Time-Up for Capitalism?

Economic Turmoil

It is almost impossible to watch or listen to a news programme daily without mention of increased levels of debt, or another bail-out package, stock market crisis or wildly fluctuating commodity prices.This turmoil is now the norm, and the real question is where will it all end? Can we really spend our way out of this crisis? How many more austerity measures are needed…more importantly, who will suffer from these and for how long? The prevailing economic system has produced a disparity in wealth which is so stark that even the wealthiest individuals in society are calling for tax hikes to save the situation. This shows that the economic building blocks need to be dismantled, as they have failed to produce a commercial model which not only promotes free enterprise and rewards effort, but is at the same time equitable and sustainable for a global society.

Time to Ask the Difficult Questions...

Too often I have heard people, whilst acknowledging that the western capitalist system is a long way from perfect, stating ‘but it’s the best we have…’ or ‘it’s better than the alternative...’ …whatever that perceived ‘alternative’ may be. However, the gravity of the current global meltdown has people now openly questioning what were previously perceived as holy grails. In the same way the long held belief in Einstein’s discovery of E=MC2 is being challenged by scientists today – any scientist brave enough to challenge this just a week ago would likely have been supervised in a straitjacket to a padded cell – those with independence of mind are questioning the future of capitalism. The BBC recently posed the question ‘Has Western capitalism failed?’ on its website. Intellectuals are now prepared to argue that a different model needs to be adopted.

...Accept the Current Predicament...

In the early 1950s, a U.S. social psychologist conducted an experiment, whereby he infiltrated a cult that believed UFOs were coming to rescue them from a flood that would destroy the earth. As the supposed Judgement Day came and went, the leaders, instead of altering their views as incorrect, simply assigned a longer time horizon to their expectation, and encouraged members to escalate their own commitment. This helped them to avoid the pain of realising the ideology they followed was false… at least for a while longer.

The behaviour of our own political elite today could be interpreted in the same way. Rather than accepting that the current course of capitalism is flawed, we are urged by our leaders to commit ourselves to the system even more, and encouraged to pull together to resolve the debt crisis.

One really needs to stop and think... just whose debt is it we are being asked to pay off through increased taxation and reduced services? Surely the free market policy we prescribe to dictates that those responsible for poor investment decisions – primarily the banks – should be liable? And if that’s means they collapse, why are we paying for their profligacy?

One commentator put it quite simply... if a child over spends on your credit card, the only solution is to take the credit card away…to extend the credit limit will in no way rectify the overspend.

...And the Unpalatable Truth!

‘Once you eliminate all other possibilities, whatever remains, however improbable, must be the truth.’ Such goes one of Sherlock Holmes famous quotes. So, what are the possibilities, and what will remain? Therein lays the current predicament for the upholders of the current world order. What they would like the populations to believe is that the only alternative to the capitalist system is socialism. And what kind of alternative is that? In truth, once the two models of economics are eliminated – socialism, which has already been rejected by nations globally, and capitalism, which is now crumbling under a mountain of debt, there is only one alternative – an economy based on Islamic principles.

This is the unpalatable truth which many cannot bear to hear.

The Need for an Alternative

So, what is it that the Islamic economic system has to offer? Why is it different? Can it resolve the problems of the global economy today?

Some of the principles are well known and being talked about by serious economists who are brave enough to consider an alternative. For example, a return to the gold standard to underpin the money supply is now openly debated and being established in small pockets. Economist Chandran Nair, of the Asian Think Tank GIFT (Global Institute For Tomorrow), is one of those also open to consider a different model. His contribution to the debate about capitalism can be seen here, and his discussion with Stephen Sackur on free market capitalism on Hardtalk is also well worth watching. Although he does not argue from an Islamic viewpoint, his ideas demonstrate the thinking about a revised model which fundamentally challenges the underlying principles of how we view an economy.

Islam – The Balanced System

Islam as an ideology can be understood to be the ‘middle way.’ It is a balance between the extremes of free-market capitalism of the right, and authoritarian socialism of the left. This balance is sometimes the reason people incorrectly equate Islamic with socialism (Islamic socialism movements were common in Muslim countries in the 20th century) as well as capitalist principles (freedom to earn, or market forces). As a system revealed by the Creator, it recognises human nature, the need for the fulfilment of basic needs, as well as the need for enterprise and entrepreneurial spirit. However, it does not dispense of a moral code which is sacrificed in capitalist economies, which result in the vast inequalities in wealth and opportunity.

Hamid Chaudry

Bayyina Foundation

VIDEO: The Truth About The London Riots 2011

The Truth about The London Riots 2011.

THE EVENT

The Event referred to took place in England in the year 1694 with the birth of the Bank of England as the national Bank. The Bank of England was not the first national bank. Two other national banks were created before the Bank of England. The first national bank was the Banco de Spiritus Sanctus or the Bank of the Holy Spirit (amazing name!) which became the first national Bank in 1605 of, which State? None other than the Vatican. The Bank, founded by Pope Paul V, has ceased to perform financial miracles for the Popes -now it is in the hands of the Italian State- but the Vatican possesses its own official bank, piously called the Institute for Religious Works. The second was the Bank of Sweden (Sveriges Riksbank) founded in 1668. The reason why we have chosen the Bank of England as the birth of the State is because only England with the beheading of their King and the creation of the Parliament had the right social chemistry to trigger the unprecedented unfolding of this institution, the State. Only in England, and for the first time, the debt of the Sovereign had the conditions to become what became known as the National Debt. A concept whereby the debt incurred by the Sovereign, no longer belongs to him, but to the entire nation.

This does not mean that in the year 1694, the State, with all the features with which we know today, suddenly appeared. No, the State gradually developed into its full flesh in the years to come. What took place in this year, was the coming together of two institutions banking and government in a new fashion which created the necessary mixture for the unfolding of the State. We can say that the seed of the State was created. This seed contained the potential for all the features that were to unfold in the years to come. The seed contained the forerunner elements of the Central Bank, fiat money and the national debt. How did it happen? And what happened?

The Revolution over, and the Dutch William of Orange on the throne of England (1689-1702) a climate of discovery and experimentation with money matters was flourishing in England. It was a time of treasure hunting companies, “quick money making” schemes and new banking designs. It was all further encouraged by the small boom of 1692-5. In this climate the Bank of England was born.

At the time England was financially exhausted after half a century of war. Unable to increase taxes and unable to borrow, Parliament became desperate for some other way to obtain money. There were two groups of men who saw a unique opportunity arise out of this necessity. The first group consisted of the political scientists within the government. The second was comprised of the monetary scientists from the emerging business of banking.

The opportunity came in 1694, when the King needed money to raise an army for the war with France. The King went to the rich merchants and goldsmith bankers in London to acquire this money. Several schemes for a public bank were submitted. Finally, William Paterson, a Scotsman, fronted several syndicates and made a proposal in imitation of similar successful ventures in Italy and the Netherlands (especially the Bank of Amsterdam founded in 1609 -seen by many as the father of modern banking). After a few failed attempts, he and his merchant backers eventually proved successful.

Patterson wrote a brief presentation for the initial stock offering entitled “Brief Account of the Intended Bank of England” [quoted by Prof. Carroll Quigley of Georgetown University, in "Tragedy and Hope: A History of the World in Our Time", 1966], in which he wrote: “the bank hath benefit of interest on all moneys which it creates out of nothing.” This simple sentence, by the world’s first Central Banker, was going to become the key issue to the unfolding monetary destiny of the world for the next three hundred years.

The meaning of the sentence is that “under the government’s authority” the Bank of England would issue paper money created “out of nothing”, which would in turn be loaned at interest to various borrowers. The commercial banks had done this before, but this time it was endorsed by the “authority of the people”, the Parliament. The meaning of “out of nothing” is that the notes of the Bank of England were only partially backed by gold or silver, not to the point of complete convertibility. From the very beginning the Bank never professed to make its issues of notes square exactly with its coin and bullion, though, of course, it made its liabilities square with its assets. This issue has remained a mystery for most people even today. How can the liabilities be equal to the assets, and yet there are more notes than specie? The issue is at the heart of banking itself, but we leave this issue of “magical” accounting for another occasion, we will simply refer to it as fractional reserve banking, meaning, the ability of the bank to lend more than what it holds in cash or creating money “out of nothing”.

By early May 1694 the parliament passed a statute appointing a new tax on ship tonnage expected to raise £140,000 per year. £100,000 of this was earmarked to pay interest (at 8% per annum) on a new £1.2 million loan which the government was going to borrow from the Bank. The loan would “only” cover about ¼ of that year’s expenditures upon the Nine Years War (1689-97) with France.

The £1.2 million loan was paid into the Exchequer in instalments between August and December. Shareholders received interest of 8% on the full amount of the loan, although they had “only” had to contribute £720,000 in actual cash, the rest had been created “out of nothing”. The loan was paid to the government with the cash of the shareholders, who by November had supplied 60% of the amounts for which they had subscribed. The rest was paid with so-called “sealed bills”: £1000 paper notes stamped with the Bank’s corporate seal. The government used these bills in turn to pay its suppliers. Since they bore interest at about 3% per annum, many were held as investments; those few that were returned to the Bank for cash were reissued and employed in further loans.

The Bank had a double function: it managed the Government’s accounts and made loans to finance the Government but it also operated as a commercial bank: it took deposits and issued notes to private customers. Much of the cash from the shareholders was used not for the war loan but to circulate additional sealed bills issued out to private borrowers, raising returns even further.

The authorizing statute had imposed two important limitations: the Bank could lend no more than £1.2 million to the government without parliamentary dispensation and could issue no more than £1.2 million in sealed bills. The first limitation actually proved an asset, since over the next year or two Bank directors often made it an excuse for refusing further loans to the Crown (loans they were reluctant to make in any case). But the ceiling on sealed bills was a real constraint. Bank directors evaded it by issuing what they called “running cash notes”. Instead of being stamped with the Bank’s seal, these small-denomination notes were merely signed by its cashiers and they bear no interest (unlike the sealed bills). The Bank’s numerous critics tried to make an issue of this, but the notes continued in circulation. These “running cash notes” became in fact the forerunners of present-day paper currency.

By February 1695, the bank had advanced to the Government not only the whole of its original capital of £1,200,000, but also a further sum of £300,000. But there were even bigger remittances to follow within the next eighteen months. The government could not stop borrowing, breaking the limitations that it had imposed on itself. The government had just discovered the possibility of an “almost” endless means of finance. But of course, the problems started to come.

The new money created by the Bank of England splashed through the economy like rain in April. Consequently, when these plentiful banknotes landed in the other banks’ hands, they quickly put them into the vaults and then issued their own certificates in even greater amounts. As a result, prices doubled in just two years. Then, the inevitable happened: There was a run on the bank, and the Bank of England could not produce the coin. In May of 1696, just two years after the Bank was formed, a law was passed authorizing it to “suspend payment in specie” [suspend payment in gold for the face value of the note being presented]. By force of law, the Bank was now exempted from having to honour its contract to return the gold. Fiat money had been born. With it one of the key features of the modern State had been born.

With this event two other institutions had been born: the Central Bank and the National Debt. That Central Bank is still with us and has become a dominant institution in today’s economy and that national debt we, the citizens, still carry forward and which in aggregate, is in fact unrepayable. The citizens of Britain still have not been able to repay their debt three hundred years later. Today the national debt of Britain is 1 trillion pounds.

In 1694, the Bank of England was not yet a central bank in the modern sense but it was the seed for the central bank. The capacity to act as lender of last resort and regulator of financial activity within the economy at large was only developed gradually during the next century as the complexity of the financial system grew.

As the Government borrowed more and more money, these outstanding loans were called the National Debt. This debt was different from before. Sovereign’s debt had always existed. However, how the king could make his promise to pay trustworthy, was the critical problem. Defaulting had become a common phenomenon in England since the medieval period. In the medieval period, tax collection was a very difficult task; the king often relegated local agents and office holders to collect taxes for the sovereign, a practice curiously called tax farming. Generally, these agents or office holders had tax exemption privilege, narrowing the tax base and reducing tax revenue. Tax was never enough. Borrowing against the taxes was the only choice. For the king the best choice was to default to his creditors. Although cooperation with the creditors seem to be the best choice, this was not always possible. Creditors (later bankers) and Kings had a difficult relationship. Cooperation could not crystallise. This changed for ever with the Bank of England.

The establishment of the Bank of England altered the sovereign’s (State’s) incentives to accept debt. The debt could be easily distributed to all the people by a new mechanism: the issue of non-redeemable or partly redeemable paper money. Thanks to the Bank the State was capable of making its debt trustworthy. It was not “his” debt it was the “national” debt. The State provided the Law to make the new money legal, the bank could provide almost endless amounts of that money. The two institutions seemed to gain, they could cooperate for the first time. This event altered the sovereign’s (State’s) incentives to accept more debt. From this moment onwards, the raising and raising of debt would reach unprecedented levels in history. This debt fuelled the extraordinary rise of the banking institution and brought it from the fringes of society to the very centre by becoming the new master of the economy.