Would the West accept being saved by Islamic finance?

The Nobel prize winner for economics, Eugene Fama, born in 1939 and one of the fathers of monetarism and the neoliberal ideology, is known for having pre-emptively asserted that “the idea of efficient markets is a simple assertion that states that the prices of securities and assets reflect all the information known”. It is in fact following on from the work of economists like Fama, like Milton Friedman (1912-2006) – also a Nobel winner in 1976 – and like Burton Malkiel, born in 1932, that financial markets went through a real transformation at the beginning of the 1980s. And this was with active participation from the most powerful political leaders of the time like Margaret Thatcher and Ronald Reagan, who even asserted in his inauguration speech on 20th January 1981 that “government is not the solution to our problem, government is the problem”.

From this point onward, economic conservatism and social regression reigned supreme. The void left by the government was of course filled by the exponential development of a financial sector that was labelled “efficient”, even “perfect”. This financial system was in fact supposed to supply all services to the economy. The markets would be a sort of judge of the peace, putting company and household finances back in order by benevolently bestowing their efficiency on all the economy. The admirers of financial markets were even convinced that their prices were the result of a rational equilibrium, and that employment was nothing more than a variable in optimising stock market valuations. It is in fact Burton Malkiel – not yet a Nobel winner! – who assured us that “the true value of markets will triumph in the end because the stock market is a mechanism of long-term precision”.

The deregulation of our economies and the financial system of course comes right back to this idea of the efficient market. There’s no need for regulation or security measures if the market is optimal. It’s therefore pointless to try to harness a beast that regulates itself via price, that eliminates the weakest – that is to say those who have made bad decisions – and that makes the rich richer. It’s therefore really natural selection in action with these financial markets, deemed to be omniscient and infallible. As this self-regulation brings its beneficial effects on the economy, the task of the government must therefore be to strip itself back to its most simple form. Alas, this restriction of government – a prerequisitefor financial deregulation – has been giving rise to banking and stock market crises repeatedly for more than thirty years. This laissez-faire attitude that has spread from the British and Americans to continental Europe, then on to Latin America and Asia, it’s the whole planet that has slowly been infected by speculative bubbles that when burst have intense and ravaging financial, economic and of course human costs.

Nowadays, it’s the whole spectrum that has been contaminated by this financialisation: energy, real estate, foodstuffs, but also education and even healthcare in certain countries. All these facets of economic activity have been trapped in a complex web spun by financialisation. For example, Goldman Sachs has invested several million dollars in prisons in New York state, with the following projections: recover its stake if recidivism drops 10%, double it if this rate improves, or lose half the stake if crime rates don’t improve in New York! Our societies have now reached such a level of decadence that they are delegating such responsibilities to the financial sector, and their most basic duties with regards to citizens in distress. These “social impact bonds” demonstrate that the moral obligations of the collective have now ceded their place to financial institutions who raise funds to generate profit, while slowly replacing the government.

In the best of worlds where the market is supposed to be efficient, scams and skulduggery are meant to be impossible! In fact, since markets cannot be efficient in the presence of criminal activity, these dishonest acts can quite simply not exist…precisely because of the efficiency of the markets! However, who knows, maybe in 2019 – more than ten years after the subprime crisis! – Wall Street and the City’s new maxim will be “I’ll be Gone, You’ll be Gone”. This would tell us that tomorrow’s disasters – an inevitable consequence of today’s behaviour – are not the problem of financial types who won’t be here to see them…and that it’s other people who will have to clean up the mess.

In truth, with the financial sector’s abuseshaving become part and parcel of our ethics, honest bankers and financiers are no longer fit to compete with their fraudulent colleagues. It’s simple: a bank that doesn’t seek to hide its losses, sell off its toxic assets, launder money, or manipulate the price of a derivative product would no longer be competitive and would ultimately be doomed to bankruptcy, or to have its stock market value severely damaged. Darwin’s theory of natural selection teaches us that the strong outlive the weak. In the world of finance, it’s the liars who survive and even prosper, while those who play by the rules are damned.

This steamroller of scams and skulduggery has a name: Gresham’s law, taken from the name of Elizabeth I’s financial advisor during the 16th century. It’s a fiendish mechanism that was described by George Akerlof, born in 1940 and Nobel winner in economics in 2001, as such: “Dishonest transactions tend to drive honest transactions out of the market. This is why the cost of dishonesty is higher than that of cheating”. Gresham’s law – that has now become dominant in financial markets – means the evaporation of ethics and the arrival of crime, that has now become endemic. Those who respect the law and morality are therefore being forced into non-existence while their reckless rivals stay put thanks to tricks and manipulation that reduce their costs, or boost their profits. In other words, nowadays, it’s becoming “too costly” to be honest and evil is prevailing over good in economics!

At the time, England and elsewhere, silver coins of unequal purity were in circulation. Consumers and suppliers then jealously hoarded those that had a higher proportion of silver and got rid of the less favourable ones. In truth, it was during the Middle Ages that Gresham’s law reared its ugly head because only coins of mediocre quality were exchanged in daily trade whereas those with a higher degree of purity were kept to one side, destined for the black market, or even melted down. This bad silver was therefore routinely used over the good silver, a bit like us who – today – prefer to pay with used, torn, and scrunched up bills so as to keep the banknotes that are in a better state. It’s a totally typical – and inoffensive – example of Gresham’s law: we spend the most tattered banknotes in our wallets first!

Nowadays, a country like India – a country that is fully demonetising – is harshly suffering this Gresham law after its authorities unilaterally decided in 2016 to withdraw 24 billion 500 and 1,000 rupee notes (around 10 and 15 $) from circulation. That’s 80% of cash that was circulating. The Indian government is struggling to put new notes into circulation, particularly the 100 rupee note that is widely used by all types of consumers and vendors. It’s actually no less than about thirty 100 rupee notes that the average Indian keeps in their wallet today, whereas before demonetisation this number was about four or five. Also, their life span in the hands of a consumer is around 15 days whereas it was 2 or 3 before. These bills are now sought after and credit card payments are given priority (when the vendor approves), thus allowing people to hold on to their precious bills for as long as possible. The 100 rupee bill is now seen throughout the Indian subcontinent as “good” money whose circulation and exchange has basically become static, replaced by credit and debit card payments that in this context represent the “bad” money that people look to get rid of as quickly as possible.

The consequence of India’s risky demonetisation is once again savagely hurting the poor, who don’t have credit and debit cards. The grocers, the barber and the cornershop keeper have been hit by the brutal collapse of their bottom line due to the rarity of these banknotes, and because of consumers no longer having the chance or the means to pay by card. The governmentdid install cash machines, but they mainly only dispense 2,000 rupee notes – which are valued highly by organised crime and fraudsters – and have turned out to be totally useless to citizens who simply want to live and trade. In a situation where exchanges in cash make up nearly half of GDP and more than three quarters of jobs in India were cash-in-hand prior to demonetisation, Gresham’s law is causing a dramatic increase in instability and misery.

In such an environment where Gresham’s law seems to be becoming standard and spreading its mischief – as we can see – not only in the West but also now in such an enormous country as India, how can we not be thinking about Islamic finance as a way of rescuing – even civilising – the world of finance? With the most significant feature of a sukuk being that it must imperatively be linked to an underlying asset that generates revenue, we can then understand better why Islamic bonds are elementary to financial stability. With such rules, it is in fact impossible to take on debts that are not backed, amortised, or at least partially offset by future revenue. Wouldn’t respecting this principle have avoided the over-indebtment of many of our Western nations? Also, wouldn’t morale have been saved with products like the “musharakah” or “mudarabah” that allow profits to be made, but that also oblige everyone involved to share any losses.

Let’s think of Western banks and their shareholders being bailed out with taxpayer money without seeing the slightest of adverse consequence. Let’s also think of the countries of peripheral Europe who, with their reckless spending from 2010 onwards to save their financial institutions, are now impoverishing their youth with unemployment rates bordering on 50% thanks to an austerity imposed by these same financial markets… Finally, let’s think of countries like Greece that had to sell off strategic assets for giving in to the sirens of predators like Goldman Sachs who knowingly manipulateits public accounts.

Since money has no sacred value in the world of Islamic finance, and since money is seen simply for what it really is – a means of payment –, the degree of risk that investors are willing to take on has been significantly reduced. Assets and goods that don’t exist at the moment a contract is signed can simply not be sold in advance! Money is therefore always and in all circumstances linked to the real economy. Consequently, this simple principle fundamentally discourages speculation and totally eliminates all derivative products, whose raison d’être is to process phantom assets. It’s the subprime crisis, like the sovereign debt crisis in Europe, that we could have been spared from, and it’s the exacerbated volatility of financial, commodity and foodstuff markets that would have been nicely reduced if our Western world had taken a leaf out of the book of Islamic finance.

Islamic finance can now make finance accessible to everyone, with products that everyone can understand, and it can hopefully bringthisframework to a decadent Westernised financial systemthat’s got drunk on its own power. Because money and finance are just a means, not the end goal. And because it’s finally time to break this spiral caused by Western finance that keeps ravaging economies and putting populations at risk. Or, as Amartya Sen, Nobel winner in economics and born in 1933, elegantly put it: “How is it possible that an activity so useful as finance has become so immoral?”