Monday, July 14, 2008

The Porsche Economy - Part II

Quote of the week:
'In Bradford all nurseries have been ordered to convert their dolls' houses into miniature mosques so that Muslim teddies have somewhere to pray'. - Mark Steel in a column about being Muslim in Britain.

Commentary of the week:

What is 'Finance'? (Part II - contd. from last week):

Now that all of you budding Islamic Financiers know how an Economy works, we should start drilling down a bit into how Finance works as well. Most people think you need to wear an over-priced suit and drive a Porsche to prove that you know anything about financial matters (who am I to argue with that?), but sometimes, just sometimes this knowledge seeps out and finds its way into the hands of bicyclists, paddlers and slow & short walkers like me who refuse to pay more for a suit than they would for a bad hair-cut - and who in turn, pass the protected word on to discerning readers like you in order to give you the tools you need to deflate the next overblown financial ego you meet.

As the sheer brilliance of last week's commentary is probably seared onto your minds, you will of course remember that one of the factors of production in an economy is Capital. Within the larger factor of capital is the field of finance, which is the name given to the movement of some kinds of capital between various actors in an economy. For example, if you have ever played Monopoly, you know that there is a lot of Property / Railways / Hotels / Houses available in that economy. These are the solid assets that we can call capital. There is also a 'bank' (not a real bank in the modern sense of the word), but the entity that holds the cash and really allows players to trade money, rents, property etc. with each other. That 'bank' in Monopoly does many of the things that the financial sector does in the real economy. Building on this only somewhat oversimplified example, Capital can include things such as buildings, plants, machinery and of course, the popcorn that Spengler asked us to invest in last week. Finance on the other hand, is more limited in the sense that finance should really only include the more liquid kinds of capital that are either in the form of cash already (both electronic and actual), or is instantly or somewhat easily convertible into cash (some definitional latitude please). The world of Finance then, has two main categories that sometimes leach into each other a bit with hybrid products, but which will be treated as distinct for our purposes here because they carry different legal rights and are easier to understand that way. The two categories then, are Debt Finance and Equity Finance.

Debt Finance is the movement of capital (or money) between Savers (people who have saved money) and Borrowers (people who are lo and behold, borrowing money in some way to finance something they cannot or do not buy with their own money). This is usually done through the medium of banks or credit unions or secondary lenders. The way this works is that I deposit $100 into a bank and then the bank turns around and loans >$1000 (not a typo) to my neighbour or my neighbour's company as some kind of debt. The account or product I use to make a deposit into the bank can include things such as cheque-ing accounts, savings accounts, GIC's and most other kinds of guaranteed deposits. For the borrower, my neighbour in this case, this includes things such as Mortgages, lines of credit, Mezzanine (the cool word of the day) Debt, Project financing and all manner of interest-bearing loans that my neighbour, may God Bless him, can use to finance something he cannot afford and is willing to pay some extra fee for as he uses and repays the funds that don't really belong to him, the bank, or even me (think about this one a bit).

Equity Finance is the movement of capital (or money) between Investors (people who are buying some portion of a commercial enterprise) and Entrepreneurs or Partners (people who are willing to give up some ownership of their enterprise in return for funds in order to run it). This is usually done through the medium of capital markets such as the TSX (now you know what an IPO is), or private markets (now you know what I do at Ittihad) that facilitate investment of private capital into companies or projects. The obvious examples of this kind of finance includes things like Stocks, Mutual Funds, Seg Funds, Principal Protected Notes (PPN's), ETF's (which are technically shares), LP units and all manner of other jargonic things that pass for financial non-solutions which people like you and me invest in because someone told us it was a good idea and we believed their expertise at the time because our 24th baby was crying and the season finale of 'Little Mosque on the Prairie' was on TV and besides - how many things is one person really supposed to know?

Just one more thing this week my friends - hang in there. You should also know that while Finance is divided into Debt and Equity, the ratio between them is quite skewed. The debt in an 'advanced' economy at any given moment in time is more than 10 times the amount floating around in equity (don't ask me how I know this). This is why when people like the Fed or Bank of Canada Governor speak, markets hang on their every word. What moves markets and the economy is the debt portion of finance and the interest rate on that debt. Think of this as an inverted pyramid, with a small amount of actual cash at the bottom, but a progressively large amount of debt as you move higher. This is one reason why the financial sector is more unstable than postal workers who have had almost enough but cannot decide decisively.

So where does this fit in with Islamic Finance? Well, you have to actually take a step further back and ask what kind of an economy would enhance our various Faiths and allow us to live sustainable and contributory lives rather than the predatory ones we perhaps have to live today - but since we are on the topic of finance, let's talk about the cash. True Islamic Finance then, would simply not have a debt component, there would be no inverted pyramid (no $1000 loans on $100 deposits) and no government would be able to borrow money in order to go to war because the population would simply not buy the bonds necessary for such an enterprise. Of course, this would also perhaps mean that there would be no shiny new Porsche in every garage even if we all try really hard because bicycles might be the way to go instead. Perhaps that is why we continue to work within a debtor thought-process that impoverishes us spiritually - because having no debt is fine and dandy, but the drive up to Northern Ontario in a Porsche my friends, is probably priceless.

Upcoming Events:



Finance News:

1. RBC entering the Islamic Finance space! - How exciting, now we will finally get to see if Canadian Muslims are actually as smart as they seem and whether they will defeat this (major hat-tip to Hisham Rahman) ... read more here

2. CDN bank to declare more losses? It seems that the end is nowhere in sight as far as the credit crunch is concerned ... read more here

3. Ottawa tightens up the mortgage rules they just loosened in 2006. Can you say - 'No Foresight'? ... read more here

Economic News:

1. Some more evidence about how Oil prices and Inflation are affecting small farmers in some rural areas (example of India) ... read more here

2. The domino effect in currencies after the fall of the US$. This has the potential to be a huge depressor of living standards across much of the world ... read more here

3. Does Free Trade help poor people? (or do more poor people help Free Trade?) ... read more here

4. How securitization often results in situations of 'moral hazard' ... read more here

5. How the UK has managed to take on more debt than its GDP ... read more here

Islamic / Middle East / Emerging Markets:

1. N / A

Interesting but not all Finance:

1. How the backdoor to Peace in difficult situations is sometimes held open by Faith ... read more here

2. 'Goodbye from the World's Biggest Polluter' ... read more here

3. For Muslims in the audience who think the media is unfair ... must read

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