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ECONOMIC SOLUTION: Debt relief, in the form of interest write-off or debt writedown, is what is required to tackle the current financial crisis, says Zaleha Kamarudin
SINCE the United States subprime mortgage crisis that started in mid-2007, the global economy has been on a downward trend, expected to shrink for the first time since the Great Depression. Business confidence, even in major economies -- the United States, Europe and Japan -- has been plummeting while more and more jobs are being lost.
The US unemployment rate is 8.2 per cent while that of the eurozone is around 11 per cent. The outlook for the global economy is indeed not so good. Recognising that conventional monetary measures are no longer working, the leaders of nations basically adopted a Keynesian-style fiscal stimulus to rejuvenate the ailing global economy.
The economic stimulus packages included the loosening of credit restrictions and tax cuts to offset the decline in the industrial and export sectors. Malaysia announced a stimulus package of US$2.3 billion (RM7.3 billion) in November 2008 and another massive US$20 billion in March the following year, the largest it had ever done. Its neighbours, too, put in similar packages: Singapore US$13.5 billion and Thailand US$1.1 billion. So long as a nation is not in a liquidity trap, such stimulus packages may work.
For the developed nations that are, however, in liquidity traps, like the US, Europe and Japan, such stimulus packages may not work. The reason is that in a liquidity trap, conventional interest rate measures would not stimulate economic growth through increased borrowing. This is because the economy, in that state, would have been highly leveraged and unable to take on more debt.
Hence, what these countries need is not so much economic stimulus packages but rather some relief from spiraling debt. Debt relief, in the form of interest write-off or debt writedown, is what is much needed in the current context of global economic and financial crisis. It is particularly important for the US to give debt relief to its real economy sector, firstly, because the global crisis emanated from there and, secondly, the size of its economy matters, being a significant trading partner to the rest of the world.
I hope President Barack Obama recognises that it is in debt relief where the solution lies and not in mere bank bailouts or quantitative easings.
For the poorer nations, the 2009 G-20 Summit in London decided that the "wealthier" nations would beef up the International Monetary Fund (IMF) to about US$1 trillion, to be forwarded to those poor nations as loans, over and above the already suffocating levels they are in. Again, what these countries need is debt relief and not further debt.
Without debt relief, my prediction is that, firstly, the world would experience serious inflation in the coming years, affecting all economies, with the poor nations being the hardest hit. Prices of all commodities, including grains like rice and wheat, can be expected to skyrocket, even though the recession itself may bring down the price of things like properties, cars and financial assets, etc. Secondly, the crisis would continue to spread worldwide.
Hence, the decision reached at the G20 Summit -- bailouts and economic stimulus packages but minus debt relief -- seems not a truly economic solution but rather a political one, which is likely to continue to pull down the global economy.
Below we provide some measures, that nations can emulate to mitigate the crisis and protect themselves from the highly possible economic depression. The actions are divided into immediate short-term actions and long-term actions.
First and foremost, we need to recognise that a root cause of the entire monetary fiasco is the characteristic of the monetary system itself, where most fiat money is issued in the form of debt with compounded interest imposed on it. This places an exponentially growing debt burden on the real productive economy. The excess growth of money supply in the economy translates into inflation and asset price bubbles, which actually brings about a widening gap in income and wealth distribution, even contributing to poverty.
Being unable to match the exponential growth in the money aggregates, the real economy ultimately succumbs and starts to default on loans. This starts off a spiralling event of foreclosures and bankruptcies, which, in turn, causes money supply to contract, that is a monetary meltdown. This meltdown, in turn, brings about a recession with all its ill-effects like unemployment, business failures and crimes.
At extreme levels, when debt levels become unrepayable, the economy finally falls into a liquidity trap where even low interest rates cannot encourage borrowing that can stimulate the economy. Major economies -- like the US, Europe and Japan -- are currently at this stage.
Such a compound interest rate is much abhorred in Islam, as depicted in the following Quranic verse:
"O ye who believe! Devour not usury, doubled and multiplied; but fear Allah. that ye may (really) prosper." (Imran 3:130) In short, from an Islamic perspective, the global economic crisis is fundamentally the effect of a compound interest-based monetary system known as riba in Islamic finance. This interest effect is exacerbated by the fact that fiat money itself is created out of thin air.
For developed nations, the first and foremost immediate action needed is to give their real productive economy relief from the "overpowering" debt obligations. The exponential part of interest obligations needs to be written off, requiring only the principal portions to be repaid. This action would release the economies from the liquidity trap they are in.
Countries that are not in liquidity traps sooner or later would also have to do a similar thing. Requiring borrowers to pay only the principal amount is also the prescription from an Islamic perspective, as depicted in following Quranic verse regarding debt obligations and interest charges.
"If ye do it not, take notice of war from Allah and His Messenger. But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly." (Al-Baqarah 2:279)
In this regard, an interesting article has been written by economist Michael Hudson, The Lost Tradition of Biblical Debt Cancellations, which is available free on the Internet. It gives an interesting historical account of periodic events when all debts -- public and private -- were cancelled and slaves freed, that is the Jubilee Years. Apparently, even Jesus Christ had remarked that he had come to proclaim the Jubilee Year.
Next, new money needs to be injected into the economy through expansionary monetary policies. New fiat money may not be the preferred choice but, rather, is necessary given the current "flawed" system that we have; that is to counter the destruction of money that takes place during a meltdown. This, nonetheless, most economies are already doing, and constitutes what bailouts essentially are. The bailout money should, however, be injected into productive sectors to revive the real economy, prevent layoffs, and not distributed as bonuses.
One of the effects of the dollar and euro crisis, together with bailouts and quantitative easings, is serious global inflation. Hence, nations must take steps to lessen the burden of inflation on their people. This may include:
DISTRIBUTING food-stamps to the poor and vulnerable, financed by taxing the higher income group;
CONTROL the price of basic necessities;
INCREASE the number of small-holdings of food producers, processors and distributors;
ENCOURAGE and provide assistance to new graduates to enter into agri-business, and CURB monopolistic and oligarchic food production and distribution.
There are calls from some quarters to nationalise commercial banks and consider public banking to prevent such debt crises. They propose this to ensure that newly-created fiat money is not privately owned. The power of money creation should lie with the government alone and all new money creation should, therefore, be publicly owned. Hence, the recent spate of nationalisation of financial institutions in the US, UK and Europe is, therefore, justified.
Unlike most states in the US that are in financial distress, North Dakota, which has its own public banking, is almost crisis-free. Hence, in the US, there is now a strong movement emerging in favour of public banking. The Institute for Public Banking, headed by Ellen H. Brown, is an example.
Perhaps, less-affected nations like Malaysia and other developing nations should plan and embark on nationalisation of banks now and should not wait until things get worse before acting.
Governments may consider putting in place complementary currencies and payment systems, to supplement scarce national currencies. This is an important measure that nations concerned about the welfare of their citizens should do immediately.
The monetary meltdown that is spreading globally entails simply the destruction of money, which, in turn, translates into recession. Hence, all the observed events, that is from high debt levels, collapse of mortgage markets and recession are fundamentally a monetary phenomenon. The real productive sector, however, suffers due to the fallacies inherent within that monetary system.
This time what we observe glob ally is not a normal economic cycle, but rather a systemic breakdown. The world needs an immediate replacement -- a new global monetary order. The Islamic finance and economic system has a lot to offer the world, to bring growth, stability, sustainability and justice back into the global economic order.
For this purpose, it helps to note that the monetary system is an information system. Hence, we can introduce a new global monetary system and, thereby, mitigate the monetary meltdown using the existing electronic money and payment infrastructure, without having to rely on physical money interest charges.
Money can be made available freely just like any other public good. There is no reason for anyone to borrow money at interest for money is merely information, that is, a means for keeping score. The WIR Bank of Switzerland works on this principle. In its history of operation since the 1950s, it has given out billions of dollars of interest-free financing.
Complementary currencies do not place burdens on future generations and also they do not sow the seeds of future bubbles and busts. Secondly, money in the complementary currency system is created as and only when a good service is created and exchanged. Hence they are non-inflationary in nature.
Thirdly, unlike credit card transactions, the "money" here is created by the individual as and when necessary without having to borrow it; and hence the dispersion of money is faster, wider and deeper. Accordingly, economic recovery would be faster.
Such an information system would allow individuals and businesses to continue to transact even though the current meltdown causes a lack of money in circulation; and recession can, therefore, be contained. If the system is based on gold as a unit of account, the gold numeraire would also place stability into the system and eliminate monetary sector induced inflation.
The paper acknowledges the input and views put forward by Prof Dr Ahamed Kameel Mydin Meera, head, Department of Finance, Faculty of Economics & Management Sciences, International Islamic University Malaysia
Prof Datuk Seri Dr Zaleha Kamarudin is rector of the International Islamic University Malaysia. The above was a keynote speech at the United Nations Thematic Debate and Dialogue on the State of the World Economy on May 17 and 18 in New York