recognized the need for a single, or at least coordinated, regulatory framework. Little was done in response to this felt need, and solvency concerns were left in the hands of home regulators, whilst host regulators could only concern themselves with the liquidity of foreign banks (in the case of branching). This took place as EU banks grew highly dependent on wholesale funding, often cross border that eventually proved unreliable. The inadequacy of this approach is best illustrated by the problems of the Icelandic banking system, which had been predicted by many commentators for some years. Icelandic banks took retail deposits in many countries and invested in equity assets (directly or via lending) as if they were holding companies or hedge funds. There were little regulators in the UK or elsewhere could do about this, and Icelandic banks built up asset bases that summed to more than ten times Iceland
Events of the crisis
2007 saw growing realisation of potential losses on sub-prime mortgages as US US
These losses, along with uncertainty and concern about asymmetric information due to the opaque structures of related structured asset-backed securities (ABS), combined to generate sales of such assets. Sales led in turn not just to price falls but also to market liquidity failure for the over-the-counter (OTC) markets for the ABS. Prices fell and trading became difficult or impossible even among the lowest risk trances of the relevant securities. As noted by ECB (2008), price falls affected not only the standardized instruments such as index-based collateralized debt obligations (CDOs) but also the ‘bespoke’ structures that are not normally traded but which are nonetheless marked to market, since implicit prices for the latter are derived from the former. Furthermore, Scheicher (2008) shows econometrically that there was indeed a major element of concern over market liquidity and lower risk appetite in accounting for the fall in prices/rise in spreads and not only credit risk. Such liquidity and risk aversion effects are omitted from standard CDO pricing models.
This liquidity failure was aggravated by rising margin requirements, which limited the freedom of action of speculative investors such as hedge funds, and led them to sell holdings of ABS. It was also worsened by lesser risk capital allocated to market making in such products due to the rise in volatility and lesser revenues to investment banks, which limited their ability to take risks.
The rush to sell securitized assets may also have been worsened by the impact of mark-to-market accounting on the capital of leveraged institutions and reliance on quantitative techniques of trading and risk management that assume continuous liquidity (IMF, 2008a). Long-term investors may have been constrained from taking contrary positions that could have renewed market liquidity due to excessive leverage (e.g. of hedge funds) and consequent credit restrictions in the context of mark-to-market accounting. Later the ban on short selling further constrained hedge funds’ freedom of action.
Banks were impacted rapidly by the market liquidity failure for securitized loans due to mark-to-market pricing, so price falls affected solvency. This was unlike banking crises in the past where loans have typically been held at historic cost with no specific price. Furthermore, the fact that a great many ABSs were held in conduits and SIVs spread the contagion, since these institutions require financing in the market for asset-backed commercial paper. Doubts by money market funds regarding the ABS that the conduits and SIVs held led on to a market-liquidity collapse of the asset backed commercial paper (ABCP) market also, which meant sponsoring banks had to take the assets back onto their balance sheets. The extensive holding of US ABSs by EU banks and related conduits and SIVs spread the impact internationally.
Meanwhile, traders’ attempts to hedge, meet margin calls or realize gains in safer or more liquid markets, transmitted the demand for liquidity contagiously, affecting liquidity in other markets. Market makers in a range of markets were often unwilling to trade at posted prices (IMF, 2008a) due to uncertainty, volatility and concern about default risk of counterparties.
There are also new patterns in funding-liquidity risk which link from market-liquidity risk. Banks were unable to securitize the mortgages and other loans they were issuing owing to the liquidity collapse of the ABS market. They also experienced calls on back-up lines of credit for conduits and SIVs unable to issue ABCP. Accordingly, banks hoarded liquidity in order to provide sufficient funding for their ongoing business. This hoarding was aggravated by fear of counterparty risk in the inter-bank market due to other banks’ undisclosed losses on ABS from credit and liquidity risk. Mark to market becomes a highly uncertain process when liquidity collapses (ECB, 2008), giving rise to concern that assets of counterparties are wrong measured. One consequence of these problems of funding-liquidity risk was the failure of the solvent UK US
These combined features led on to the emergence of historically large premium and quantity rationing of funds in the domestic inter-bank markets in the US , UK
The ongoing process unleashed by the crisis can be referred to as deleveraging (IMF, 2008b), as banks and other institutions sought to reduce exposure to high risk sectors, selling assets or reducing asset growth, as well as reducing dependence on unstable wholesale funding and rebuilding capital adequacy. Arguably, it is also involving a reduction in the excess capacity that has built up in the financial system over many years (Davis and Salo, 1998). The process is aggravated by the ongoing fall in asset prices and rise in private sector defaults on loans, as noted above, as well as by closure of securitization markets, notably in Europe . By September 2008 it seemed that the crisis was ongoing, but not worsening. However, following the bankruptcy of Lehman Brothers (unsupported by the authorities) in mid-September, there was a sharp worsening of market conditions and the process of deleveraging became disorderly as counterparty risk perceptions ballooned.
The equity market, which had been surprisingly little affected by the crisis up to that point, began to fall sharply. This particularly reflected low confidence in banks that were dependent on wholesale funding, because markets for such funds, that had previously been costly and restrictive, proved to be totally closed to such institutions after Lehman’s failure. Cross-border lending was even more sharply curtailed than domestic, showing again the historic instability of the international inter-bank market (Bernard and Bisignano, 2000). Money market funds in particular underwent losses when Lehman’s collapsed, and this led to them ‘breaking the dollar’ and needing support from the Federal Reserve. They underwent massive redemptions ($320 billion in one week), as did hedge funds and mutual funds, leading to forced asset sales which intensified the downward spiral in asset prices. Instead of offering liquid funds to banks, money market funds began rather to compete with them for financing. The Fed had to start purchasing commercial paper directly from non-financial companies to avoid a liquidity crunch for them. A large number of creditors, including significant hedge funds, had their assets frozen in the Lehman bankruptcy, and were forced to find alternative funds, adding to selling pressure in equity markets.
The authorities acted in the wake of the worsening of market conditions. The US UK US
Banks dependent on cross-border financing were hardest hit. For example, the two major Belgian banks have had to be nationalized and all three Icelandic banks failed in October. Significant public sector stakes totaling £37 billion were taken in three major lenders in the UK UK
Public intervention had been made urgent by the fact that the equity market seemed to foresee a liquidity crisis for many banks when medium-term funding became due in coming years. The UK UK
Nature of Money:
One of the wrong presumptions on which all theories of interest are based is that money has been treated as a commodity. It is, therefore, argued that just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value, or just as he can lease his property and can charge a rent against it, he can also lend his money and can claim interest thereupon.
Islamic principles, however, do not subscribe to this presumption. Money and commodity have different characteristics and therefore they are treated differently. The basic points of difference between money and commodity are as follows:
(a) Money has no intrinsic utility. It cannot be utilized in direct fulfillment of human needs. It can only be used for acquiring some goods or services. A commodity, on the other hand, has intrinsic utility and can be utilized directly without exchanging it for some other thing.
(b) The commodities can be of different qualities while money has no quality except that it is a measure of value or a medium of exchange. Therefore, all the units of money of the same denomination, are hundred per cent equal to each other. An old and dirty note of RS1000/= has the same value as a brand new note of Rs.I000/=.
(c) In commodities, the transactions of sale and purchase are effected on an identified particular commodity .If A has purchased a particular car by pinpointing it, and seller has agreed, he deserves to receive the same car. The seller cannot compel him to take the delivery of another car, though of the same type or quality. Money, on the contrary, cannot be pin-pointed in a transaction of exchange. If A has purchased a commodity from B by showing him a particular note of Rs.l000/- he can still pay him another note of the same denomination.
Based on these basic differences, Islamic Shariah has treated money differently from commodities, especially on two scores:
Firstly, money (of the same denomination) is not held to be the subject matter of trade, like other commodities. Its use has been restricted to its basic purpose i.e. to act as a medium of exchange and a measure of value.
Secondly, if for exceptional reasons, money has to be exchanged for money or it is borrowed, the payment on both sides must be equal, so that it is not used for the purpose it is not meant for i.e. trade in money itself.
Imam Al-Ghazzali view on the Nature of Money
Imam Al-Ghazzali (d.505 A.H.) the renowned jurist and philosopher of Islamic history discussed the nature of money in an early period when the Western theories of money were not existent, at all. He stated:
"The creation of dirhams and dinars (money) is one of the blessings of Allah. They are stones having no intrinsic usufruct or utility, but all human beings need them, because every body needs a large number of commodities for his eating, wearing etc, and often he does not have what he needs and does have what he needs not... therefore, the transactions of exchange are inevitable. But there must be a measure on the basis of which price can be determined, because the exchanged commodities are neither of the same type, nor of the same measure which can determine how much quantity of one commodity is a just price for another.
Therefore, all these commodities need a mediator to judge their exact value Allah Almighty has, therefore, created dirhams and dinars (money) as judges and mediators between all commodities so that all objects of wealth are measured through them... and their being the measure of the value of all commodities is based on the fact that they are not an objective in themselves. Had they been an objective in themselves, one could have a specific purpose for keeping them, which might have given them more importance according to his intention while the one who had no such purpose would have not given them such importance and thus the whole system would have been disturbed. That is why Allah has created them, so that they may be circulated between hands and act as a fair judge between different commodities and work as a medium to acquire other things. So, the one who owns them is as he owns every thing, unlike the one who owns a cloth, because he owns only a cloth, therefore, if he needs food, the owner of the food may not be interested in exchanging his food for cloth, because he may need an animal for example. Therefore, there was needed a thing which in its appearance is nothing, but in its essence is everything. The thing which has no particular form may have different forms in relation to other things like a mirror, which has no colour, but it reflects every colour. The same is the case of money. It is not an objective in itself, but it is an instrument to lead to all objectives.
During the horrible depression of 1930s, an "Economic Crisis Committee" was formed by Southampton Chamber of Commerce in January 1933. The Committee consisted of ten members headed by Mr. Dennis Mundy. In its report the committee had discussed the root causes of the calamitous depression in national and international trade and had suggested different measures to overcome the problem. After discussing the pitfalls of the existing financial system, one of the committee's recommendations was that "In order to ensure that money performs its true function of operating as a means of exchange and distribution, it is desirable that it should be traded as a commodity."
This real nature of money which should have been appreciated as a fundamental principle of the financial system remained neglected for centuries, but it is now increasingly recognized by the modern economists. Prof. John Gray, of Oxford University
"Most significantly, perhaps transactions on foreign exchange markets have now reached the astonishing sum of around $1.2 trillion a day, over fifty times the level of the world trade. Around 95 percent of these transactions are speculative in nature, many using complex new derivative's financial instruments based on futures and options. According to Michael Albert, the daily volume of transactions on the foreign exchange markets of the world holds some $900 billions -equal to France Britain
The size of derivatives mentioned by John Gray was, by the way, of their daily transactions. The size of their total worth, however, is much greater. It is mentioned by Richard Thomson in his "Apocalypse Roulette" in the following words: "Financial derivatives have grown, more or less from standing starting in the early 1970s, to a $64 trillion industry by 1996. How do you imagine a number that big? You could say that if you laid all those dollar bills end to end, they would stretch from here to the sun sixty-six times, or to the moon 25 900 times"'
James Robertson observes in his latest work, 'Transforming Economic Life' in the following words:
"Today's money and finance system is unfair, ecologically destructive and economically inefficient; the money-must-grow imperative derives production (and thus consumption) to higher than necessary levels. It skews economic effort towards money out of money, and against providing real services and goods. It also results in a massive world-wide diversion of effort away from providing useful goods and services, into making money out of money. At least 95% of the billions of dollars transferred daily around the world are for purely financial transactions, unlinked to transactions in the real economy."
This is exactly what Imam Al-Ghazzali had pointed out nine hundred years ago. The evil results of such an unnatural trade have been further explained by him as follows:
"Riba (interest), is prohibited because it prevents people from undertaking real economic activities. This is because when a person having money is allowed to earn more money on the basis of interest, either in spot or in deferred transactions, it becomes easy for him to earn without bothering himself to take pains in real economic activities. This leads to hampering the real interests of the humanity, because the interests of the humanity cannot be safeguarded without real trade skills, industry, and construction."
It seems that Imam- Al-Ghazzali has, in that early age, pointed out to the phenomenon of monetary factors prevailing on production, creating a wide gap between the supply of money and the supply of real goods which has emerged in the later days as the major cause of inflation, almost the same 'terrible potential' of trading in money as explained by John Gray and James Robertson in their above extracts. We will examine this aspect a little later, but what is important at this point is the fact that money, being a medium of exchange and a measure of value cannot be taken as a "production good" which yields profit on daily basis, as is presumed by the theories of interest. This is a mediator and it should be left to play this exclusive role. To make it an object of profitable trade disturbs the whole monetary system and brings a plethora of economic and moral hazards to the whole society.
The Nature of Loan
Another major difference between the secular capitalist system and the Islamic principles is that under the former system, loans are purely commercial transactions meant to yield a fixed income to the lenders. Islam, on the other hand, does not recognize loans as income-generating transactions. They are meant only for those lenders who do not intend to earn a worldly return through them. They, instead, lend their money either on humanitarian grounds to achieve a reward in the Hereafter, or merely to save their money through a safer hand. So far as investment is concerned, there are several other modes of investment like partnership etc which may be used for that purpose. The transactions of loan are not meant for earning income.
The basic philosophy underlying this scheme is that one who offers his money to another person has to decide whether:
(a) he is lending money to him as a sympathetic act; or
(b) he is lending money to the borrower, so that his principal may be saved; or
(c) he is advancing his money to share the profits of the borrower.
(b) he is lending money to the borrower, so that his principal may be saved; or
(c) he is advancing his money to share the profits of the borrower.
In the former two cases (a) and (b) he is not entitled to claim any additional amount over and above the principal, because in the case (a) he has offered financial assistance to the borrower on humanitarian grounds or any other sympathetic considerations, and in the case (b) his sole purpose is to save his money and not to earn any extra income.
However, if his intention is to share the profits of the borrower, as in the case (c), he shall have to share his loss also, if he suffers a loss. In this case, his objective cannot be served by a transaction of loan. He will have to undertake a joint venture with the opposite party, whereby both of them will have a joint stake in the business and will share: its outcome on fair basis. Conversely, if the intent of sharing the profit of the borrower is designed on the basis of an interest-based loan, it will mean that the financier wants to ensure his own profit, while he leaves the profit of the borrower at the mercy of the actual outcome of the business. There may be a situation where the business of the borrower totally fails. In this situation he will not only bear the whole loss of the business, but he will have also to pay interest to the lender, meaning thereby that the profit or interest of the financier is guaranteed at the price of the destructive loss of the borrower, which is obviously a glaring injustice.
On the other hand, if the business of the borrower earns huge profits, the financier should have shared him in the profit in reasonable proportion, but in an interest-based system, the profit of the financier is restricted to a fixed rate of return which is governed by the forces of supply and demand of money and not on the actual profits produced on the ground. This rate of interest may be much less than the reasonable proportion a financier might have deserved, had it been a joint venture. In this case the major part of the profit is secured by the borrower, while the financier gets much less than deserved by his input in the business, which is another form of injustice.
Thus, financing a business on the basis of interest creates an unbalanced atmosphere, which has the potential of bringing injustice to either of the two parties in different situations. That is the wisdom for which the Shariah does not approve an interest-based loan as a form of financing.
Once interest is banned, the role of 'loans' in commercial activities becomes very limited, and the whole financing structure turns out to be equity-based and backed by real assets. In order to limit the use of loans, the Shariah has permitted to borrow money only in cases of dire need, and has discouraged the practice of incurring debts for living beyond one's means or to grow one's wealth. The well-known event that the Holy Prophet refused to offer the funeral prayer (salat-ul janazah) of a person who died indebted was, in fact, to establish the principle that incurring debt should not be taken as a natural or ordinary phenomenon of life. It should be the last thing to be resorted to in the course of economic activities. This is one of the reasons for which interest has been prohibited, because, given the prohibition of interest, no one will be agreeable to advance a loan without a return for unnecessary expenses of the borrower or for his profitable projects. It will leave no room for unnecessary expenses incurred through loans. The profitable ventures, on the other hand, will be designed on the basis of equitable participation and thus the scope of loans will remain restricted to a narrow circle.
Conversely, once interest is allowed, and advancing loans, in itself, becomes a form of profitable trade, the whole economy turns into a debt-oriented economy which not only dominates over the real economic activities and disturbs its natural functions by creating frequent shocks; but also puts mankind under the slavery of debt. It is no secret that all the nations of the world, including the developed countries, are drowned in national and foreign debts to the extent that the amount of payable debts in a large number of countries exceeds their total income. Just to take one example of UK
Peter Warburton, one of the UK
"The credit and capital markets have grown too rapidly, with too little transparency and accountability. Prepare for an explosion that will rock the western financial system to its foundation."
Overall Effects of Interest
Interest-based loans have a persistent tendency in favor of the rich and against the interests of the common people. It carries adverse effects on production and allocation of resources as well as on distribution of wealth. Some of these effects are the following:
(a) Evil effects on allocation of Resources
Loans in the present banking system are advanced mainly to those who, on the strength of their wealth, can offer satisfactory collateral. Dr. M. Umar Chapra (Senior Economic Advisor to Saudi Arabian Monetary Agency) who appeared in this case as a juris-consult has summarized the effects of this practice in the following words:
"Credit, therefore, tends to go to those who, according to Lester Thurow, are 'lucky rather than smart or meritocratic. The banking system thus tends to reinforce the unequal distribution of capital. Even Morgan Guarantee Trust Company, sixth largest bank in the U.S has admitted that the banking system has failed to 'finance either maturing smaller companies or venture capitalist' and 'though awash with funds, is not encouraged to deliver competitively priced funding to any but the largest, most cash-rich companies. Hence, while deposits come from a broader cross-section of the population, their benefit goes mainly to the rich."
The veracity of this statement can be confirmed by the fact that according to the statistics issued by the State Bank of Pakistan in September 1999, 9269 account holders out of 2,184,417 (only 0.4243% of total account holders) have utilized Rs.438.67 billion which is 64.5% of total advances as of end December 1998.
(b) Evil effects on production
Since in an interest-based system funds are provided on the basis of strong collateral and the end-use of the funds does not constitute the main criterion for financing, it encourages people to live beyond their means. The rich people do not borrow for productive projects only, but also for conspicuous consumption.
Similarly, governments borrow money not only for genuine development programs, but also for their lavish expenditure and for projects motivated by their political ambitions rather than being based on sound economic assessment. Non-project-related borrowings, which were possible only in an interest-based system have thus helped in nothing but increasing the size of our debts to a horrible extent. According to the budget of 1998/99 in our country 46 percent of the total government spending is devoted to debt-servicing, while only 18% is allocated for development which includes education, health and infrastructure.
(c) Evil effects on distribution
We have already pointed out that when business is financed on the basis of interest, it may bring injustice either to the borrower if he suffers a loss, or to the financier if the debtor earns huge profits. Although both situations are equally possible in an interest-based system, and there are many examples where the payment of interest has brought total ruin to the small traders, yet in our present banking system, the injustice brought to the financier is more pronounced and much more disturbing to the equitable distribution of wealth.
In the context of modern capitalist system, it is the banks that advance depositors' money to the industrialists and traders. Almost all the giant business ventures are mostly financed by the banks and financial institutions. In numerous cases the funds deployed by the big entrepreneurs from their own pocket are much less than the funds borrowed by them from the common people through banks and financial institutions. If the entrepreneurs having only ten million of their own acquire 90 million from the banks and embark on a huge profitable enterprise, it means that 90% of the projects is created by the money of the depositors while only 10% was generated by their own capital.
If these huge projects bring enormous profits, only a small proportion (of interest which normally ranges between 2% to 10% in different countries) will go to the depositors whose input in the projects was 90% while all the rest will be secured by the big entrepreneurs whose real contribution to the projects was not more than 10%. Even this small proportion given to the depositors is taken back by these big entrepreneurs, because all the interest paid by them is included in the cost of their production and comes back to them through the increased prices. The net result in this case is that all the profits of the big enterprises is earned by the persons whose own financial input does not exceed 10% of the total investment, while the people whose financial contribution was as high as 90% get nothing in real terms, because the amount of interest given to them is often repaid by them through the increased prices of the products, and therefore, in a number of cases the return received by them becomes negative in real terms.
While this phenomenon is coupled with the fact, already mentioned, that 64.5% of total advances went only to 0.4243% of total account holders, it means that the profits generated mostly by the money of millions of people went almost exclusively to 9,269 borrowers. One can imagine how far the interest-based borrowings have contributed to the horrible inequalities found in our system of distribution, and how great is the injustice brought by the modern commercial interest to the whole society as compared to the interest charged on the old consumption loans that affected only some individuals.
How the present interest-based system works to favor the rich and kill the poor is succinctly explained by James Robertson in the following words:
"The pervasive role of interest in the economic system results in the systematic transfer of money from those who have less to those who have more. Again, this transfer of resources from poor to rich has been made shockingly clear by the Third World debt crisis. But it applies universally. It is partly because those who have more money to lend, get more in interest than those who have less; it is partly because those who have less, often have to borrow more; and it is partly because the cost of interest repayments now forms a substantial element in the cost of all goods and services, and the necessary goods and services looms much larger in the finances of the rich. When we look at the money system that way and when we begin to think about how it should be redesigned to carry out its functions fairly and efficiently as part of an enabling and conserving economy, the arguments for an interest-free inflation-free money system for the twenty-first century seems to be very strong."
The same author in another book comments as follows:
"The transfer of revenue from poor people to rich people, from poor places to rich places, and from poor countries to rich countries by the money and finance system is systematic One cause of the transfer of wealth from poor to rich is the way interest payments and receipts work through the economy.
(d) Expansion of artificial money and inflation
Since interest-bearing loans have no specific relation with actual production, and the financier, after securing a strong collateral, normally has no concern how the funds are used by the borrower, the money supply effected through banks and financial institutions has no nexus with the goods and services actually produced on the ground. It creates a serious mismatch between the supply of money and the production of goods and services. This is obviously one of the basic factors that create or fuel inflation.
This phenomenon is aggravated to a horrible extent by the well-known characteristic of the modern banks normally termed as 'money creation'. Even the primary books of economics usually explain, often with complacence, how the banks create money. This apparently miraculous function of the banks is sometimes taken to be one of the factors that boost production and bring prosperity. But the illusion underlying this concept is seldom unveiled by the champions of modern banking.
The history of money creation' refers back to the famous story of the goldsmiths in medieval England
Initially, it was abuse of trust and a sheer fraud on the part of the goldsmiths not warranted by any norm of equity, justice and honesty. It was a form of forgery and usurpation of the power of the sovereign authority to issue money. But overtime, this fraudulent practice turned into the fashionable standard practice of the modern banks under the 'fractional reserve' system.
How the money changers and bankers have succeeded in legalizing the creation of money by the private banks, in spite of the strong opposition from several rulers in England and USA, and how the Rothchilds acquired financial mastery over the whole of Europe and the Rockfeller over the whole of America is a long story, now lost in the mist of numerous theories developed to support the concept of money-creation by the private banks. But the net result is that the modern banks are creating money out of nothing. They are allowed to advance loans in the amounts ten times more than their deposits. The coins and notes issued by the government as genuine and debt-free money have now a very insignificant proportion in the total money in circulation, most of which is artificial money created by advances made by the banks.
The proportion of real money issued by the governments has been constantly declining in most of the countries, while the proportion of the artificial money created by the banks out of nothing is ever-increasing. The spiral of loans built upon loans is now the major part of the money supply. Taking the example of UK
So although the banks do not create currency, they do create cheque book money, or deposits, by making new loans. They even invest some of this created money. In fact, over one trillion dollars of this privately created money has been used to purchase US bonds on the open market, which provides the banks with roughly 50 depositors. In this was though fractional reserve lending, banks create far in excess of 90% of the money and therefore cause over 90% of our inflation."
The role of dolor based currency system
The collapse of the Bretton Woods System, three decades ago, had several causes. It was due partly to the gradual deterioration in the net reserve position of the United States United States
The situation today is similar in some respects but different in others. The reserve position of the United States is not at issue, because the dollar is no longer tied to gold, and the United States United States had a current-account surplus in the 1960s, although it was not large enough to cover the capital outflow from the United States , most notably the large direct-investment outflow from the United States to Europe . Today, by contrast, the United States United States United States exceeded US claims on foreigners by $2.94 trillion, and foreign official dollar holdings held in the United States
Some say that this situation is sustainable for several more years. I’ll tell you why I disagree. But let me first remind you of two more differences between the present situation and the one in 1971, when the Bretton Woods System started to disintegrate:
First, we do not face a sudden collapse of a rule-based regime, because we don’t have a rule-based regime. Three of the four key players, the euro zone, Japan , and the United States China
Second, the dollar was the main reserve currency available during the Bretton Woods era, and governments not wanting to hold more dollars had only one obvious alternative – buying gold from the US Treasury. Few governments did that, however, during the final years of the Bretton Woods era. They knew that a further fall in the US gold stock could trigger a scramble for gold and the collapse of the system itself – which is what happened in August 1971, when the anticipation of additional gold losses prompted the United States
We thus face the rising risk of a disorderly shift from the present dollar-based monetary system to a multiple-currency monetary system based on the dollar and the euro. Some of my European friends would welcome the ultimate outcome, a large international role for the euro, but they should be worried about getting there quickly.
We began with the collapse of the Bretton Woods System, but those who believe that the US Japan China China China
Roubini and Setser (2004) have raised several objections to this reassuring story. They note, for example, that the likely growth of the US United States
How, then, will the story end? There is no gold window to close and no way to negotiate general exchange-rate realignment like the short-lived realignment cobbled together in 1971. One can conceive of an orderly ending, involving a bargain among the key countries, but mainly a bargain between Beijing and Washington
Let’s start with fundamentals. A large reduction of the US
This brings us, then, to the disorderly ending. There is, as yet, no evidence that foreign central banks are selling dollars, although there are lots of rumors. During 2003, in fact, the share of the dollar in total reserves, measured at constant exchange rates, rose by more than 2 percentage points, from 68.4 per cent of identifiable currency reserves to 71.7 percent. Put differently, the dollar accounted for 88.9 per cent of the total increase in currency reserves during 2003.
The problem I foresee, however, need not begin with a big shift by a very large holder of dollars. It is as likely to begin with diversification at the margin. Asian and other central banks will go on buying dollars in the foreign-exchange market in order to keep their currencies from appreciating. But they may then return to the foreign-exchange market to sell the dollars for euros. Should this practice spread, moreover, it will be hard for any prudent central bank to add to its dollar holdings, and some may begin to sell more dollars – to reduce their dollar holdings, not merely keep them from growing.
The economic implications are obvious. The euro will appreciate vis-à-vis the dollar, and US interest rates are bound to raise on account of the fall in the foreign demand for US government debt. The further effects are equally obvious, although we cannot know their size. The euro area will suffer deterioration in its trade balance, although the effect may be damped down by slower economic growth, which has been heavily export dependent. The United States US US
Our story would change, for example, if the European Central Bank began to intervene in the foreign-exchange market to hold down the dollar price of the euro – if it were willing to ‘print’ the euros demanded by other central banks. That would shortcircuit the painful process I have just described. The ECB might find it hard to sterilize the money-supply effects of large-scale intervention, but there are ways in which it can deal with that problem.
We conclude with two observations. Proposals of the sort I have just made would not obviate the need to reduce the US
The role of capitalist corporate structures
The current crisis emerged from the workings of the capitalist class structure. Capitalism’s history displays repeated booms and busts punctuated by bubbles. Capitalism’s cycles range unpredictably from local, shallow and short to global, deep, and long. To keep capitalism is to suffer its chronic instability. To deal effectively with capitalism’s recurring crises requires changing to a non-capitalist class structure.
Since the mid-1970s, workers’ average real wages stopped rising. This was partly because capitalists’ computerization of production displaced workers. Capitalists also decided then to move more production to foreign countries for higher profits. Since employers thus needed fewer workers in the US
However, workers’ productivity kept rising (more machines, more pressure, and more skills). They produced ever more for their employers to sell, yet the employers paid them no more. The surpluses extracted (exploited) by capitalist employers – the excess of the value added by each laborer over the value paid to that laborer – rose. The last 30 years realized capitalists’ wildest dreams. Yet, stagnant wages and booming surpluses also eventually plunged US
The financial profits depended on the rising surpluses that depended on the stagnant wages. Financial profits also depended on the flip side of stagnant wages, namely massive worker borrowing. Because rising consumption had become the measure of personal success in life, wage stagnation since the 1970s rendered most US
In effect, US US
Eventually, the rising costs of the double squeeze’s strangled the boom. Families’ rising indebtedness meant that illnesses, job loss, divorces now yielded the added tragedy of defaults on debts. Rising steadily and ominously across 2007, defaults on credit card debt, auto loans, student loans and mortgages took off in 2008. The new kinds of securities based on workers’ debts began to lose value in the markets. Banks, hedge funds, and others holding those securities faced mounting losses. Corporations that insured those securities via credit default swaps, etc., could not pay when so many securities’ values collapsed. Banks had used their depositors’ money and borrowed still more to buy such securities. Banks’ losses prevented repaying those loans or guaranteeing their depositors’ money. Financial markets froze as borrowers and lenders stopped trusting one another and drastically reduced transactions. Bust followed bubble followed boom, once again.
US corporate boards of directors had taken three interconnected steps to produce that sequence. They froze workers’ real wages, they extracted much more surplus from their rising productivity, and they distributed that rising surplus in ways that were cumulatively unsustainable. Irrational capitalist exuberance once again overreached its limits. The specifically capitalist system of producing and distributing surpluses proved itself yet again fundamentally crisis prone.
Had this capitalist system been replaced by another, say one in which the workers who produced the surpluses in each enterprise also functioned as the collective appropriator and distributor of those surpluses, US
Of course, such a class structures would have its own, different contradictions and problems. Such a class structures would interact with political institutions in ways different from how capitalist class structures do. Gender equality, environmental sustainability, and many other issues would still need attention, but they would be dealt with very differently.
Thus the urgent questions are: Will responses to this latest capitalist crisis continue to ignore or deny the role of capitalism’s class structure? Will the crisis consequences of allowing capitalist boards of directors to appropriate and distribute surpluses go unrecognized? If so, the personal, political, economic and cultural losses inflicted by this latest capitalist crisis will fail to teach their key lesson: a genuine solution requires progress beyond the capitalist class structure
What is the solution?
It is argued that the present crisis is the result of regulatory failure to guard against excessive risk-taking in the financial system, especially in the US
The demagogic declarations about the need to curb excessive bonuses and regulate boardroom pay are just so much hot air. How are these miracles to be performed? By what mechanism? The bankers have a thousand ways of evading regulation. They keep off-the-books accounts that make it all but impossible for regulators to discover their fraudulent activities. Even the US
The argument in favour of regulating the stock markets is absurd, as was the decision to ban (temporarily) the practice of "selling short". In order that the markets can function, it is necessary for people to buy and sell shares, and they must do so on the basis of estimating whether the share price is going to rise or fall. The idea that it is permissible to buy shares only when they are rising is clearly an absurdity.
The credit rating agencies were supposed to distinguish good credit from bad, rated securitized mortgage packages without looking at the weaknesses of underlying mortgages. Similarly, purchasers of American debt issued by Fannie Mae and Freddie Mac cheerfully assumed that the US US
The conclusion is quite clear. Either we have a free market based on the pursuit of profit, or we have a nationalized planned economy. But "regulated capitalism" is a contradiction in terms. In another article, The Financial Times puts the question far more clearly:
"No matter what hare-brained ideas politicians come up with to curb controversial pay packets, bright minds in finance will find a way round them or exit the regulated part of the industry."
What is necessary is to abolish these grotesque casinos that decide the fates of millions altogether and replace capitalist anarchy with a rational society based on a planned economy. It is said that the measures taken by Bush and Brown represent nationalization. But these measures have nothing in common with the socialist idea of nationalization. They are not intended to remove economic power from the hands of the wealthy parasites that constitute a monstrous burden on society and an obstacle in the path of progress. On the contrary, they represent an attempt to protect the interest of these parasites by giving them vast subsidies, paid for out of the pockets of the working class and the middle class.
Socialists are radically opposed to these policies, which have nothing in common with genuine nationalization and are only a kind of state capitalism, intended to safeguard the capitalist system. They lead inevitably to an increase in monopolization, mass sackings, bank closures, higher mortgages and other anti-working class measures. The bankers are rewarded for their nefarious activities by the state, which buys up all their losses, then spends further vast amounts of the taxpayer's money to make them profitable, and when this has been done, to sell them back to the bankers, who from this will make a double killing at the expense of society. Then they can resume their speculating and thieving all over again.
What is necessary is to take the commanding heights of the economy out of private hands, by nationalizing the banks and insurance companies and big companies with minimum compensation on the basis of proven need only. Only when the productive forces are in the hands of society, will it be possible to establish a rational socialist plan of production, where decisions are taken in the interests of society, not of a handful of wealthy parasites and speculators.
That is the fundamental aim of socialism. It is an idea that will now be understood and welcomed by millions of people who previously regarded it as it as something strange and alien. The people demonstrating on the streets of New York United States
The real solution of this problem and how it will work
First, the dominance globally what has loosely come to be called the neo-liberal order? In monetary terms, the period from the 1980s has seen the rise of financial liberalization, increased and often times unfettered capital flows and simultaneously, the increasing incidence and amplitude of global financial instability. The Asian Financial Crisis of 1997-1998, the collapse or near collapse of the economies of Mexico (1995), Russia (1998), Turkey (2001) and Argentina (2002), among others are but symptoms of the same phenomenon.
Secondly, the last twenty years or so have been a particularly tempestuous time for Islamic countries. Images and experiences - both personal and professional - come readily to mind: the Iranian revolution, the Iranian-Iraqi War, the Gulf War, the windfall gains of oil against a sea of poverty in other Muslim nations, the "Resurgence of Islam", the persecution of Muslims in places as diverse as Bosnia, Rohingya, Chechnya, Palestine and others through to the tragic events of September 11th. These are images that are full of contradiction, of pain and of irony. Interestingly, many commentators have traced the rise of the neo-liberal order to the unilateral withdrawal from the Gold Standard by the Nixon administration in 1971. This effectively allowed the United States
The developing countries must also be vigilant and active in formulating multilateral trade rules. Developing countries have now found that the rules drawn up in the WTO are sometimes biased in favor of the rich countries, and negatively affect the interests of developing countries. The TRIMS (trade related investment measures) agreement prohibits governments from having local content policy (i.e. requiring that certain projects or industries make use of a minimum level of local materials). The TRIPS (trade related intellectual property rights) agreement makes technology transfer to local firms more costly, and the prices of patented products such as medicines have become prohibitive. The rich countries seem to be fond of putting many issues and rules in the WTO because it has a strong enforcement mechanism. Countries that do not comply can be taken to the dispute settlement mechanism, which may force them to change their national policies or face trade sanctions. Thus, WTO rules can be used unfairly as a powerful tool to discipline developing countries.
The rich countries are now attempting to introduce yet more issues into the WTO. They are proposing negotiations to start on new agreements on investment, competition policy and transparency in government procurement. The common aim of these proposed agreements appears to be to grant maximum rights of entry and operation to foreign firms, their products and services, and to reduce the rights of countries to regulate these firms. Therefore, governments, the private sector and the civil societies in developing countries must pay close attention to what is happening in the WTO and take a very active part in putting forward our views and positions, so that new issues that are detrimental to our interests are not injected into the WTO system.
The careful and proper management of the forces of globalization, and the democratic governance of global institutions like the IMF, the World Bank, the WTO and the UN, are critical goals for developing countries to attain, if we are to survive and prosper in the years ahead.
Many of the weak nations in the world today are Muslim nations. While there is much wrong with the global system, in the spirit of muhassabah, we must also recognize that there is also at least as much that is not right with ourselves too. For a start, we should note that some of the most capital surplus countries and some of the most capital deficit nations are both Islamic countries. While unfettered capital flows have contributed greatly to the instability of the global financial system, there is much that we can do to intermediate capital between Islamic countries in an orderly and brotherly fashion, from basic development finance (including infrastructure finance) to venture capital, trade financing and capital market activity. The raising of living standards of other Islamic countries would, over time, create markets for us to trade in a recurring and mutually beneficial fashion. It is important for the Muslim ummah in general and the Muslim intellectuals in particular to keep questioning conventional wisdom in our effort to create a more just and equitable system. We cannot afford to be complacent and treat the status quo as a given.
Need to accelerate trade
Among the lessons to be learnt from two decades of financial crises and an unstable and less than just global monetary system is that trade between countries need to be accelerated ahead of the liberalisation of financial flows. Here, Islamic countries are in a unique position to trade with each other in both goods and services. We are blessed with much of the world's natural resources and among the ummah there is enough expertise - albeit fragmented currently - to turn this into value-added finished goods. In services, we should exchange our experiences and intellectual and human capital - in education, in the professional services and in tourism, among others - so that we can prosper together. For the non-Muslim world, as much it is for the Muslim world, it is in mankind's own interest that the disenfranchised among us be given a stake in this world as well as the next. I believe that wars, disease, migration and terrorism, and many other trials of our times, are but symptoms of a deeper malaise of poverty and disenfranchisement. In this regard, we are reminded of a beautiful hadith compiled in Sahih Bukhari Volume 3, Book 44, Number 673 Narrated An-Nu'man bin Bashir:
The Prophet s.a.w. said,
The Prophet s.a.w. said,
"The example of the person abiding by Allah's order and restrictions in comparison to those who violate them is like the example of those persons who drew lots for their seats in a boat. Some of them got seats in the upper part, and the others in the lower. When the latter needed water, they had to go up to bring water (and that troubled the others), so they said, 'Let us make a hole in our share of the ship (and get water) saving those who are above us from troubling them. So, if the people in the upper part left the others to do what they had suggested, all the people of the ship would be destroyed, but if they prevented them, both parties would be safe."
Restated, this is of course a classic collective action situation and a powerful reminder of our need to live together and to assist each other. Trading with each other is one important way that we are enjoined, indeed commanded, to help each other. In this context, I believe that the gold dinar could be an important facilitating mechanism to simultaneously increase trade among Muslim nations and to provide alternative and parallel solutions to move away from an inherently unstable and ultimately unjust global monetary system by anchoring our financial settlements in a finite, stable and enduring medium that is gold. What then is the purpose of the gold dinar? I believe that one of the important roles that the gold dinar can play is in encouraging the freedom of trade by acting as a universally accepted medium of exchange. And by encouraging trade between Muslims, it encourages cooperation between Muslims from both a financial and economic perspective. In Islamic history, we have seen that trade not only united Muslims, it was also a very important means of spreading Islam. It was perhaps no accident that the Holy Prophet s.a.w. was born in Makkah, a major center of trade in the Arabian Peninsula at that time. When Islam took root in the Arabian Peninsular, trade was the main vehicle for dakwah activities for the spread of Islam from Andalusia in Spain to the Cape of Good Hope in Africa and to the Malay Peninsula . It is fact that the volume of trade among Islamic countries, before the Western colonization began, was at a very healthy level.
. It was through traders that Yathrib learnt of the new faith called Islam, thereby opening the way for the Hjira and establishment of Medina China
As a result of the hurdles left by our colonial invaders and masters, we find ourselves today trading through Europe or through some third non-Muslim country. The continued dependence of the Islamic countries on the West is illustrated by the following:-
(i) The intra OIC trade is only 12% of the total trade of the OIC countries. In other words, the trade of the OIC countries with the non-OIC countries is 8 times the size of the intra-OIC trade.
(ii) The total volume of the OIC countries is only 7% of the total international trade, although 60% of the natural resources of the world are found in the OIC countries.
(iii) Lebonan and Turnkey export butter to Belgium , the United Kingdom and some other European countries, while Iran , Pakistan and Syria import butter from Europe .
(iv) Egypt is a big export of textile, but Algeria , Indonesia and Iran purchase textile from Europe .
What is the role of the gold dinar?
The proposed gold dinar will not replace the domestic currencies. The domestic currencies (e.g. Ringgit) will continue to be used for domestic transactions in the respective countries. The gold dinar will be used only for external trade among the participating countries. Initially, the gold dinar will not exist in physical form. It will merely be defined in terms of gold. For example, if one gold dinar is equivalent to one ounce of gold, and the price of one ounce of gold is today at US $290, then the value of one gold dinar will be US$290 or equivalent in other currencies, on the basis of the prevailing exchange rates. The actual settlement for trade can be by way of the transfer of equivalent amount of gold. It will not be a physical transfer of gold from one country to another, but a transfer of beneficial ownership in the gold custodian's account. Where it is not possible to transfer the gold, payment can be made by way of an equivalent amount in other acceptable currencies, but this should be the exception rather than the rule.
How will the gold dinar be used?
The gold dinar will be used, initially, for settlement of trade on the basis of bilateral payment arrangements (BPAs). Eventually the BPAs will be converted into a multilateral payments arrangement (MPA), with the participation of as many countries as possible. The following is an illustration of how these arrangements work:-
Bilateral Payment Arrangement (BPA)
· Two countries, say Malaysia and Saudi Arabia
·The trade will be denominated in gold dinar.
· The value of one gold dinar is defined, say, as one ounce of gold.
· The Malaysian exporters will be paid in Ringgit by Bank NegaraMalaysia
· The Saudi Central Bank will do the same for its exports and imports.
· Say, at the end of the 3 months cycle ending on March 31, the total exports fromMalaysia to Saudi Arabia is 2 million gold dinar and the total exports of Saudi Arabia to Malaysia
· Therefore, for that particular 3 months cycle ending on March 31, the Saudi Central Bank will pay Bank Negara 0.2 million gold dinar. The actual payment can be by way of the Saudi Central Bank transferring 0.2 million ounce of gold in its custodian's account, in the Bank of England in London, to Bank Negara's account with the same custodian. The important point to note here is that, under this mechanism, a relatively small amount of 0.2 million gold dinar is able to support a total trade value of 3.8 million gold dinar. In other words, we optimize on the use of foreign exchange. Even countries that do not have a large amount of foreign exchange reserves can participate significantly in international trade under this mechanism.
·The trade will be denominated in gold dinar.
· The value of one gold dinar is defined, say, as one ounce of gold.
· The Malaysian exporters will be paid in Ringgit by Bank Negara
· The Saudi Central Bank will do the same for its exports and imports.
· Say, at the end of the 3 months cycle ending on March 31, the total exports from
· Therefore, for that particular 3 months cycle ending on March 31, the Saudi Central Bank will pay Bank Negara 0.2 million gold dinar. The actual payment can be by way of the Saudi Central Bank transferring 0.2 million ounce of gold in its custodian's account, in the Bank of England in London, to Bank Negara's account with the same custodian. The important point to note here is that, under this mechanism, a relatively small amount of 0.2 million gold dinar is able to support a total trade value of 3.8 million gold dinar. In other words, we optimize on the use of foreign exchange. Even countries that do not have a large amount of foreign exchange reserves can participate significantly in international trade under this mechanism.
The summarise, we have spent a good part of the last two decades in establishing Islamic financial systems in our respective countries. we believe the time is now right to complete or complement the domestic systems with an international system - a system that will allow each Muslim country to reach out to one another and strengthen the level of trade - a system that will also allow the ummah to use its collective surpluses to fund each other, and help each other grow.
Bibliography
1.http://www2.treasury.gov.my/index.php?option=com_content&view=article&id=878%3Ainternational-islamic-university-malaysia-2002-international-conference-on-stable-and-just-global-monetary-system&catid=53%3Aucapan&Itemid=251&lang=my
8. www.cia.org
No comments:
Post a Comment