Friday, November 30, 2007

Islamic Banks : Another Destructive Tool

1. The above caption sounds odd but it is true and demands an explanation from IDB. Islamic Research and Training Institute–IRTI established in 1981 to undertake research and training for enabling the economic, financial and banking activities in Muslim countries to conform to shariah.

2. Rationale of Islamic banking: IRTI occasional paper no:2 holds “People need banking services. Now, since the banking services are needed but interest is prohibited, Islamic economies have to find alternative ways of performing various banking functions. This challenge provides the rationale of Islamic banking”. Thus Islamic banks must perform the following functions totally free of interest and the like:
(i) Financial intermediation between savers and fund users
(ii) Offer loans for genuine needs of all sectors of the economy and government without any service charge which is prohibited by Quraanic tennet: “you are entitled to your principal amounts.” Hadeeth qudsi declares “reward for qard is 18 times” implying that Islam wants vast use of loans. An article in Sept.2002 issue of ‘Islamic Economic Studies’ held “Dayn financing plays an important role in Islamic financial system”. Dayn includes both loan and debt.
(iii) Limit profit earning to genuine risk-taking financing modes avoiding risk-free fixed-return modes resembling interest.

3. Shortcomings and misdeeds of ‘Islamic Banks’:- Islamic banks avoid giving loans–the most needed primary banking service. They do not encash commercial papers and do not open letters of credit. They exploit Islamic sentiment of their clients and neither promote Islamic economic ideals nor do they contribute to economic development of Muslim countries. By transferring funds mobilized from Muslims to western financial markets they deprive Muslim countries of their due share in economic development. Their misdeeds and shortcomings as identified below render them unworthy of their name:-

(a) “The case of Islamic banking cannot be advanced unless a strong system of inter bank transactions based on Islamic principles is developed. The lack of such a system forces the Islamic banks to turn to conventional banks for their short term needs of liquidity which the conventional banks do not provide without either an open or camouflaged interest”-‘Introduction to Islamic Finance’ by M.Taqi Usmani chairman / member of a dozen Shariah advisory boards of ‘Islamic Banks’.
(b) “In order to effectively replace interest, the Islamic economy needs a comprehensive financing mechanism defined as a mechanism which provides monetary financial accommodation to enterprises but remains neutral with respect to their longer-run ownership structure”- IRTI Research Paper 29.
(c) “… some IBs hold temporarily idle balances whereas other IBs need these balances and both groups are unable to benefit from these funds due to the lack of short-term financial instruments” – IRTI Research Paper 41.
(d) “But what if the government needs cash (to pay salaries or buy services) and needs it now. The option available, so far, is borrowing from public or banking sector on interest. Almost all Islamic governments borrow on interest” – ‘IRTI Seminar Proceedings no 39’.
(e) “The modes of financing used by Islamic banks are dominated by fixed-return modes especially Murabahah… The profit sharing modes account for less than 14% financing. While Islamic banks and investment funds have so far mobilized huge financial resources, a large part of these resources have found its way into western financial markets. There is no Islamic (or for that matter, conventional indigenous) financial institution which has been able to channel savings from western countries into Muslim countries”-IRTI Occasional Paper no 2.
(f) “The asset side of Pakistan’s interest-free banks mirrors that of Islamic banks elsewhere. Approximately 80-90% of return-bearing assets have been devoted to trade related mark-up techniques with some participation in equity investment and musharika partnerships. The mark-up contracts used bear striking resemblance to interest-bearing trade credits”-‘Islamic Finance – Theory and Practice’ by Paul S. Mills and John R. Presley.
(g) “Islamic banking in practice is often very different from Islamic banking in theory. The majority of actual Islamic transactions involve disguised interest rather than genuine sharing of risk, profit and loss”. – ‘Islamic Banking and Finance’ by Andrew Cunningham.
(h) “Murabahah has become by far the most widely used Islamic financing instrument accounting for over 80% of Islamic financing. Some Shariah boards have questioned the extensive use of Murabaha in view of the limited risks involved to the financier and the similarity of the percentage mark-up to interest. Islamic finance is often approached from the perspective of the service provider rather than the needs of the client. The financial instruments have largely been developed from what is practicable and convenient for the bank… often it has been a case of adapting and modifying conventional instruments so that they can be seen to be Islamically legitimate” – ‘Islamic Finance’ by Rodney Wilson.
(j) “Mark-up does not, in essence, differ from the interest system”–IDB–IRTI Islamic Translation Series no 8. Pakistan Federal Shariat Court Judgment on interest (Riba).
(k) “Originally Murabahah is not a mode of financing. It is only a device to escape from interest and not an ideal instrument for carrying out the economic objectives of Islam”.–‘Introduction to Islamic Finance’ by M.Taqi Usmaini.
(l) “What is being done [in Murabahah] is a fictitious deal which ensures pre-determined profit to the bank without actually dealing in goods or sharing any real risk”–‘Elimination of interest’ by Prof. Khurshid Ahmad.
(m) In an interview published in ‘Arab News’ of 17 Jan. 2004 Prince Al-Waleed ibn Talal chairman of $20 billion worth Kingdom Holding company said: “My point is why do the profits of Islamic banks go down when world interest rates fall and their profits go up when the interest rates go up. In the light of my seven years experience as chairman of Saudi United Bank, I can tell you that there is no such thing as an Islamic bank”.

4. Claim of the advocates of Interest and their challenging questions: The misdeeds and shortcomings of Islamic banks cited above prompted advocates of interest in Pakistan to claim that interest- free banking is not feasible and that Islamic banking is heela banking. They also raised the following challenging questions about ‘Islamic Banks’:-

(i) Is there any single bank in the Islamic or non-Islamic world that is truly run on an interest-free basis?
(ii) Can a central bank conduct its monetary policy without a norm of interest?
(iii) Are not the practices of Islamic Banks a queer blend of interest-based modes of finance carrying a façade of Islamic names?
(iv) What are exactly the Islamic compliant instruments of finance? Can these instruments meet the myriad and diverse needs of modern trade, finance and banking?
(v) When and where have these instruments been applied and with what degree of success?
(vi) Does the Islamic Development Bank as the model Islamic bank operate on interest-free basis? If that is the case why did it offer to extend a loan to Government of Pakistan after nuclear detonation at an interest rate of 5% above LIBOR?
(vii) By what mechanism can Islamic banks undertake financial intermediation that is the primary function of all commercial banks throughout the world?

5. IDB President’s recognition of the necessity of resolving the problems faced by ‘Islamic Banks’: My personal request to IDB President during 4th International Conference on Islamic Economics and Banking held in UK in Aug.2000 for solving the problems faced by ‘Islamic Banks’ brought the following response in IDB letter of 2nd Oct. 2000 “Referring to the documents submitted to H.E The President of Islamic Development Bank (IDB) about your observation on the Islamic Banking movement, we appreciate very much your good efforts and insights. The Islamic Banks’ Office of IDB will try to do its best to communicate to the Islamic Banks the shortcomings that you had mentioned in your document”.

6. IRTI’s slack attitude towards resolving the problems faced by ‘Islamic Banks’: Since early 1999 I have been requesting IRTI officials to solve the problems faced by ‘Islamic Banks’ as they bring disrepute to Islamic banking and damage the cause of elimination of interest. I pleaded that TMCL is the comprehensive financing mechanism needed by Islamic economy for replacing interest effectively. I argued that use of TMCL as lending instrument would solve the problems faced by ‘Islamic Banks’, effectively replace interest and pave the way to economic co-operation among Muslim countries. They neither accepted my pleas nor found their own solution of the problems. They remained unmoved even by the plea that the problems remaining unresolved for years after identification were weakening the case for elimination of interest. My last fully substantiated plea to solve the problem by way of TMCL brought the following unreasoned responses’ from IRTI not mentioning any strategy or intention to solve the crucial problems:-

Chief, Islamic Banking & Finance Division:
“We have discussed the matter of Time Multiple Counter Loan on several occasions. We have different views about the scheme. While I respect your views, I do not subscribe to them. We have previously agreed that no productive result will come out of further discussions surrounding the scheme. I therefore, regret not being able to continue this discussion with you.

Director IRTI:
“I regret to inform you that presently IRTI is not in a position to hold any discussion meeting, symposium, seminar or conference on the subject of TMCL as suggested by you. Nevertheless I am thankful to you for the consideration you have shown to IRTI by thinking of us for this task”.

These responses signify the misfortune and decadence of Muslim Ummah. While others are conducting research on planets and space, premier financial Islamic Research Institute officials decline to explore the potential of an innovative financial instrument for replacing interest – the worst crime in Islamic jurisprudence!

7. Damage done by ‘Islamic Banks’ to the cause of elimination of interest: Due to the problems faced by ‘Islamic Banks’ remaining unresolved they continued functioning defectively. The claim of the advocates of interest remained unrefuted and their challenging questions remained unanswered. Consequently they succeeded in getting the Supreme Court Judgment of 23 Dec 99 ordering elimination of interest set aside on 24th June 2002.

8. Remedy for the damage done by ‘Islamic Banks’: Now the riba case is again with Federal Shariat Court of Pakistan for readjudication. Pro-interest lobby may win in that court also unless it is shown that interest-free banking is feasible. It is therefore incumbent upon Islamic economists specially Directors of IRTI, International Institute of Islamic Economics–Islamabad, Islamic Foundation–UK, Malaysian Institute of Economics and Research, General Council for Islamic Banks and Financial Institutions–Bahrain, Institute of Islamic Banking and Insurance–UK and Centre for Research in Islamic Economics–King AbdulAziz University–Jeddah, to devise, for presentation in the court, feasible interest-free banking plan that can satisfactorily refute the claim of the advocates of interest and answer their challenging questions. However, if they are unable to do so, then in fulfillment of their religious and professional duty, they must endorse TMCL plan for interest-free banking described in my book ‘Interest-free Banking’ available on website The novel idea of TMCL for replacing interest was the fruit of about 50 years’ intensive research by late Prof. Shaikh Mahmood Ahmad applauded in Supreme Court of Pakistan Judgment in Riba case as “our country’s most outstanding economist and researcher and a leading thinker... had devoted a considerable part of his life to the study of the theory of interest”.

Mr.Muhammad Akram Khan in his book ‘Islamic Banking in Pakistan–The Future Path’ says” The financial institutions have not explored the potential of TMCL --- the concept is loaded with infinite possibilities of application in interest-free finance”.

e-mail from Dr.Ismail Sirageldin (John Hopkins University USA):
“I find your suggestion for a TMCL system to replace the conventional interest based system and your elaboration on its mechanism and merits most stimulating and careful. Your paper and proposal goes a long way in elucidating the problems and the roads to perfecting an Islamic banking system that acts as an effective vehicle for sustained development while adhering to the Islamic ethical system. I congratulate you on that, but more essential, I congratulate you on starting free thinking dialogue in this important issue, a truly Islamic way to advance and exchange knowledge and development.

e-mail from Dr.Zubair Hassan (International Islamic University Kuala Lumpur):
“Personally I do find TMCL a sound instrument as replacement of interest, more so after reading your reply to clarify certain doubts”.

e-mail from Dr.M.Kabir Hassan (Deptt. Of Economics and Finance University of New Orleans USA–“Your proposal appears logical to me --- I will incorporate this idea in my recent work on ‘Innovations in Islamic Finance”.

All those who want Muslim Ummah to get rid of interest are requested to do what they can to strengthen the case of Islamists in Federal Shariat Court. Any suggestions as to what should be done in this connection will be gratefully received.
(By Abdul Wadood Khan who can be reached at,

The Fallacy Of Paper Money

The history of fiat money, to put it kindly, has been one of failure. In fact, EVERY fiat currency since the Romans first began the practice in the first century has ended in devaluation and eventual collapse, of not only the currency, but of the economy that housed the fiat currency as well.
Why would it be different here in the U.S.? Well, in actuality, it hasn’t been. In fact, in American short history, they have already had several failed attempts at using paper currency, and it is my opinion that today’s dollars are no different than the continentals issued during the Revolutionary War. But I will get into that in a moment. In the meantime, I will show you that fiat currencies have not been successful, and the only aspect of fiat currencies that have stood the test of time is the inability of political systems to prevent the devaluation and debasement of this paper money by letting the printing presses run wild.
Although Rome didn’t actually have paper money, it provided one of the first examples of true debasement of a currency. The denarius, Rome’s coinage of the time, was, essentially, pure silver at the beginning of the first century A.D. By A.D. 54, Emperor Nero had entered the scene, and the denarius was approximately 94% silver. By around A.D.100, the denarius’ silver content was down to 85%.
Emperors that succeeded Nero liked the idea of devaluing their currency in order to pay the bills and increase their own wealth. By 218, the denarius was down to 43% silver, and in 244, Emperor Philip the Arab had the silver content dropped to 0.05%. Around the time of Rome’s collapse, the denarius contained only 0.02% silver and virtually nobody accepted it as a medium of exchange or a store of value.
When the Chinese first started using paper money, they called it “flying money,” because it could just fly from your hands. The reason for the issuance of paper money is simple. There was a copper shortage, so banks had switched to the use of iron coinage. These iron coins became overissued and fell in value.
In the 11th century, a bank in the Szechuan province of China issued paper money in exchange for the iron coins. Initially, this was fine, because the paper money was exchangeable for gold, silver, or silk. Eventually, inflation began to take hold, as China was funding an ongoing war with the Mongols, which it eventually lost.
Genghis Khan won this war, but the Mongols didn’t assume immediate control over China as they pushed westward to conquer more lands. Genghis Khan’s grandson Kublai Khan united China and assumed the emperorship. After running into some setbacks with paper currency, Kublai eventually had some success with fiat money. In fact, Marco Polo said of Kublai Khan and the use of paper currency:
“You might say that [Kublai] has the secret of alchemy in perfection…the Khan causes every year to be made such a vast quantity of this money, which costs him nothing, that it must equal in amount all the treasure of the world.”
Even Helicopter Ben would be impressed. Marco Polo went on to say:
“This was the most brilliant period in the history of China. Kublai Khan, after subduing and uniting the whole country and adding Burma, Cochin China, and Tonkin to the empire, entered upon a series of internal improvements and civil reforms, which raised the country he had conquered to the highest rank of civilization, power, and progress.”
Wait a second, I thought we were bashing fiat currencies here…Can anyone say crackup boom? Since Marco Polo experienced this firsthand, and has been very helpful to us thus far, I think I will allow him to finish his analysis of China’s paper money experiment.
“Population and trade had greatly increased, but the emissions of paper notes were suffered to largely outrun both…All the beneficial effects of a currency that is allowed to expand with a growth of population and trade were now turned into those evil effects that flow from a currency emitted in excess of such growth. These effects were not slow to develop themselves…The best families in the empire were ruined, a new set of men came into the control of public affairs, and the country became the scene of internecine warfare and confusion.”
I wonder if Keynes read Marco Polo’s experiences with Chinese fiat currencies when he said that the U.S. government should just bury bottles full of money in old mine shafts to spur economic growth.
The French have been particularly unsuccessful in their attempts with fiat money.
John Law was the first man to introduce paper money to France. The notion of paper money was greatly helped along by the passing of Louis XIV and the 3 billion livres of debt that he left.
When Louis XV was old enough to make his own mistakes, he required that all taxes be paid in paper money. The currency was backed by coinage…until people actually wanted coins.
The theme of the day…the new paper currency rapidly became oversupplied until nobody wished to own the worthless junk anymore and demanded coinage for their currency.
Oops. It looks like Law didn’t think that anyone would actually want coins ever again. After making it illegal to export any gold or silver, and the failed attempts by the locals to exchange their paper currency for something of actual value, the currency collapsed.
John Law became the most hated man in France and was forced to flee to Italy.
In the latter part of the 18th century, the French government again tried to give paper money another go. This time, the pieces of garbage they issued were called assignats. By 1795, inflation of assignats was running at approximately 13,000%. Oops.
Then Napoleon stepped on the scene and brought with him the gold franc. One of the good things that Napoleon realized is that gold is the way of a stable currency, and that’s what pretty much ensued during his reign.
After Waterloo had come and gone, the French gave it another go in the 1930s, this time with the paper franc. It took only 12 years for them to inflate their currency until it lost 99% of its value. History has proven a couple things about the French: 1) They are quick to surrender and 2) They are very talented at making worthless currency.
Post-World War I Weimar Germany was one of the greatest periods of hyperinflation that ever existed. The Treaty of Versailles was essentially a financial punishment placed on Germany to make reparations.
The sums of money to be paid by Germany were enormous, and the only way it could make repayment was by running the printing press. (Huge unpayable debt — that sounds familiar. I wonder what the solution in the U.S. will be.)
Inflation got so bad in this period that German citizens were literally using stacks of marks to heat their furnaces. Here is a brief timeline of the marks per one U.S. dollar exchange rate:
April 1919: 12 marks
November 1921: 263 marks
January 1923: 17,000 marks
August 1923: 4.621 million marks
October 1923: 25.26 billion marks
December 1923: 4.2 trillion marks.
In recent times, fiat failures have become more common occurrences. For the sake of time, I won’t go into extensive details of all these examples of paper money failures, because there are SO many. But here you have it:
In 1932, Argentina had the eighth largest economy in the world before its currency collapsed. In 1992, Finland, Italy, and Norway had currency shocks that spread through Europe.
In 1994, Mexico went through the infamous “Tequila Hangover,” which sent the peso tumbling and spread economic hardships throughout Latin America.
In 1997, the Thai baht fell through the floor and the effects spread to Malaysia, the Philippines, Indonesia, Hong Kong, and South Korea.
The Russian ruble was not the currency you wanted your investments denominated in 1998, after its devaluation brought on economic recession.
In the early 21st century, we have seen the Turkish lira experience strokes of hyperinflation similar to that of the mark of Weimar Germany.
In present times, we have Zimbabwe, which was once considered the breadbasket of Africa and was one of the wealthiest countries on the continent. Now Mugabe’s attempts at price controls, combined with hyperinflation, have the nation unable to supply the most basic essentials such as bread and clean water.
In the U.S., I should say the lessons were not learned. There are many consistencies from the above-mentioned stories that led up to the eventual collapse of the currencies.
The scary thing is that the U.S. has some of these above-mentioned characteristics, the ones that lead to useless paper money becoming just that. More on that in just a second. I would first like to give a brief look at the U.S. attempts with paper money in America's short history.
The first attempt with paper money came in 1690 with the issuance of Colonial notes. The first Colonial notes were issued in Massachusetts and were redeemable for gold, silver, corn, cattle and other commodities.
The other Colonies quickly jumped on the toilet paper money bandwagon and began issuing their own paper currencies. Like a broken record, the money quickly became overissued. The lessons of John Law and others were definitely not learned. It is not good enough just to say that a currency is backed by commodities. It actually HAS to be backed by commodities. Essentially, it was still a fiat money, and in a short period of time, Colonials became as good as toilet paper.
The next experiment came during the Revolutionary War. Big surprise — the issuance of paper money was used to finance the war efforts. This time, the currency was called a continental.
The crash of the continental was spectacular, and the phrase “not worth a continental” was coined. This brought on a large distrust for paper currency, and until 1913, toilet paper money in the U.S. wasn’t used.
Enter the infamous Federal Reserve and its monopoly on money and interest rates. Now we have the greenback.
Although the money was “officially” backed by a gold standard until 1971, it wasn’t a true gold standard. When the government found it inconvenient to have a gold standard, it just made it illegal for U.S. citizens to hold gold or exchange dollars for gold.
As reported on
“Under the infallible leadership of President Franklin Roosevelt, it was made illegal to own gold. On March 11, 1933, he issued an order forbidding banks to make gold payments. On April 5, Roosevelt ordered all citizens to surrender their gold — no person could hold more than $100 in gold coins, except for collector’s coins. He also made it unlawful to export gold for payment abroad, unless done through the Treasury. The penalty for defying Roosevelt was 10 years in prison and a $250,000 fine.”
But the official demise of the dollar was locked into place in 1971 when “Tricky Dick” Nixon completely severed all ties between the dollar and the gold standard. During the decade that followed, the U.S. experienced some of the worst inflation in its history, only matched by today’s U.S. monetary and fiscal irresponsibility.
The U.S. of A. has all the characteristics set in place that have led to the collapse of every other fiat currency money in history.
We are currently at war, and the financing of this war is extremely inflationary. In fact, if you look back at our history, since 1914, the U.S has engaged in 16 military conflicts. We have been involved in some form of violent international accord in 44 of the past 93 years. The overwhelming majority of military conflicts result in monetary inflation.
The U.S. has a debt similar to that of Weimar Germany. All though the reasons for the debt are completely different, it appears that this Mount Everest of IOUs is going to be impossible to pay back. I guess the U.S. could just print 10 trillion dollar bills and hand them out, but the implications of such actions are obvious.
We are currently increasing the supply of dollars at a rate of 13% per annum. This over-issuance of a currency has been the leading indicator of a currency on the brink.
So what’s in the future for the dollar?
Some, myself included, might say that the dollar has already failed. It has lost over 92% of its value since its initial issuance in 1913. After the revaluation in 1934, the dollar dropped another 41%. In my opinion, it already is useless paper money, but for the above-mentioned characteristics, which are alarmingly similar to the circumstances that led up to the eventual collapse of the dollar’s toilet paper predecessors, I believe that we have seen only the tip of the iceberg of the dollar’s inevitable path toward becoming absolete paper money.

The Myth Of "Islamic banking"

The so-called "Islamic bank' is a usurious institution contrary to Islam. The 'Islamic bank" is an absurd attempt to resolve, as was done in the case of Christianity, the unswerving opposition of Islam to usury for fourteen centuries.
Since its origin, the 'Islamic bank' has been patronized and promoted by usurers. Their only intention was to incorporate the thousand million Muslims of the world--who in general would scornfully avoid using any banking or usurious institution--into the international financial and monetary system. The artificial creation by the colonial powers of the so called 'Islamic states', itself a contradiction in terms, whose character is markedly anti-lslamic, was the historical result of the end of territorial colonization and the beginning of the financial neo-colonialism.
The universal establishment of the western constitutional model (the model of the French revolution) brings with it the establishment of artificial and unnatural boundaries, the creation of a repressive ministerial bureaucracy, the exacting of taxes, the imposition of artificially legalized money and the legalization of usury (the banking system) - measures which are all profoundly contrary to Islam. The Islamic Bank is thus nothing more than a typically degenerate and belated product of the so-called 'Islamic states'.
In order to speak on the "Islamic Bank", the new science of so-called 'Islamic economics' has emerged from the American and European universities. However fallacious these two self-supporting concepts of economics are concepts regarded with scorn by the Muslims of traditional education they have served as a justification for the new class of state functionaries and bureaucrats who have come to constitute a kind of 'Islamic modernism'. A few years of mediocre education in western universities will not allow many of the Islamic economists to discover that the foundations of economics have been shattered as a science and in practice in the very Europe which saw it come into existence.
The rationalistic framework of the positive sciences which has been called into question in Europe has been currently defended by those neo-bureaucrats who are still fascinated by their years of education in the West. Even though the sincere, albeit naive, faith of the majority of those who participate in these modernist movements cannot be denied, time and a greater maturity has shown them the bitter side of the ideological and scientific modernism in which they have placed their trust.
The return of the Islamic tradition has not only been the best antidote against this modernism in those Muslim countries but in the hand of a new generation of Muslims in the West it has also resulted in the transcending of modernism and brought about the culmination of our western civilization which today is of {universal character.}
In contrast to the modernist confusion, the position of the Shari'a of Islam clear and does not admit any controversy.
Allah says in the Qur'an:
"Oh you who believe! Have fear of Allah and give up what remains of what is due (to you) of Usury. If you do not, then take notice of war (against you) from Allah and His Messenger." {Qur'an 2,278}
From this it is clear that the Muslims must not only abandon Usury but that he is also obliged to fight against usury. The 'Islamic bank' is a totally crypto-usurious institution and like all the other usurious constitutions must be rejected and fought. Besides the falsehood of its very name we can enumerate at least three reasons why its practice is considered usurious.
A. The creation and utilization of artificial paper-money whose use is a confined monopoly.
The Shari'a prohibits the forceful imposition of one single money on the market; what is explicitly stated is that money can be any kind of merchandise which is socially accepted as a means of exchange. If besides this we add to this the character of monopoly inherent in a (paper-)money -- without any value as a commodity -- whose value is imposed by the state, then it becomes clear the manipulation and acceptance of this system has nothing to do with the deen of Islam. Moreover given that there does not exist a single state in the world where the monetary system of paper money is not applied then this is sufficient reason for affirming that the Muslims live in a world where authentic Islamic governance is absent.
There exists no justification of a strategic or a political kind in the imposition of paper money as a prop for a possible Islamic government since this imposition is based on a deception of the people who support this government: moreover it is a contradiction that a just and equitable government finance itself by means of robbing from the very people whom it is governing.
The use of paper money by any institution is contrary to the nature of Islam. In the case of the bank however there is an added element to this contradiction -- namely the capacity of the bank to freely create paper money by means of credit -- which is independent of whether this paper-money is used for honest business or usurious loans. The use of credit to artificially expand the monetary resources is emphatically forbidden in the Shari'a.
"It is not permitted to pay a loan by asking the lender to receive payment from a third person who owes money to the lender...."
Consequently it is not allowed to settle a debt with another debt.
"It is not permitted that you sell something that you do not possess on the understanding that you will buy it and will give it to the buyer." ('Al-Risala' of Ibn Abi Zaid al-Qayrawani, chap. 34).
Imam Malik says, "A person should not buy a debt due to another person, be he present or absent, without the confirmation of the person who owes the debt. He is buying something which has not been guaranteed to him and so if the contract is not completed what he has paid loses its value. This is an uncertain transaction and is not good." ('Al Muwatta' of Imam Malik, chap. 31).
The confirmation of a debt is an indispensable condition for its transfer; the confirmation occurs with the guaranteeing that the debt can be and will be paid. In other words notice will be given that someone with a debt which is unpayable will be able to transfer it to another person. Not even in debts of sale is the lack of confirmation of guarantee permitted.
Imam Malik distinguishes between someone who becomes indebted for something that he possesses and someone who becomes indebted for something which he does not have in his possession, this latter kind of debt is disapproved of since it leads to usury and fraud ('Al-Muwatta', chap. 31), like in the case of the banks.
The Shari'a prohibits the commercialization or multiplication of a debt without the means to guarantee it. Thus, the banking business as such cannot exist in Islam; the only function it could have would be to restrict itself to being an institution for transferring money but without the capacity to expand the amount of credit.
B) The usurping of part ownership
The second reason why the Islamic bank is a fallacy is the constitutive structure of its ownership. In Islam the constitution of any business must guarantee the identification of ownership and the respect of this ownership. There thus exist two forms of constitution for a business by two of more persons.
1. The loan (or qirad ) by which the investor transfers the property of their investment to an agent who manages the business.
2. Co-ownership in which all the investors have made a prior agreement as to the execution of a specific business (by means of a contract) and in which ownership is based on equality of conditions between all the co-owners.
The structure of the 'Islamic banks' is based not on the strictness and exactness of the Shari'a but rather on the model of the corporation in the West in which the exercise of property is not carried out by those who --nominally --are the owners but is carried out by means of a system of usurpation which we can call by the majorities'.
This means that the innocent investor who takes part in this type of business contract has no protection of his investment since neither establishes a business loan (qirad ), in accordance with the way this type of contract is defined, nor is he able to make decisions with respect to the very business in which he is a co-own.owner (unless this same person is the majority) since this is not decided beforehand in the contract.
Thus this type of contract is not a business contract but a sophisticated and unprotected surrender of one's right of ownership. Whoever is the majority at any one time, then that person (or group of persons) and only that person is the authentic owner of the business. That is to say, in accordance with our understanding only the person who can decide is the owner in fact. For this reason the system of majority is neither co-ownership, Or, as we shall see, a loan.
The business loan (qirad ) is not a loan of money for a specific period made without knowing what is going to be invested in, but rather it is made for the establishment of a specific business:
Imam Malik says, "It is not permitted for the agent to stipulate that the use of the money of the qirad is his for a certain number of years and that it cannot be withdrawn from him during this period of time." He says, "It is not correct that the investor stipulates that the money of the qirad should not be returned for a certain number of years which are specified since the qirad is not for a specific time." ('Al-Muwatta' of Imam Malik, chap. 31).
The contract of the business loan on qirad implies the specifying of the person who is the agent or new owner and on whom the total responsibility of the investment rests. Thus the loan cannot be established by an indeterminate majority or with the persons who represent it if they, between them, form a single co-ownership) without jeopardizing the exercise of co-ownership of the minority co-owners, who are bound by the decisions (of the majority) despite disapproving of them.
This means that firstly before someone invests in a business it has to be known what that business is, prior to investment (according to basic conditions which arc made known in a reasonable way beforehand, and which are complete,with w condition wanting in any way); secondly it means that the person (or persons) who is the decision maker in such a business is the owner (or co-owners) and that reciprocally only the owner (or the owners) decides with respect to the business;
Thirdly, that in every co-ownership the owners enjoy the same status (the fulfillment of the contract which they have and agreed to) even though they participate to different degrees (such that the profits are distributed proportionally); and fourthly it means that those contracts in which, without there occurring any loan, the owner is deprived of the right of ownership to exercise control, then in these contracts there is a usurpation of ownership.
In short, the structure of co-ownership of the 'Islamic banks' in which the shareholders are invited to participate is not acceptable ; in Islam since it consists of an unjustified usurpation of the ownership of the minority shareholders in favor of the executive council or administrator which represents the majority.
C. The payment of the usurious interest

Due to the very structures and the arena in which the 'Islamic banks' deals in a contract , fluctuation in value is generated which affect the individual transactions the bank makes. As a result an contracts made by the ' Islamic bank' are usurious. Short of removing ourselves completely from the monetary system then we are of necessity justified in affirming that every commercial contract made with in this system is already usurious since the values makes of one of the commodities which is interchanged, namely completely the paper money is being increased by pressure , force and the state monopoly. The usurious nature of these institutions is much deeper however.
Every loan of a commodity open to devaluation and whose value was superior when it was received, is usurious. In general a loan cannot be made of a commodity whose value is changeable. If however a devaluation happens unexpectedly the payment of a compensation equal to the devaluation of the lent merchandise will have to be established (and this cannot be confused with the interest). This fact denies the validity of the principle of 'interest-free' on which 'Islamic banks' are based, since paper money cannot be taken as a authentic money with a stable value. Every time this bank borrows paper money for a time, it gains the devaluation suffered by this money during the time of the loan. It is like the typical usurious trick which consisted of the loaning of wheat when it has limited value (during harvest) and stipulating that it be given back when wheat has attained a better price on the market (several months after the harvest).
This however does not mean that the taking of an interest which is equal to inflation makes the operation of loans in paper-money permissible since this commodity can never become the object of a free and fluctuating evaluation.
The payment of dividends, except when considered as the sharing out of the profits of the business and when accepted unanimously by ad the co-owners is payment of usurious interest The Shari'a contains no doubt in this respect: the only possible justification for the increase or decrease at the time of the return of the loan is the resulting profit or loss of the business, connected with that loan. None of the parties can reserve the use of a pan of the profits without them having been previously distributed:

"The person who makes an investment cannot stipulated that he retain part of the profit without sharing it with the agent; likewise the agent cannot stipulate that he retain a pan of the profit without sharing ." ('Al-Muwatta' of Imam Malik, chap. 31)
This however is what happens when the agent does not distribute all the profits but rather an estimation of them. The profits are simply the difference between the value (or market price) of the invested goods and the value of the goods and the value of the goods obtained by the business. Then the results or profits are not an 'objective' estimation but rather a demonstrable reality.
It may be however that the parties to the business contract want to extend the contract and continue the profit already made by establishing a 'mutually acceptable' payment as if it were the same as partial payments of the total profit. But this 'mutually acceptable' payment means that if even one of the parties was not in agreement with the proposition to continue the business or not in agreement with the calculation of the profit which has been 'objectively' estimated by someone -- or even a majority of the co-owners -- then he can, by exercising his right of ownerships dissolve the business and verify-- by the sales of the business goods--if the estimate was correct or not.
This will not violate the right of ownership of the rest of the co-owners since the contract will have been completed; besides this can be continued by buying it again from the sale of liquidation of the person who does not want to continue or who does not accept the profits which have been estimated. The calculation of the resulting profits is logically identical for all types of business whether they be established by way of a business loan (or qirad ) or as co-ownership. The qirad in general is established for a particular business with a particular person, where the results are clearly defined but it is not to be thrown to a basket of other business that the investor cannot clearly identify in full, that is not only the nature of the business and the identity of the agent but specially the exact results of the business.
In short the system of calculation or estimation of the dividends of the modem corporations adopted by the 'Islamic banks', are not the actual resulting profits of the business and as such, by their excessive estimation or underestimation, they represent a usurious interest. Even besides the fact that this estimation cannot possibly always be correct, there is the fact that the very contract itself is unacceptable, since in the type of contract that the corporation make with the shareholders the fact that the latter have to renounce their right of co-ownership without even being able to refuse what they consider to be an incorrect estimation represents an illegitimate usurpation of ownership.
Usury has corrupted the market, transforming it into a usurious system. There is no way of establishing an (equitable) market without going outside of the modem monetary and financial systems. All attempts to recuperate an (equitable) Islamic market with (equitable) Islamic business and transactions must be based on the Qur'anic principle of Equity (al-'Adl){Qur'an 2, 282} which is also defined in the Shari'a. Islam, besides being the situation of the Muslims themselves, a situation based on the Qur'an and our tradition of fiqh, is and has been for centuries an impregnable fortress Of guidance and source of unparalleled knowledge for the Muslims. The 'Islamic bank' is a Trojan horse which has been infiltrated into Dar al-lslam.

What Is Inflation ?

Let’s first break this question down into the two types of inflation; monetary inflation and price inflation. Price inflation is the general rise in prices of goods and services. This is the one everyone talks about. You here the complaint "Gee…how expensive "fill in the blank" has gotten!" It is important to point out that price inflation is not a problem; it is a symptom . This is a very crucial difference. If price inflation is a symptom, then what is the problem? The problem is monetary inflation. "Monetary inflation" is a fancy phrase meaning the creation (really "excessive" creation) of a particular currency. In our case, it is the excessive creation of Riyals. Those riyals can be infused into the economy either through the actual printing (or electronic creation) of riyals or through credit ultimately issued by a central & commercial banks. In any case, monetary inflation is the cause of price inflation.

Stated another way, monetary inflation is the problem and price inflation is the symptom. Monetary inflation means increasing the money supply. Keep in mind that when we talk about "price inflation", it doesn’t always mean rising prices of goods and services; it can also mean that assets can experience price inflation as well. Whenever we hear about an "asset bubble" it is a reference to how an asset has risen in price far above its realistic market price (the effects of supply-and-demand) due to an excessive influx of monetary inflation. Some recent examples of asset bubbles (excessive price inflation of assets due to the problem of monetary inflation) are the Internet/ Tech stock bubble of the late 1990s and the real estate bubble of 2002-2006 and the saudi stock market's bubble of 2006.
It is an important distinction to point out the difference of a "bull market" and an "asset bubble". A bull market—rising prices for an asset (such as stocks, real estate, etc.)—is a natural and ordinary event. It is an extension of supply-and-demand; there are more buyers than sellers of the asset so the result is "rising prices." An asset bubble is an artificial and unnatural event. The rise in the price of the asset is primarily driven by monetary inflation (such as through the excessive issuance of credit). Because a bubble is unnatural and ultimately unsustainable, it inevitably "pops"; the artificial boom then becomes an artificial bust. As the economist Ludwig von Mises ( painstakingly pointed out, booms and busts (as well as recessions, depressions and hyper-inflation) are not creations of a free market; they are in fact created by government mismanagement of monetary and fiscal policy. Back to inflation…

Why is it necessary to "fight inflation"?
Inflation is a pernicious and destructive economic force. Inflation at a real-world rate of 2% or lower (preferably ‘zero") is tolerable for an economy. 3-5% inflation is bad but it can be manageable. Beyond that, it can be destructive. When inflation soars into double digits and beyond, it can cause tremendous damage to the economy. Thanks to the efforts of private sources (coupled with data from the Federal Reserve), it has been recently (early 2007) calculated that price inflation is in the 6-9% range and the money supply is expanding at an alarming rate of about 13%. Keep in mind that inflation is effectively a hidden tax that wreaks the most havoc to lower income and middle income folks. Inflation destroys purchasing power and those with limited income, fixed income or little in the way of savings are hurt the most. This is why there are many analysts that have voiced the opinion that the United States (specifically the Federal Reserve) should significantly limit and/or shrink the growth of the money supply and eventually return to the gold standard.
During the hundred-year span of 1812-1912, there was virtually no price inflation as our country strictly adhered to a gold standard. From 1913 to the 1930s, the United States slowly, partially and then completely abolished the gold standard in our economy. The end result was that a dollar that was worth 100 cents in 1913 is now, in 2007, worth less than three cents.
If monetary inflation is the problem, who is responsible?
Central bank / commercial banks
So what should the Fed be telling us about inflation?
They should be informing us about monetary inflation. Specifically, the management and growth of the money supply. The Fed can start by reinstating the M3 money supply measurement which they stopped reporting in March 2006. M3 is the broadest measure of the money supply and it is indeed a critical number for the financial markets. Fortunately, M3 was reconstructed by private sources (such as The money supply growth rate hit an astounding and disturbing 13% recently. This is the real problem and all of us need to be informed about excessive monetary inflation and its’ insidious effects.

What is the core rate of inflation?
Here is where the controversy lies. When you talk to some reporters and economists, they will tell you that the core rate is important to the Fed and to the financial markets. Please understand the following point; the core rate is not important and it should be dropped or ignored. As a financial planner, educator and writer, it is definitely not important to me or to my clients, students and readers. What possible importance does it have? It is only important to the Fed and to some politicians but beyond that, the core rate is useless, meaningless and misleading. If this commentary sounds too harsh, then let’s think about it for a moment. Think about why the core rate is only important to the government.
It is not an accident that Bernanke and other officials spend most of their time talking about the core rate and not about monetary inflation or "real-life" inflation. Imagine for a moment that you are the head of the Fed. Would you rather talk about monetary inflation and the money supply (what you are directly responsible for) or about something vague and distant like … the core rate of inflation? If you were responsible for inflation, what would you rather talk about; an inflation rate of 6-9% (the realistic inflation) or about some benign, vague rate that is only a measly 1.9%?
Let’s face it; the more Bernanke talks about "the core rate" and about "being under 2%", the more the financial press reports the same. The average reporter ends up thinking "gee, he’s talking so much about the core rate…it must be important!" Again, it is important to the government because that way they can talk about some seemingly innocuous measurement and essentially keep everyone calm. "Excited? Concerned? About what? After all, the core rate is only a measly 1.9%!"
The more tangible reason for the government to under-report inflation is so that payments to Social Security recipients and other pensioners are lower. Keep in mind that the initial wave of baby boomers (78 million total.) start retiring in 2008. Over time, every percentage point that is not being paid is worth trillions. So now we can see a solid reason why a lower inflation rate is important to the government. A lower rate is good publicity and it also means trillions in savings.
Why isn’t the core rate important to the financial markets?
Why isn’t the core rate important to retirees?

Why isn’t the core rate important to investors?
As you read this, millions of investors are making choices with their money. What will they invest in? If they think that inflation is benign, then they will invest accordingly. But what if they were aware of real-world inflation? Think about your own actions. What would you do differently if you knew that inflation was 8% instead of 2%? You would certainly invest at least a portion of your portfolio in inflation hedges such as gold, silver, energy and related securities. For investors, a return must be generated that meets or exceeds the real-world rate of inflation. Yes…that includes the costs of food and energy. Therefore, for investors, the core rate is meaningless.

* We spend little or no time addressing the problem (monetary inflation).
* We spend too little time addressing real-world price inflation
* We spend very little time addressing the point that the dollar is losing value due to excessive monetary inflation.
* We spend too much time talking about the core rate of inflation which has no real value to consumers, retirees, investors or anyone else for that matter.

The banking System Is Corrupt

The ignorance of coin, credit, and circulation is unfortunately, a widespread occurrence – causing perplexities, confusion in the financial markets. Is it the fault of the common man that he cannot understand the complexities of a monetary system that moved Lord Keynes to say that not one man in a million understands money?

What is meant by fractional reserves? It would seem that reserves are reduced to a fraction, but a fraction of what? Perhaps we should seek the wise counsel of the Federal Reserve, as this is their raison d’etre.

Required reserve balances are balances that a depository institution must hold with the Federal Reserve to satisfy its reserve requirement. Reserve requirements are imposed on all depository institutions – which include commercial banks.
Where The Money Comes From ?
Trillions of dollars are said to be everywhere.. Today billions of dollars are tossed around from computer to computer without the blink of an eye. Trillions are now the topic de jour.
Budgets, deficits, and international money flows are all described using trillions or parts thereof.
The Beginning
On that fateful day when Federal Reserve Notes were first issued, it is obvious that a huge number of dollar bills had to be printed. Now, the printing press is pretty much obsolete; the only money that actually gets printed is used to replace old and worn Federal Reserve notes already in circulation. In vogue today is electronic money – fast food style.
The process actually begins with the Treasury Department printing a piece of paper called a bond, which is done electronically. Treasury bonds are debt obligations (liability) of the government to repay a loan - with interest.
The Treasury sells bonds to the public. The bonds the public does not buy, the Treasury deposits with the Federal Reserve. When the Fed accepts the bond from the Treasury, it lists the bond on its books as an asset.
The Fed assumes the government will make good on its promise to pay back the loan. This is based on the belief that the government’s power to tax the people is sufficient collateral.
Because the Fed now has an asset that it didn't have before receiving the Treasury bond, the Fed can now create a liability that is offset by its new asset.
The liability that the Fed creates is a Federal Reserve check. It gives the Treasury the check in payment for the Treasury bond.
The Federal Reserve check is endorsed by the Treasury and is deposited in one of the government's accounts at the Federal Reserve. The government can use the deposits to write checks against, to pay for government expenses.
This is the first new money flow to enter the system. Various government contractors, vendors, etc. receive these checks as payment for services rendered, and they take the checks and deposit them in their commercial banks.
The Second Step
The deposits in the commercial banks take on a sort of split personality.
On the one hand, the deposits are the bank’s liabilities, as they owe the total sums to their depositors.
However, because of FRACTIONAL RESERVE lending, the bankers get to lend out 9 times what they have on deposit.
The commercial banks get to list the deposits as RESERVES.
In other words, FRACTIONAL RESERVE lending allows the commercial banks to create 9 times more money then they have on reserve. The banks lend money they don’t have, and:
They get to charge interest on it.
As the newly issued money is put to work by borrowers, they then spend it and the receiver then deposits it in their bank account, and the bank starts the reserve lending policy all over again. This is why the Money supply must expand by the amount of interest owed on the debt.
If it didn't, the debt would not be able to be serviced. There is no money created without creating debt, they are one and the same. Wealth is not created by creating money by fiat – only debt. As the Fed has admitted:
"Commercial banks create checkbook money whenever they grant a loan, simply by adding new deposit dollars in accounts on their books in exchange for a borrower's IOU."
Fractional reserve lending invokes the moral hazard of fidelity of contract. Banks have on deposit (reserve) at most 10% of the “money supply.”
This means that if more than 10% of depositors go to the bank at one time to withdraw “our” money – there isn’t any money to withdraw beyond the 10% reserves.
Which means that 90% of the money supply is non-existent, nothing more than a fleeting illusion.

The Problem With Today's Money

Where does money come from? money is created by banks. Banks create money, not from their own earnings or from the funds deposited by customers, but from the borrowers' promises to repay loans. Most importantly, borrowers not only promise to repay, but to repay with interest, and the bank writes the amount of money of both into the borrower's account.
Whereas most paper currencies used to be backed by gold, that is no longer the case, and we have instead a fiat currency backed by nothing except the word of the central banks that the money is worth its stated value. Moreover, money today is created as debt, that is, money is created whenever anyone takes a loan from a bank. In fact, every deposit becomes a potential for a loan-a process which can be and is repeated many times, ultimately creating infinite amounts of money from debt.
The bottom line is that banks can create as much money as we can borrow! One wonders how individuals, banks, governments, and other entities can all be in debt at the same time, owing astronomical amounts of money. This question is answered when we consider that banks don't lend actual money; they create it from debt, and since debt is potentially unlimited, so is the supply of money. But what is so wrong with this scheme? Hasn't it been working all these years? Actually, there are several things very wrong with it.
The first issue is that the people who produce the real wealth in the society are in debt to those who lend out the money in that society. Moreover, if there were no debt, there would be no money.
Most of us have been taught that paying our debts responsibly is good for ourselves and for the economy. We imagine that if all debts were paid off, the economy would improve. In terms of individual debt, that's true, but in terms of the overall economy, the exact opposite is true. We are continually dependent on bank credit for money to be in existence-bank credit which supplies loans. Loans and money supply are inextricably connected, and during the Great Depression, the supply of money plummeted as the supply of loans dried up.
Secondly, banks only create the amount of the principal of loan. So where does the money come from to pay the interest? From the general economy's money supply, most of which has been created in the same way.
The problem is that for long-term loans, the interest far exceeds the principal, so unless a lot of money is created to pay the interest, a lot of foreclosures will result. In order to maintain a functional society, the foreclosure rate must be low, so more and more debt must be created which means that more and more interest is created, resulting in a vicious and escalating spiral of indebtedness. Furthermore, it is only the lag time between the time money is created to the time debt is repaid that keeps the overall shortage of money from catching up and bankrupting the entire system. It takes only a few second of reading the headlines of the financial pages during this month, August, 2007, to notice that foreclosure rates and lag time are threatening to meltdown the entire U.S. economy. The preferred method of the Federal Reserve and central banks addressing this calamity is, yes, you guessed it: to create more debt. The lowering of interest rates in recent years, the bombardment of credit card applications we find regularly in our mailboxes, the red ink in which the United States government is drowning are all an attempt to stave off the collapse of the entire system.
Can any sane human being believe that this situation can persist forever? What is the inevitable outcome of a fiduciary game of musical chairs? Monetary historian, Andrew Gause, answered this question:
One thing to realize about our fractional reserve banking system is that, like a child's game of musical chairs, as long as the music is playing, there are no losers.

And finally, a system based on fractional reserve banking is, to say the least, not sustainable because it is predicated on incessant growth. Perpetual growth requires perpetual use of resources and the constant conversion of precious resources into garbage just to keep the system from collapsing.

A crucial assumption that must be questioned is the practice of usury or the charging of interest for lending money. It is a moral and a practical issue because it necessarily results in lenders ending up with all the money, particularly when foreclosures happen. Not only is debt deplorably profitable for lenders in terms of interest and service charges, but when borrowers cannot pay, as in the case of housing foreclosures, lenders walk away with the proceeds

Thursday, November 29, 2007

US Has To Put Its Financial House In Order

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the US economy. If the subprime mortgage meltdown is half as bad as predicted, low US interest rates will be required in order to contain the crisis. But if the dollar's plight is half as bad as predicted, high US interest rates will be required if foreigners are to continue to hold dollars and to finance US budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and over-extended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington's ability to borrow abroad. Without the ability to borrow abroad, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

A few years ago the euro was worth 85 cents. Today it is worth $1.48. This is an enormous decline in the exchange value of the US dollar. Foreigners who finance the US budget and trade deficits have experienced a huge drop in the value of their dollar holdings. The interest rate on US Treasury bonds does not come close to compensating foreigners for the decline in the value of the dollar against other traded currencies. Investment returns from real estate and equities do not offset the losses from the decline in the dollar's value.

China holds over one trillion dollars, and Japan almost one trillion, in dollar-denominated assets. Other countries have lesser but still substantial amounts. As the US dollar is the reserve currency, the entire world's investment portfolio is over-weighted in dollars.

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The US dollar has lost 60% of its value during the current administration. Obviously, countries are not locked into accumulating dollars.

The reason the dollar has not completely collapsed is that there is no clear alternative as reserve currency. The euro is a currency without a country. It is the monetary unit of the European Union, but the countries of Europe have not surrendered their sovereignty to the EU. Moreover, the UK, a member of the EU, retains the British pound. The fact that a currency as politically exposed as the euro can rise in value so rapidly against the US dollar is powerful evidence of the weakness of the US dollar.

Japan and China have willingly accumulated dollars as the counterpart of their penetration and capture of US domestic markets. Japan and China have viewed the productive capacity and wealth created in their domestic economies by the success of their exports as compensation for the decline in the value of their dollar holdings. However, both countries have seen the writing on the wall, ignored by Washington and American economists: By offshoring production for US markets, the US has no prospect of closing its trade deficit. The offshored production of US firms counts as imports when it returns to the US to be marketed. The more US production moves abroad, the less there is to export and the higher imports rise.

Japan and China, indeed, the entire world, realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and to rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia's economic development.

The dollar's decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer. As new dollars are still being produced at high rates, their value has dropped.

If foreigners were to stop accumulating new dollars, the dollar's value would plummet. If foreigners were to reduce their existing holdings of dollars, superpower America would instantly disappear.

Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. However, now these deficits seem to have passed the point of no return.

The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The US trade deficit will close when foreigners cease to finance it.

The budget deficit cannot be closed by taxation without driving up unemployment and poverty. American median family incomes have experienced no real increase during the 21st century. Moreover, if the huge bonuses paid to CEOs for offshoring their corporations' production and to Wall Street for marketing subprime derivatives are removed from the income figures, Americans have experienced a decline in real income. Some studies, such as the Economic Mobility Project, find long-term declines in the real median incomes of some US population groups and a decline in upward mobility.

The situation may be even more dire. Recent work by Susan Houseman concludes that US statistical data systems, which were set in place prior to the development of offshoring, are counting some foreign production as part of US productivity and GDP growth, thus overstating the actual performance of the US economy.

The falling dollar has pushed oil to $100 a barrel, which in turn will drive up other prices. The falling dollar means that the imports and offshored production on which Americans are dependent will rise in price. This is not a formula to produce a rise in US real incomes.

In the 21st century, the US economy has been driven by consumers going deeper in debt. Consumption fueled by increases in indebtedness received its greatest boost from Fed chairman Alan Greenspan's low interest rate policy. Greenspan covered up the adverse effects of offshoring on the US economy by engineering a housing boom. The boom created employment in construction and financial firms and pushed up home prices, thus creating equity for consumers to spend to keep consumer demand growing.

This source of US economic growth is exhausted and imploding. The full consequences of the housing bust remain to be realized. American consumers lack discretionary income and can pay higher taxes only by reducing their consumption. The service industries, which have provided the only source of new jobs in the 21st century, are already experiencing falling demand. A tax increase would cause widespread distress.

As John Maynard Keynes and his followers made clear, a tax increase on a recessionary economy is a recipe for falling tax revenues as well as economic hardship.

Superpower America is a ship of fools in denial of their plight. While offshoring kills American economic prospects, "free market economists" sing its praises. While war imposes enormous costs on a bankrupt country, neoconservatives call for more war, and Republicans and Democrats appropriate war funds which can only be obtained by borrowing abroad.

By focusing America on war in the Middle East, the purpose of which is to guarantee Israel's territorial expansion, the executive and legislative branches, along with the media, have let slip the last opportunities the US had to put its financial house in order. We have arrived at the point where it is no longer bold to say that nothing now can be done. Unless the rest of the world decides to underwrite an economic rescue to America, the chips will fall where they may.

Tuesday, November 27, 2007

Abu Adhabi To The Rescue Of Citibank

Citi had to raise $7.5 BILLION of quick cash so they borrowed it from the MIDDLE EAST! This is the biggest bank in the united states that :

1) Needed $7.5 BILLION of emergency cash
2) Couldn't get it from any other bank in the states or the Federal Reserve
3) Diluted their common stock shares without identifying WHY they were doing this

Based on the implied cost of capital to Citicorp of the $7.5 billion dollar investment by Abu Dhabi, the implication is that Citicorp may be on the verge of insolvency. The deal is structured as a passive, subordinated convertible security with an 11% dividend and is convertible into 4.9% of the Company, based on a price conversion scale that ranges from $31.83 to $37.24 and the conversion expires in Sept 2011. Without further details on the conversion feature, and keeping the analysis "plain vanilla" for these purposes (i.e. we don't have all the terms of the deal and there's some theoretical "nuances" to consider) I'm assuming the average conversion price would be $34.53. And assume Citicorp stock performs such that it is worthwhile for Abu Dhabi to convert into common (i.e. the stock rises above the conversion range by 2011 and I doubt Abu Dhabi would do this if they didn't believe in that event). Based on yesterday's closing price of $30.70, th e implied cost of capital to Citicorp on the conversion feature is 12.5%, plus they've paid out an 11% dividend. That's an all-in cost of capital of 23.5%.

Now, just on the surface, the 11% dividend is similar to the yield that a mid-quality junk bond issuer would have to pay to get bond deal done. But the 23.5% implied cost of capital embedded in this deal reflects the kind of return that would be required for a "vulture" investor to invest in a highly distressed company. In other words, the cost of capital to Citicorp's shareholders of this deal implies that the rate of return required to induce investment capital into the Company reflects an assessment by the market that Citi is on the verge of insolvency. I would be interested to know if the good folks in Abu Dhabi were allowed to see the real "insider" financials at Citi, including ALL of the off-balance-sheet financing structures AND all of the derivatives.
While the popular press is heralding this as a "lifeline from a Middle Eastern nation," I see it as a sign of significant distress at Citigroup. Unless I am missing something, an 11% yield is what one would expect from something in the high risk or "junk" category. To me, this suggests that Citigroup is desperate for new capital.

Sunday, November 25, 2007

Financial Terrorism Against Humanity

Not one in a thousand understands why the existing monetary system is the ultimate terror against humanity. In order to investigate the causes of wars, violence, poverty, prostitution, and unemployment, one has to analyze the origin and source of money & banking.
Today's money is only "property" which is a set of legal rights. That property is the claim, it is not the thing; example, you have property in the land, in a five dollars bill. Property is money only if it reliably can be exchanged for most other property or for labor (medium of exchange).
Ownership of a central bank note is money. The note itself is not money (it is ink on paper). Like all property, money is not physical, it can be traded without actually changing hands. Money is a form of property that reliably can be traded for other property or for labor (services). Historical examples of money :ownership of tobacco & gold.
At present, money comes in two forms : (a) ownership of central bank notes and (b) debts of banks (i.e. credits). It has no intrinsic value, it is a means of measurement to gauge real wealth (goods & sevices) an individual controls. Its primary function is to activate production and facilitate the purchase and sale of goods & sevices, and to provide a means to store wealth in a form other than real property.
Are all debts money ? No. A person IOU is not money.
Are all IOU's worthless ? No. Banks'IOUs are widely accepted; e.g. the balance in your checking account.
Banks'credit is money, your credit is not.
Banks do not lend out ownership of central bank notes. Instead, banks issue new IOUs and lend them out. The IOUs are technically a form of money called "debt", but most usually, such money is called "credit". Thus, banks lend out debts of the bank, IOUs of the bank.
On examining the anatomy of a bank loan, it is a temporary swap of debt that is NOT money (i.e. the borrower's debt) for debt that IS money (i.e. the bank's debt). Therefore, all the loans are trade : when you borrow money, you are trading your debt for the bank's debt for a certain fee : interest rate. In reality, you traded for a debt that nobody trust (not money) for a debt that everybody trust (is money). Ultimately, interest is the money paid in exchange for the temporary use of the bank's credibility. "Credit" comes from the latin "credo" meaning "I believe", and "credible" comes from the latin "credibilis" meaning "worthy of belief". Bank lends not money but an IOU, which is not backed by any monies. They create as much as we can borrow, worse yet, they create only the principal not the interest.
All national circulating medium of exchange are now at the mercy of loan transactions of banks which lend not money but promises to supply money they do not poessess. Without the borrower's document to sign (promise to pay) the banks have nothing to lend.

Money is the NOTHING you get for SOMETHING before you can get ANYTHING. Those nothing, something and anything of this definition refer to things of real value in themselves, usually termed goods & services i.e. wealth.
From the poimt of view of the owner or possessor of it, money is the credit he has established in his favour with the community in which it passes current or is "legal tender", by having given up in the past valuable goods & sevcies for nothing, so as to obtain at his own convenience, in the future, equivalent value in turn for nothing. The owner of money is the creditor and the issuer of it is the debtor.
Thus, Money is a legal claim to wealth over and above the wealth in existence, all of which in an individualistic society is already in the ownership of others independently of this claim. The owners of money possess claims to what they have given up, but what they have given up does not actually exist.
From the point of view of the issuer, money is a right of action against the community to supply goods & services, or what is the same thing, to discharge the debt incurred through obtaining them from the seller, so that a right of action against a bank to supply money on demand is a right of action against the community to supply goods & services on demand.
The owner of money is the creditor and the issuer of it is the debtor, for the owner of money gives up goods and services to the issuer. This is the origin of modern money as nothing for something on the part of the legitimate user, as something for nothing on the part of the issuer.

Almost all money in existence in the economy represents debt. Checkbook money exists only as a bookkeeping entry on the ledgers of banks and is created every time a bank makes a loan or an investment. Banking is the only business where all the inventory is created as it is needed at no cost and essentially without labor. There are no purchases made and no effort expended other than that made by the employee who entered the new numbers (merchandise) - the checkbook money.
Depositing into the borrower's checking account an amount equal to the amount of the loan is the way banks generally extend credit at the same time create new money. The monumental problem comes because only the principal is created and lent - not the interest. Still the interest must be repaid along with the principal to the money creators, obviously a physical and mathematical impossibility.
What gives value to money ? its exchange value depends simply on the amount of wealth (goods & services) people voluntarily prefer to go without rather than to possess; and that is the same as the amount of credit they retain as money.

Finally, we all should ask three questions, I have yet to find the answers :
1- Why do governments choose to borrow money from private banks at interest when governments could create all the interest-free money they need, themselves?
2- Why create money as debt, why not create money that circulated permanently ?
3- How can a money system dependent on perpetually accelerating growth be used to build a sustainable economy ?

Tuesday, November 20, 2007

The Lost World Of Capitalism

It is now commonplace and politically correct to blame what is referred to as the excesses of capitalism for the economic problems we face, and especially for the Wall Street fraud that dominates the business news. Politicians are having a field day with demagoguing the issue while, of course, failing to address the fraud and deceit found in the budgetary shenanigans of all governments – for which they are directly responsible. Instead, it gives the Keynesian crowd that run the show a chance to attack free markets and ignore the issue of sound money.
Capitalism should not be condemned, since we haven’t had capitalism. A system of capitalism presumes sound money, not fiat money manipulated by a central bank. Capitalism cherishes voluntary contracts and interest rates that are determined by savings, not credit creation by a central bank. It’s not capitalism when the system is plagued with incomprehensible rules regarding mergers, acquisitions, and stock sales, along with wage controls, price controls, protectionism, corporate subsidies, international management of trade, complex and punishing corporate taxes, privileged government contracts to the military-industrial complex, and a foreign policy controlled by corporate interests and overseas investments. Add to this centralized federal mismanagement of farming, education, medicine, insurance, banking and welfare. This is not capitalism!

You see folks, Central Banking is, and always has been, a key tenet of Communism -- not Capitalism.
This is reality.

Monday, November 19, 2007

The Dollar In An "SOS" Mode

The global fiat dollar-based financial system is in crisis and is threatening the prosperity and stability of world economy. Financial excesses of all kinds have undermined its legitimacy and its efficiency. The U.S. dollar is losing investors'confidence while many banks are caught in the turmoil of the subprime credit (unworthy credit).
The overall background is the unprecedented real estate bubble that took place worldwide, from 1995 to 2005. In the United States, for example, owner-occupied home prices increased annually by an average of about 9 percent. The market value of the stock of owner-occupied homes in the U.S. rose from slightly less than $8 trillion in 1995 to slightly more than $18 trillion in 2005. It has been contracting ever since.
World inflation rose for twenty years, until 1980, which was followed by a period of disinflation . The entry of China into the World Trade Organization (WTO) on December 11, 2001, with its abundant labor and low wages, unleashed strong deflationary forces worldwide. This in turn led to lower inflation expectations paving the way for the Greenspan Fed to keep interest rates abnormally low.
Persistent low interest rates and low inflation expectations led to strong growth in money supply due to a binge in borrowing and to a vast increase in market valuation, not only in real estate but also in stocks and bonds. Banks and other mortgage lending institutions took advantage of the opportunity to introduce some financial innovations in order to finance the exploding mortgage market. These innovations resulted in the severing of the traditional direct link between borrower and lender and the reduction in the lending risk normally associated with mortgage loans.
Thus, with the connivance of the rating agencies and of the Federal Reserve System, large banks invented new financial products under various names such as "Collateralized Bond Obligations" (CBOs), "Collateralized Debt Obligations" (CDOs), also called "Structured Investment Vehicles" (SIVs), which had the characteristics of unfunded short term commercial paper. In the residential mortgage market, for example, mortgage brokers and retail lenders would sell their mortgage loans to banks, which in turn would package them together and slice them into different classes of mortgage-backed securities (RMBS), carrying different levels of risk and return, before selling them to investors.
Indeed, these new financial instruments were the end result of a process of "asset securitization" and were slices of bundles of loans, not only of mortgage loans but also of credit cards debts, car loans, student loans and other receivables. Each slice carried a different risk load and a different yield. With the blessing of rating agencies, banks went even one step further, and they began pooling the more risky financial slices into more risky bundles and divided them again to be sold to investors in search of high yields.
By selling these new debt instruments to investors in search of high yields and higher yields, including hedged funds and pension funds, banks were doubly rewarded. First, they collected handsome managing fees for their efforts. But second, and more importantly, they unloaded the risk of lending to the unsuspected buyer of such securities, because in case of default on the original loans, the banks would be scot-free. They had already been paid and had been released from the risk of default and foreclosure on the original loans.
The banks' residual role was to collect and distribute interest, as long as borrowers made their interest payments. But if payments stopped, the capital losses incurred because of the decline in the value of unperforming loans would instead be carried by the investors in CBOs and CDOs. The banks themselves would suffer no losses and would be free to use their capital bases to engage in additional profitable lending. In fact, the end of the line investors became the real mortgage lenders (without reaping all the rewards of such risky loans) and the banks could reuse their capital to pyramid upward their loan operations. These were the best of times for banks and they gorged themselves without restraint. Some of them paid their employees tens of billions of dollars in year-end bonuses.
Indeed, and it is here that the Fed and other regulatory agencies failed, first line mortgage lenders became more and more aggressive in their lending, with the full knowledge that they could profitably unload the risk downstream. This explains the expansion of the "subprime" mortgage market where borrowing was done with no down payment, no interest payments for a while and no questions asked as to the income and creditworthiness of the borrower. These were not normal lending practices. Such Ponzi schemes could not last forever. And when housing prices started to decline, foreclosures also increased, thus shaking the new financial house of cards to its foundations. Banks became the reluctant owners of some of the foreclosed properties at very discounted values.
Why then are so many banks in financial difficulties, if the lending risk was transferred to unsuspecting investors? Essentially, because when the housing boom burst, the banks' inventory of unsold "asset-backed securities" was unusually high. When the piper stopped playing and investors stopped buying the newly created risky investments, their value plummeted overnight and banks were left with huge losses still not fully reflected in their financial balance sheets. Indeed, banks that did not unload their stocks of packaged mortgages were forced to accept ownership of foreclose properties at very discounted values. With little or no collateral behind the loans, bad-debt losses became unavoidable.
Since noboby knows for sure the value of something which is not traded, it will take months before banks come to terms with the total losses they have suffered in their stocks of unsold pre-packaged "asset-based securities". It is more than a normal "liquidity crisis" or "credit crunch" (which results when banks borrow short term and invest in illiquid long term assets); it is more like a "solvency crisis" if the banks' capital base is overtaken by the disclosure of huge financial losses incurred when the banks are forced to sell mortgaged assets in a depressed real estate market.
This is this financial and banking mess which is unfolding under our very eyes and which is threatening the international financial system. There are four classes of losers. First, the homebuyers who bought properties at inflated prices with little or no down payment and who now face foreclosure. Second, the investors who bought illiquid mortgage-backed commercial paper and who stand to lose part or all of their investments. Third, the holders of bank stocks who profited when the system worked smoothly but who now face declining stock values. And, finally, anybody who stands to fall victim, directly or indirectly, to the coming economic slowdown.

لماذا لا ينصرنا الله؟

سأل أحدهم منذ فترة عن سبب عدم نصرتنا مع أننا نقوم بمعظم الشعائر الإسلامية ونلتزم بمعظم العادات الإسلامية وقال لما لم ينصرنا الله ونحن المسبحون المصلون الآمرون بالمعروف والناهون عن المنكر؟ وقال لعل العديد منا يخطر بباله هذا السؤال بعد ما رأي في رمضان الألوف تدعوا وتبتهل بنصرة المسلمين المستضعفين في كل مكان وأعينهم تفيض من الدمع وأبصارهم خاشعة لله
سؤاله البريء، إذا افترضنا حسن النية، مردود عليه منذ ألوف السنين: الإجابة باختصار علي هذا السؤال تحتاج معرفة كيفية تحول العرب المسلمون من رعاع لا يُؤمن لهم جوار وتنتهك حرماتهم ويتخطفهم الناس من حولهم إلي قادة أمم ومعلموا البشرية وأنشئوا في وقت قياسي دولة مؤسسية بسطت سلطانها علي الكرة الأرضية في أقل من خمسين سنة؟ ودحروا أمتين من اقوي الأمم في زمانهما وهي الفرس والروم ونشروا الأمن والسلام في ربوع المعمورة. الجواب ببساطة أننا بحاجة للعودة لمبادئ لإسلام الحنيف والاستقاء من منابعه الصافية كتاب الله وسنة خير الأنام صلي الله عليه وسلم والعمل بهما اقتداءً وإتباعا وليس فقط في مظاهر الملبس وطريقة الكلام بترديدنا إن شاء الله وخلافه والتزامنا الصلاة والصوم والحج وسائر العبادات مع افتقادنا لروح الإسلام وهي العمل والصبر وعدم التواكل ومعرفة أن الله ما جعل سبب من غير مسبب ولعل تكون لنا العبرة في السياق القرآني المعجز حينما أخبرنا عن مريم البتول وقد أتاها المخاض فأمرها ربنا جلت قدرته بأن تهز النخلة " وهزي إليك بجزع النخلة تساقط عليكي رطباً جنيا " سورة مريم الآية 34 وهل المرأة في حال المخاض تستطيع أن تهز قشة؟ ولكن شاءت قدرة الله أن تعلمنا بأنه يجب العمل وبذل الجهد في كل وقت مع الدعاء الصادق والله يتولي التوفيق وأن الدعاء بلا عمل تواكل حتى الحديث النبوي الذي يُستشهد به علي التكاسل والتواكل " لو أنكم توكلتم على الله حق توكله لرزقكم كما يرزق الطير تغدو خماصاً و تروح بطاناً"
قرن النبي صلي الله عليه وسلم الحصول علي الرزق بالحركة فقال تغدو وتروح ولو مكثت في عشها ما طعمت ولكنها بحثت وجابت الأجواء بحثا عن رزقها. وأي نصر يحتاج للأخذ بأسبابه "إن تنصروا الله ينصروكم ويثبت أقدامكم". وما أجمل قول الناسك الزاهد إبراهيم بن أدهم ملخصا سبب عدم الاستجابة لدعاءنا:
- عرفتم الله ولم تؤدوا حقه. - وقرأتم كتاب الله ولم تعملوا به. - وادعيتم عداوة الشيطان وواليتموه. - وادعيتم حب الرسول صلى الله عليم وسلم وتركتم أثره وسنته. - وادعيتم حب الجنة ولم تعملوا لها. - وادعيتم خوف النار ولم تنتهوا عن الذنوب. - وادعيتم أن الموت حق ولم تستعدوا له. - واشتغلتم بعيوب غيركم وتركتم عيوب أنفسكم. - وتأكلون رزق الله ولا تشكرونه. - وتدفنون موتاكم ولا تعتبرون.!
والله سبحانه ينصر من ينصره ويستجيب للصالحين وفي الأثر "أطب مطعما تكن مستجاب الدعوة" والأزمة الحقيقة التي تعاني منها الشعوب الإسلامية هي أزمة أخلاق وهو ما أشار اليه منذ أمد بعيد أمير الشعراء أحمد شوقي:
وإذا أصيب القوم في أخلاقِهم فأقم عليهم مأتماً وعويلا

Wednesday, November 7, 2007

Tuesday, November 6, 2007

Understand the true meaning of a corporation

“The Corporation”

While it is common to list various typical corporate features, such as entity status, limited liability and perpetuity, there is really only one defining feature: entity status. Entity status means
that certain legal rights and duties are held by the corporation as a separate, impersonal legal entity. In the case of the private business corporation, entity status implies that title to the firm’s assets is held by the corporation in its own right, separate from its shareholders.
Illustrative of the fact that the corporate form of private enterprise deviates from traditional forms of private property, entity status renders the legal position of both corporate shareholders and managers (directors) awkward and ambiguous. As for corporate shareholders, they are commonly regarded as the owners of the corporation, but they are owners only in a limited sense. Shareholders do not have title to the assets of the corporate firm, but merely possess the right to appoint management and to receive dividends as and when these are declared; title to the firm’s assets reverts back to shareholders only when its corporate status is terminated. The lack of ownership rights over assets is illustrated by the fact that, in contrast to partners in an unincorporated partnership, corporate shareholders cannot lay claim to their share of the assets of the corporate firm nor do they have the right to force their co-partners to buy them out. Corporate shareholders can liquidate their investment only by selling their shares to third parties. In short, the ambiguity in the legal position of shareholders lies in the fact that, while certain traditional ownership rights rest with them (profit accrual and power to appoint agents to manage the firm for them), other traditional ownership rights are exercised by the corporation as a legal entity separate from them (title to the firm’s assets).

As for corporate management, their legal position is equally ambiguous. Managers are appointed by directors who are the representatives of shareholders. Ultimately, management is thus the agent for shareholders, managing the corporation as their representative.
This, however, is only part of the picture. While management is the agent for shareholders in the sense of being ultimately appointed by and accountable to them, it is also the agent for the corporation itself. After all, in order to manage the corporation’s assets, management must legally represent the corporation as the titleholder to these assets. And because the corporation is an impersonal legal entity, agency for the corporation lends a significant degree of autonomy to the position of management, which is precisely why it has proved so difficult to make shareholder control over management more effective, despite the many legislative measures aimed at enhancing management accountability to shareholders.
To sum up, the position of management is ambiguous because management acts as agent for two principals, the shareholders and the corporation.

Other typical features of the corporation like limited liability and perpetuity are not independent, original attributes, but are derived from its entity status.
Shareholders possess limited liability because they do not own the corporation’s assets and are, consequently, also not liable for claims against these assets. Responsibility for corporate debt rests with the corporation in its own right rather than with them. Corporate creditors cannot, therefore, lay claim to the personal possessions of corporate shareholders, as they can to the personal possessions of partners in an unincorporated partnership. The most shareholders can lose is their initial investment when buying the shares, which happens only when the corporation goes bankrupt and the shares lose their value. Such is the origin of limited liability for shareholders. The corporate feature of perpetuity can also be traced back to the corporation’s entity status. It is because assets are owned by the corporation in its own right rather than by shareholders that the death or departure of shareholders does not affect its continued existence.

While unincorporated partnerships need to be legally reconstituted each time partners leave, die, or are added, corporations continue irrespective of who holds their shares. The corporation’s entity status
thus gives it a life independent of the life of its shareholders, which is the sense in which it is commonly said to possess perpetuity or immortality. This kind of immortality should, of course, not be
understood as if corporations literally go on forever, since they can most certainly cease to exist, for example when they go bankrupt or lose their corporate status.

According to people should not only be granted the freedom to make their own decisions, but they should also carry the full positive and negative consequences of these decisions. Otherwise, rights get given without the accompanying responsibilities, which inevitably has the effect of stimulating irresponsible behavior.
Corporate law has been designed to facilitate a legalized flight from responsibility by those who nominally own the corporate system.”
Corporate shareholdership is a licentious and irresponsible form of ownership because it is granted privileges of ownership (accrual of profits and the appointment of agent-managers) without carrying
the obligations of ownership (payment for losses). If shareholders receive the full benefit of enterprise when things go well, why should they not also carry the full cost of enterprise when things turn awry?
Similarly, corporate management is not efficient because it enjoys the privileges of ownership (control over assets by virtue of being the agent for the corporation) without having to face the burdens of ownership (payment for acquisition or loss bearing) and without being accountable to natural persons who do carry the full extent of these burdens, as shareholders don’t do either. As already mentioned, insofar as management is accountable to shareholders, such accountability is difficult to make effective especially when shareholdership has become highly diluted.

One must not deny the tremendous productivity advantages of the corporate form of the private business firm, for which there are two closely interrelated reasons.
First, the capital base of the corporate firm is potentially much larger than that of the unincorporated partnership. Because a partner in a partnership carries personal responsibility for the assets and
debts of the firm, there will be a stronger incentive for such a person to be intimately involved in its management so as to ensure that risks remain within proper limits; absentee ownership of unincorporated partnerships is just too hazardous. Given that a firm can only be effectively managed by a limited number of fully liable owner-managers, the capital base of partnerships will thus be limited to what that limited number of partners can contribute. The corporation is free from such limitations to the number of capital-contributing shareholders, because shareholders enjoy limited liability and need not be involved in the running of the firm at all. Moreover, given that partners in an unincorporated partnership have a shared legal right to its assets, they also have the right to force their co-partners to buy them out. As a result, the larger the capital contribution of each partner, the greater the potential strain on co-partners to find the necessary capital to buy each other out, should one or more of them die or wish to leave, which is a further way in which the capital base of unincorporated partnerships is naturally limited. By contrast, because title to its assets rests with the corporation in its own right (the corporation enjoys entity status), corporate shareholders have no legal right to force their fellow-shareholders to buy them out ,with the result that such limits to its capital base do not apply to the corporation.

For these reasons the corporation hardly knows any capital restriction on size whatsoever and is thus
able to reap all the economies of scale, and the technological innovations that normally go with them, which were previously out of reach of proprietorships and partnerships. Second, limited liability provides a measure of systematic risk protection for shareholders which will enable corporations to take on more risk. This increased ability to carry risk stimulates technological innovation as well as economic activity in general. Against the productivity advantages of the corporate form stand
a number of disadvantages :

(a) Increased Speculative Instability
Because incorporation separates ownership from control, shares in a modern corporation can be traded without necessarily affecting the management nor the capital position of the firm. As a result, an active market in such shares develops more easily. By contrast, the shares in an unincorporated partnership are less marketable because they are more strongly linked to the risks and responsibilities of managing the firm, which old owners are more reluctant give up and new owners accept. Moreover, partners normally have the right to consultation in ownership transfers, which also reduces the marketability of ownership stakes in unincorporated businesses.
Unfortunately, marketability and the potential for speculative trading are intimately linked. Since incorporation significantly increases the marketability of ownership stakes, it thereby also enhances the opportunities for speculative activity in share markets.
In addition, many of the participants in speculative markets are corporations themselves and thus enjoy a degree of risk protection in the form of limited liability. Because the balance between risk and reward is tampered with, speculative activity is artificially stimulated— which is not to say that there is anything inherently wrong with such activity. The excessively speculative nature of modern stock markets adds a further source of unnecessary instability to modern capitalist practice, which has the potential of seriously disrupting the real economy. And the ease and speed with which inordinate amounts of wealth are created and destroyed on the stock exchange is surely not one of the
more attractive features of modern capitalist practice

(b) Increased Market Concentration and Concentration of Control
Because the corporate form increases the average firm size, it will also increase the degree of concentration in any given market. Furthermore, because incorporation enhances the marketability of shares as well as the ease with which capital can be raised, it also creates better opportunities to gain market share by mergers and take-overs. While gaining market share through the stock market by mergers and take-overs is a matter of persuading investors that the combination is more profitable, gaining market share through the goods market is solely a matter of persuading buyers that the quality/price of the product is better than that of competitors.
Although the one does not exclude the other and superior profit may be realized through superior price/quality with the interest of investors and goods buyers overlapping, the general buying public is ordinarily better protected against market power abuse by sellers when the stock market route to increased market share is virtually blocked, as would be the case when unincorporated business
forms are dominant once again. But it should always be remembered that the corporate firm, through its potentially larger capital base, is in a better position to realize scale economies where they
exist, which may, on balance, benefit buyers in spite of reduced competition in the relevant goods markets and the greater potential for exploitation by sellers which it entails. Put differently, corporate capitalism does generally make the broad population more prosperous, but it makes shareholders and managers disproportionately more prosperous as well as more powerful.

The problem with corporate capitalism is not only one of increased market concentration but also
of increased concentration of control. Control has become more concentrated under corporate capitalism for two reasons. First, because of the greater potential for increased firm size already discussed and, second, because of the conglomeration potential. The conglomerate firm, through pyramidal ownership structures, facilitates extensive control with relatively little ownership for the parent firm. Such ownership structures can be ascribed to the ability of firms to own other firms, which is directly attributable to the corporate form. Without incorporation only people can own firms. And because the law, since the abolition of slavery, does not allow people to own people, pyramidal
ownership structures become an impossibility. The problem with increased concentration of control is that, for a given size of the total economy, fewer people make the relevant decisions: whether and where to invest, what to buy from whom, et cetera. As a result, fewer people are likely to benefit from these decisions, which are also likely to involve larger amounts of money. After all, increased size and concentration of control reduce competition , through the increased buying power of the relevant firm, which particularly affects local labor markets and markets for investment location. Because of the relative mobility of capital, the relative immobility of labor and the scarcity of job in any given locality (especially in Third World settings), the potentially excessive size of corporate firms causes them to obtain a potentially large bargaining advantage over local labor and government, which is why the latter often bend over backward to accommodate corporate investors through tax concessions and low wage policies and why large corporations are often in a position to exercise considerable leverage in their dealings with government.

(c) Increased Strength of the Profit Motive
Since corporate shareholders are normally so diversified that they become an wide spread mass, only the lowest common denominator of their wishes can be attended to, which is to maximize return
on investment—the wish which the greatest number of shareholders have in common. Put differently, the profit motive is given additional impetus, because it has to perform the additional function of
bridging the gap between management and an estranged ownership.
The divorce of ownership from control also stimulates the development of a large, impersonal market in corporate control, which makes it even more difficult for management to moderate the pursuit
of profit, as they live under the constant threat of losing their position through take-overs—and recall how take-overs are already made easier by the corporate form. That is why corporate behavior tends to be more strongly profit-driven than people tend to be when acting in their private capacity.

(d) Loss of Personal Morality
The possession of personal responsibility enhances personal morality, because the necessity of having to face the (positive and negative) consequences of one’s freely chosen actions and commitments stimulates responsible and thus moral behavior.