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Banks are being subsidized by Central Banks and Fractional Reserve Banking

Reader comment on item: Be Careful Investing in Islamic Financial Institutions
in response to reader comment: Thanks for a good discussion

Submitted by Malik Abdul Rasheed (Qatar), Nov 29, 2011 at 04:37

Prashant,

Yes this has definitely been a good discussion. This has also served as an opportunity for me to verbalize (or type) the particulars of what Islamic finance is and what isn't. There are specific rules and guidelines to "profit sharing" hence the label Islamic Finance. There is a certain level of specificity on profit-sharing that garners the label Islamic Finance. There might be forms of profit-sharing that might fall outside of what has been stipulated as acceptable in Islam. (Sharia-compliant)

At the root of Islam's criticism of interest (at least from an economic perspective) is it invites speculation, value distortion and most importantly, eventual default. And we are not talking default on a small scale. We are talking systemic default. Depending on who you talk to, "excessive" is too broad of a term. PD Loan companies believe their interest is correct based on their risk. Libertarians believe that the fed funds rate is excessively low (or should be abolished completely), while the Federal Chairman and other Keynesian Economist (and other government monetarists) believe that the low interest rate is appropriate considering the economic circumstances of the U.S economy. Around 2006-2007 when housing industry was being pumped up with lower interest rates and cheap money, banks felt that their interest rates for their mortgages were appropriately pegged considering the current economic environment. They were wrong. And we have a long history (800 years) of statistics to prove that pegging interest rates against whatever is followed up with printed money and a default to make the "correction". When I think about how many times countries go into default while having to reissue debt, it doesn't seem to me that interest is working out quite well.

So many interest based financial schemes have been put in place to prop up a banking system that cannot depend on their own interest based system that they believe is economically superior to profit-sharing. Even with all the legal gambling schemes out there with CDOs (traunching) and insurance (CDS) every single company in the investment chain had to be bailed out. All these schemes are tied to interest and at the end of the day they were completely useless in the the purpose they were supposed to serve which is to protect principal while making a profit.

At the end of the day the Fed has to swoop in and "fix" (I use this term lightly) the situation with printed money. If most companies cannot peg an appropriate interest rate to their loans and savings (creditors) to cover future risk, then that shows me that interest seems to be a clumsy instrument for profit. Some would argue that Central Banks create interest-rate distortions and if the Free-Market would be left alone, they (Bank and other Investment firms) could successfully peg an appropriate interest rate.

Regarding your last 4 points. I'll answer in the same order.

1) It depends on the context. Interest has more short-comings than benefits. Without printed money Western economies cannot scale. If banks are so confident that interest can provide all the needed profits/risk coverage while contributing to global GDP why are they always begging the Central Bank to bail them out? If banks do not need the Fed to prop up their capital in-flows, why aren't the bank lobbyist joining the fight with Ron Paul to end the Central Bank and Fractional Reserve Banking? If their Free-Market interest based investment strategy is superior to having a Central Bank involved, why don't they just not accept the trillions of dollars that they get at some of the lowerst interest rates ever? Banks around the world should lobby with Ron Paul to shut the Central Banks down. If it's excessive interest that has undermined the U.S. economy shouldn't even lower interest rates (which we have right now) send the economy upward? The Fed Funds rate is at nearly zero. Check for yourself:

http://www.bankrate.com/rates/interest-rates/federal-funds-rate.aspx

2) I would argue that point. Do some research on IMF/World Bank policy over the last 50 years or the documentary Life and Debt. There is nothing virtuous about these institutions. It depends on the situation and I have a better label that begins with a "v",....vampire comes to mind. :-)

3) We are talking two different things. Muslims want to follow the Quran. It's a way of life that not only touches on how we worship in the Masjid but how we do our day-to-day business transactions. Non-interest based business transactions is what we want to do. If we don't want to use interest, that is our business. There is nothing bad about doing what you want to do (unless you are hurting someone). We are not hurting anyone, so who cares? We are making a religious choice. Please provide an economic argument (with sources) why not using interest is a "bad" thing.

4) Unfortunately, this is a completely subjective and anecdotal comment. I would argue those who oppose interest had thought long and hard about it. We have weighed the pros and cons from a monetary and Islamic perspective. We realize that interest has way too many short-comings (religiously and economically). It can only survive with a Central Bank wiping the behind of banks and investment firms with printed money. When banks lobby for no Central bank and Fractional reserve banking then we'll see whether interest can hold up. Otherwise it's a monetary welfare system.

I don't want to belabor the point but where are your resources? Not calling you out on this as some "gotcha" question. I just want to know where you are coming from with your ideas and thoughts in regards economic policy. Even you have suggested in point 4) that those who oppose interest have not thought deep enough on the issue. If that is the case can you provide resources that would help folks like me to dig deeper on the benefits of interest from a historical and contemporary economic perspective.

With everything said, I really enjoyed this discussion. It's hard to gauge tonality in word form, so to be clear, I'm extremely passionate about economics but I tried my best to stay on message while not attacking you personally. And thanks for not attacking me personally. I'm glad we were able to talk about this. My only suggestion is go deep on economic matters that touch on subjects that our outside of your comfort zone. Although my economic view is underscored by my faith, I still take time to read economic subjects from a wide range of subjects outside of Islam.

Malik

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