Quote of the day:
'Inflation will reduce Americans' purchasing power. Deflation will collapse the value of their assets. Between the anvil of falling prices ... and the hammer of rising ones - the American middle class is going to get smashed.' - Bill Bonner from The Daily Reckoning
Bonner makes the case that what is happening South of the border today, is very similar to what happened in Japan during the 1990's. What this would mean for Canada is the big question. We have Oil of course, but that seems like a bit of a shallow defence if our only customer for our exports no longer has money to buy our stuff. Remember all the times we took sides against China? India? Brazil?
Commentary for the Week:
Island Paradise - Part II
This week we go back to the island paradise of last year (IWB Issue 8) to resolve some outstanding questions. On a loan to each of John, Jacob and Jaffer of $1000 Absurdodollars at 5% simple annual interest, the outstanding questions were:
1. How many years will it take for John, Jacob and Jaffer to pay me back?
2. How much am I guaranteed to make in a year? How much are the boys guaranteed to make?
3. If the boys just have to pay interest at the end of every year and there are no bankruptcy courts, what will happen to all productive assets on the island?
4. How many years before one of them runs out of money? How many years before all of them run out?
Since not many of our dear readers were perhaps quite busy over the holiday season, many did not attempt these brain-teasers. As such, I will try my best, but please correct me if you think I am wrong.
1. John, Jacob and Jaffer will actually never be able to pay me back. Between the three of them, they have $3000 only. On top of this, they must pay me pack $450 ($150 each). As I am the only one with an extra supply of Absurdodollars, one or more of them will have to declare his inability to pay me back.
2. Even though I have done very little productive work such as farming, carpentry or baking, in theory I am guaranteed a return of $450. The J-boys are not even guaranteed $1 in theory. In fact, they are guaranteed to lose money because they have to compete amongst themselves for the extra $150 that each needs. They cannot get that extra $150 they have to pay me back with except from each other's original $3000. Instead of a collegial atmosphere of working together, you can rest assured that in some ways, they are now working against each other. The island paradise, with the introduction of debt-based money, soon becomes quite stressful. Each day they wake, they know that they have to make around $0.41 AbsurdoCents ($150/365 days) to meet their year-end obligations.
3. They own or control real assets such as an oven, land and tools, whereas I own some printed paper on a deserted island. At the end of the year however, once I know which one or two of them will be short of $150, I can easily ask one of them to give me his tools/assets instead of the $150. In this way, I become not only the arbiter of financial services but also the mechanism through which real assets in the economy are traded or controlled.
4. At least one of them is guaranteed to be short the $150 that he needs to pay me back by next year. Let us however, make this question more interesting. Let us assume that I tell them that they can pay me only interest if they wish. That means that they can pay me $150/yr each and I will let them keep the capital of $1000 as long as they wish. Even in this apparently liberal debt regime, it will take less than 7 years for me to claim everything on the island ($3000/$450) because that is when the J-boys will simply run out of AbsurdoDollars.
As you can see, this is a pretty extreme result of what started off as a service to the community. Simply by the virtue of having some printed paper, in 7 slothful years, I can own all productive assets. While this is a grossly oversimplified model of an economy, this model does have some lessons for us. First and foremost, we have to realize that indebtedness is not necessarily a natural state of being - we got here because of our choices, not evolution. The second is that speculative sectors of the economy do not add value in the same way that real skills do. There is big difference between sectors that create value, and those that shift it around. The final lesson of course, is inescapable - I must move to Paradise Island.
(I apologize for the typos in Issue 8, I failed to recheck the commentary before I emailed it.)
Finance News:
1. Looking behind the $100/barrel price of Oil ... only a 1000 barrels were traded at $100 ... but it made news ... http://www.theglobeandmail.com/blogs/wenergyblog0613
2. Merrill Lynch is going to post a $15B loss from subprime ... but guess who they are going after to make up the capital? ... http://www.reuters.com/article/fundsFundsNews/idUST29249020080111
3. Some of the politics behind Carbon offsets ... http://www.nytimes.com/2008/01/09/business/09offsets.html?_r=1&oref=slogin
4. Guess where else Tony Blair is working in addition to 'solving' the Middle East Crisis ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wblairbank0110/BNStory/Business/?cid=al_gam_nletter_maropen and guess what his first deal is ... http://www.nytimes.com/reuters/business/reuters-northernrock.html?ex=1357707600&en=5576193f0e6b35ff&ei=5088&partner=rssnyt&emc=rss
Economic News:
1. Many people think that economic growth in China is dependent on exports. This means that if the US economy tanks, China's economy will not be far behind. This article argues something different - that China's economy has actually reached a point such that an export slowdown will not slow economic growth appreciably. Very interesting analysis with all sorts of political implications if it is true ... http://www.economist.com/finance/displaystory.cfm?story_id=10429271
2. Good News from Merrill Lynch about your mortgage, but not so good for your income ... Recessionary fears are made public ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080109.wecooutlook0109/BNStory/robNews/home
3. CIBC says gas will be $1.50 soon ... This is funny, I've never really thought that CIBC can be right on anything but there you have it. You heard it from CIBC first ... http://www.financialpost.com/story.html?id=228661
4. News about the Loonie ... this speaks to the theory that regardless of our Oil and resources, the Loonie will be dragged down by the US relative to Asian / European currencies ... Perhaps this explains a little bit about how dependence on one customer for exports generates all kinds of vulnerabilities ... http://www.blackswantrading.com/files/3d9b61b67aa06a6/bsccc011108.pdf
Islamic / Middle East Finance:
1. Thinking of investing in solar energy? ... Some factors and companies to consider ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wrchinasun10/BNStory/SpecialEvents2/home
Miscellaneous:
1. Tata's $2500 car is unveiled ... a good discussion of how it may affect climate change but I didn't expect the Globe to be so negative. I think they would have been full of praise if this car was American instead of Indian ... then it would have been Progress ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wtatacar0110/BNStory/Business/home
Showing posts with label Fractional Reserve System. Show all posts
Showing posts with label Fractional Reserve System. Show all posts
Tuesday, May 6, 2008
The Baker, Carpenter, Farmer and the washed-up Manufacturer of Money
Quote of the day:
"We think some of the real estate companies being adversely affected are being penalised by the mortgage market" - David Jackson, the chief executive of the Dubai-government-owned investment agency, Istithmar.
You think ... ?
(It is possible that he was misquoted, but if this is the kind of rigorous, inspired thinking in place at the top of ME Sovereign Funds ... then Oil money is not in good hands. I thought the quote was important because ME companies have begun to buy many Real Estate assets in the US. Not a completely foolish move in my book, but fairly close - neither mortgage assets nor the US$ have been fully re-priced yet, so they are investing too early. But then again, what do I know ... )
[Quote from http://economictimes.indiatimes.com/News/International__Business/Dubais_Istithmar_eyes_subprime_hit_US_firms/articleshow/2613602.cms ]
Commentary for the Week:
The letters edition is coming up soon and I have not received too many that I would like to print. Thus, I am going to write something that should elicit some response. This story is actually nearing classic status, and I have just adapted it for our use (I will try and find the exact reference over the holidays so email me if you would like me to share it with you). I will also leave you with a couple of questions that you can think about over the holidays. The Newsletter will return early in the New Year ...
The Baker, Carpenter, Farmer and the washed-up Manufacturer of Money.
John, Jacob and Jaffer are three energetic friends who frequently decide to take upon challenging adventures. They have bungi-jumped from the Peace Bridge, been hot-air ballooning in Kenya and even been canoeing in the Arctic. In short, they are an excitable, enthusiastic bunch that tend to think better in isolation, but accomplish more together. For their latest escapade, they decide to take a trip around the Bermuda triangle on a sailboat.
I think you can all guess what happens next. Disaster strikes at a particularly inopportune moment, and the sailboat catches fire, burning the sail, transponder, the GPS, Radio, Cell-phones, their wallets and leaving the backup engine inoperable. They begin to drift with the ocean currents and Hurricane Bills deposits them on an unnamed, uninhibited island on a broken un-repairable sailboat. The good news is that they find enough fresh water, abundant fruits, vegetables and various animals that are easily domesticated. The uninhabited island, in other words, is a veritable paradise - at least it was until they arrive. Being energetic people, and having need of things such as shelter, sustenance and occupation, they gravitate towards tasks that suit each of them well. Thus, John becomes a carpenter, using various bits of the sailboat to fashion for himself the tools that he needs to cut trees and shape wood. Jacob becomes a cook, excelling at baking cheesecake using all-natural ingredients. Jaffer becomes a farmer, tilling the soil and domesticating animals for transportation, milk production and as beasts of burden.
As the island economy grows to beyond subsistence levels, a barter system develops whereby Jacob makes food for others while they provide him with shelter and produce. John makes buildings for them and provides them with wood while Junaid provides them with animals for transportation and produce. As their welfare increases however, they have more and more trouble keeping track of what they each owe the other. They seem to have everything they need, but no system by which they can keep account. Also, hauling wood everywhere in order to pay for his food is getting on John's usually serene nerves, creating issues for the boys. At one of their meetings over dinner, they discuss inventing money for exchange purposes. There is only one problem though - John being an engineer in his previous life, Jacob being a doctor and Jaffer being a teacher, none of them are quite sure of how to set it up. In the best tradition of democratic governance however, they decide to delay any resolution and settle for the status quo.
A few weeks after that, as John is taking apart the badly beaten sailboat on the beach even more, he notices a small craft being pushed towards the island by the waves. As the craft gets closer, he sees that there is another survivor about to land on their shores. As the craft finally lands, an immaculately dressed, professional-looking man carrying a hefty briefcase alights.
I introduce myself as 'Jawad the Money-Maker' and proceed to ask John about all the possible real estate sites on the island where I can buy a house. John looks at me a bit strangely, perhaps thinking of overcharging me for the property, but being the honest soul that he is, proceeds to explain that there are no prior owners of the land. As he introduces me to the others and I begin to understand their roles in the island economy, I realize that although they are each master of their smaller domains, they all share the resources of island. This is an unfamiliar economic system to me, and I ask them more about how they transact their business. As they explain more about bartering wood for cows and bread for wood and cows for cooked lentils, I realize that they may be meeting their personal needs in a socially optimal way (they hardly fight), but they have their economic system all wrong. I know this because being from Absurdistan, the leading economy of the day, (while they are mere Canadians) I have worked in finance long enough to know what works. I accurately describe the problems they are having lugging around cows and wood and bread in order to get cows, wood and bread from their neighbours and they recognize my genius immediately. I propose that they hire me as consultant in order to design a solution for their problems. In return, I ask that they build me a house, provide me with a horse and feed me. Not being totally clueless, they agree to the house and some food up front, with a cow to be delivered only if my solution works. Being a practical and thoughtful man, I retire to a secluded space while they build me shelter.
Once my gorgeous house overlooking the beach is complete, they ask for my solution to their barter problem. I describe it as follows: As their island economy has grown and each produces more output than he can consume himself, they must trade with each other. In order for trading to fulfill its potential, we must be efficient. As their economy is poised for further growth now that they are experts in their chosen fields, the bottleneck was no longer output, but the method by which their output was exchanged. They had now grown enough to be able to move to more efficient system than barter - into a system based on money and credit. Also, it was quite lucky for them that I was from Absurdistan and that I had some of the premier currency of the day - the AbsurdoDollar - in my possession. As the Absurdistan monetary authorities were saints in human skin, we could all be assured that the AbsurdoDollar was sound and would remain strong. Furthermore, since the boys had all been exceedingly kind, I would let them use my AbsurdoDollars for a nominal interest rate. I would loan each of them $500 in return for a lien on their productive collateral (the carpenter's tools, the baker's oven, and the farmer's land) and charge them only 10% for their use of my funds. To ensure that I was a productive member, I would also agree to keep track of prices and payments as long as they fed me.
Again, not being totally clueless, the boys negotiate me down to 5% simple interest on a loan of $1000 AbsurdoDollars for each. This way, each of them has to repay me $1050 in one year. With my ingenious solution, production of bread, wood and grain increases tremendously. John, Jacob and Jaffer are no longer carrying their production around but are able to move easily with their hands free and their wealth in their pockets. This leaves them with more time to work or research more efficient production methods. The island economy begins to hum - when they want to buy food, they pay Jacob. When they want to buy wood, they pay John. When they want to ride around on cows or eat fruits and veggies, they pay Jaffer. But there may be some trouble in paradise ...
Even though we are all agreed that this is an excellent solution, my questions for you now are as follows:
1. How many years will it take for John, Jacob and Jaffer to pay me back?
2. How much am I guaranteed to make in a year? How much are the boys guaranteed to make?
3. If the boys just have to pay interest at the end of every year and there are no bankruptcy courts, what will happen to all productive assets on the island?
4. How many years before one of them runs out of money? How many years before all of them run out?
A Happy Eid, Hannukah and Merry Christmas to all ... the newsletter will return early next year with some of your responses ...
Finance News:
1. Interesting stats and views on whether women control the Financial Planning process in families ... Why is it that while women control the majority of purchase decisions, they are not as motivated to take control of their overall financial well-being? ... This article is somewhat of a call to action ... http://www.advisor.ca/practice/growing_your_business/article.jsp?content=20071211_154533_316
2. For those that wish to follow-up and read up on the subject of last week's commentary (Tax Efficient Charitable Giving) ... http://www.advisor.ca/news/article.jsp?content=20071212_150006_7468
3. Tax-Tips - Straight from the source ... http://www.cra-arc.gc.ca/newsroom/taxtips/menu-e.html
4. Carbon-Trading comes to Wall Street ... http://www.investmentexecutive.com/client/en/News/DetailNews.asp?id=42328&IdSection=148&cat=148&BImageCI=1
Economic News:
1. Must read story of the week - The title says it all ... 'The End of Cheap Food' ... http://www.economist.com/displayStory.cfm?story_id=10250420&fsrc=nwlgafree
2. Observing the 10th Anniversary of the Asian Financial Crisis, perhaps the single most devastating financial crisis of the last century if you measure according to sheer number of people that were deeply affected (and don't include wars) ... Imagine waking up in the morning and finding out that not only is the interest rate you have to pay on your loans now over 100%, but that your local currency is also worth 1/10th or 1/100th of its value in us$ from yesterday ... (I was working in Singapore in 1997 where the currency depreciated by 20-30% in a matter of days - the change was not as 'mild' in Indonesia, Thailand and Malaysia however) ... http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Taking_stock_Ten_years_after_the_Asian_financial_crisis_2085
3. Greenspan speaks about the subprime crisis ... amazing how he absolves the Fed and thereby himself of all responsibility ... the column is admirable for the sheer hubris on display ... a bit like a policeman letting a drunk driver go when he could have arrested the fellow and then saying that the subsequent mayhem was an 'accident' waiting to happen ... No negligence, just an accident - something like being struck by lightning ... http://www.reuters.com/article/businessNews/idUSN1258328720071212?feedType=nl&feedName=usmorningdigest&sp=true
4. Central Banks around the world rally to keep the US $ from plummeting by lowering rates ... If the US were a developing country, there would be no easing of credit. The World Bank and IMF would have been sent in for 'Structural Adjustment' ... You and I will have to pay for this latest bailout through higher food and gas prices (see 1 above) ... http://www.reuters.com/article/businessNews/idUSN1262150920071212?feedType=nl&feedName=usdai&sp=true
Islamic and ME Finance:
1. The UK government is thinking very carefully about raising money through a sovereign sukuk - (More commonly known as an 'Islamic' Bond) ... I wonder how Islamic it will be if the funds raised go towards the financing of their various well-known military actions ... http://www.zawya.com/story.cfm/sidZAWYA20071210043618
2. An inspired investment or more Oil money on the way down? ... Dubai entity buys 8.1% of chip-maker AMD, even though AMD has been posting losses for a while ... this buy-in may have merit though ... maybe there is a chip-fabrication plant on the table for Dubai in the near future ... http://www.economist.com/business/displaystory.cfm?story_id=10180738
"We think some of the real estate companies being adversely affected are being penalised by the mortgage market" - David Jackson, the chief executive of the Dubai-government-owned investment agency, Istithmar.
You think ... ?
(It is possible that he was misquoted, but if this is the kind of rigorous, inspired thinking in place at the top of ME Sovereign Funds ... then Oil money is not in good hands. I thought the quote was important because ME companies have begun to buy many Real Estate assets in the US. Not a completely foolish move in my book, but fairly close - neither mortgage assets nor the US$ have been fully re-priced yet, so they are investing too early. But then again, what do I know ... )
[Quote from http://economictimes.indiatimes.com/News/International__Business/Dubais_Istithmar_eyes_subprime_hit_US_firms/articleshow/2613602.cms ]
Commentary for the Week:
The letters edition is coming up soon and I have not received too many that I would like to print. Thus, I am going to write something that should elicit some response. This story is actually nearing classic status, and I have just adapted it for our use (I will try and find the exact reference over the holidays so email me if you would like me to share it with you). I will also leave you with a couple of questions that you can think about over the holidays. The Newsletter will return early in the New Year ...
The Baker, Carpenter, Farmer and the washed-up Manufacturer of Money.
John, Jacob and Jaffer are three energetic friends who frequently decide to take upon challenging adventures. They have bungi-jumped from the Peace Bridge, been hot-air ballooning in Kenya and even been canoeing in the Arctic. In short, they are an excitable, enthusiastic bunch that tend to think better in isolation, but accomplish more together. For their latest escapade, they decide to take a trip around the Bermuda triangle on a sailboat.
I think you can all guess what happens next. Disaster strikes at a particularly inopportune moment, and the sailboat catches fire, burning the sail, transponder, the GPS, Radio, Cell-phones, their wallets and leaving the backup engine inoperable. They begin to drift with the ocean currents and Hurricane Bills deposits them on an unnamed, uninhibited island on a broken un-repairable sailboat. The good news is that they find enough fresh water, abundant fruits, vegetables and various animals that are easily domesticated. The uninhabited island, in other words, is a veritable paradise - at least it was until they arrive. Being energetic people, and having need of things such as shelter, sustenance and occupation, they gravitate towards tasks that suit each of them well. Thus, John becomes a carpenter, using various bits of the sailboat to fashion for himself the tools that he needs to cut trees and shape wood. Jacob becomes a cook, excelling at baking cheesecake using all-natural ingredients. Jaffer becomes a farmer, tilling the soil and domesticating animals for transportation, milk production and as beasts of burden.
As the island economy grows to beyond subsistence levels, a barter system develops whereby Jacob makes food for others while they provide him with shelter and produce. John makes buildings for them and provides them with wood while Junaid provides them with animals for transportation and produce. As their welfare increases however, they have more and more trouble keeping track of what they each owe the other. They seem to have everything they need, but no system by which they can keep account. Also, hauling wood everywhere in order to pay for his food is getting on John's usually serene nerves, creating issues for the boys. At one of their meetings over dinner, they discuss inventing money for exchange purposes. There is only one problem though - John being an engineer in his previous life, Jacob being a doctor and Jaffer being a teacher, none of them are quite sure of how to set it up. In the best tradition of democratic governance however, they decide to delay any resolution and settle for the status quo.
A few weeks after that, as John is taking apart the badly beaten sailboat on the beach even more, he notices a small craft being pushed towards the island by the waves. As the craft gets closer, he sees that there is another survivor about to land on their shores. As the craft finally lands, an immaculately dressed, professional-looking man carrying a hefty briefcase alights.
I introduce myself as 'Jawad the Money-Maker' and proceed to ask John about all the possible real estate sites on the island where I can buy a house. John looks at me a bit strangely, perhaps thinking of overcharging me for the property, but being the honest soul that he is, proceeds to explain that there are no prior owners of the land. As he introduces me to the others and I begin to understand their roles in the island economy, I realize that although they are each master of their smaller domains, they all share the resources of island. This is an unfamiliar economic system to me, and I ask them more about how they transact their business. As they explain more about bartering wood for cows and bread for wood and cows for cooked lentils, I realize that they may be meeting their personal needs in a socially optimal way (they hardly fight), but they have their economic system all wrong. I know this because being from Absurdistan, the leading economy of the day, (while they are mere Canadians) I have worked in finance long enough to know what works. I accurately describe the problems they are having lugging around cows and wood and bread in order to get cows, wood and bread from their neighbours and they recognize my genius immediately. I propose that they hire me as consultant in order to design a solution for their problems. In return, I ask that they build me a house, provide me with a horse and feed me. Not being totally clueless, they agree to the house and some food up front, with a cow to be delivered only if my solution works. Being a practical and thoughtful man, I retire to a secluded space while they build me shelter.
Once my gorgeous house overlooking the beach is complete, they ask for my solution to their barter problem. I describe it as follows: As their island economy has grown and each produces more output than he can consume himself, they must trade with each other. In order for trading to fulfill its potential, we must be efficient. As their economy is poised for further growth now that they are experts in their chosen fields, the bottleneck was no longer output, but the method by which their output was exchanged. They had now grown enough to be able to move to more efficient system than barter - into a system based on money and credit. Also, it was quite lucky for them that I was from Absurdistan and that I had some of the premier currency of the day - the AbsurdoDollar - in my possession. As the Absurdistan monetary authorities were saints in human skin, we could all be assured that the AbsurdoDollar was sound and would remain strong. Furthermore, since the boys had all been exceedingly kind, I would let them use my AbsurdoDollars for a nominal interest rate. I would loan each of them $500 in return for a lien on their productive collateral (the carpenter's tools, the baker's oven, and the farmer's land) and charge them only 10% for their use of my funds. To ensure that I was a productive member, I would also agree to keep track of prices and payments as long as they fed me.
Again, not being totally clueless, the boys negotiate me down to 5% simple interest on a loan of $1000 AbsurdoDollars for each. This way, each of them has to repay me $1050 in one year. With my ingenious solution, production of bread, wood and grain increases tremendously. John, Jacob and Jaffer are no longer carrying their production around but are able to move easily with their hands free and their wealth in their pockets. This leaves them with more time to work or research more efficient production methods. The island economy begins to hum - when they want to buy food, they pay Jacob. When they want to buy wood, they pay John. When they want to ride around on cows or eat fruits and veggies, they pay Jaffer. But there may be some trouble in paradise ...
Even though we are all agreed that this is an excellent solution, my questions for you now are as follows:
1. How many years will it take for John, Jacob and Jaffer to pay me back?
2. How much am I guaranteed to make in a year? How much are the boys guaranteed to make?
3. If the boys just have to pay interest at the end of every year and there are no bankruptcy courts, what will happen to all productive assets on the island?
4. How many years before one of them runs out of money? How many years before all of them run out?
A Happy Eid, Hannukah and Merry Christmas to all ... the newsletter will return early next year with some of your responses ...
Finance News:
1. Interesting stats and views on whether women control the Financial Planning process in families ... Why is it that while women control the majority of purchase decisions, they are not as motivated to take control of their overall financial well-being? ... This article is somewhat of a call to action ... http://www.advisor.ca/practice/growing_your_business/article.jsp?content=20071211_154533_316
2. For those that wish to follow-up and read up on the subject of last week's commentary (Tax Efficient Charitable Giving) ... http://www.advisor.ca/news/article.jsp?content=20071212_150006_7468
3. Tax-Tips - Straight from the source ... http://www.cra-arc.gc.ca/newsroom/taxtips/menu-e.html
4. Carbon-Trading comes to Wall Street ... http://www.investmentexecutive.com/client/en/News/DetailNews.asp?id=42328&IdSection=148&cat=148&BImageCI=1
Economic News:
1. Must read story of the week - The title says it all ... 'The End of Cheap Food' ... http://www.economist.com/displayStory.cfm?story_id=10250420&fsrc=nwlgafree
2. Observing the 10th Anniversary of the Asian Financial Crisis, perhaps the single most devastating financial crisis of the last century if you measure according to sheer number of people that were deeply affected (and don't include wars) ... Imagine waking up in the morning and finding out that not only is the interest rate you have to pay on your loans now over 100%, but that your local currency is also worth 1/10th or 1/100th of its value in us$ from yesterday ... (I was working in Singapore in 1997 where the currency depreciated by 20-30% in a matter of days - the change was not as 'mild' in Indonesia, Thailand and Malaysia however) ... http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Taking_stock_Ten_years_after_the_Asian_financial_crisis_2085
3. Greenspan speaks about the subprime crisis ... amazing how he absolves the Fed and thereby himself of all responsibility ... the column is admirable for the sheer hubris on display ... a bit like a policeman letting a drunk driver go when he could have arrested the fellow and then saying that the subsequent mayhem was an 'accident' waiting to happen ... No negligence, just an accident - something like being struck by lightning ... http://www.reuters.com/article/businessNews/idUSN1258328720071212?feedType=nl&feedName=usmorningdigest&sp=true
4. Central Banks around the world rally to keep the US $ from plummeting by lowering rates ... If the US were a developing country, there would be no easing of credit. The World Bank and IMF would have been sent in for 'Structural Adjustment' ... You and I will have to pay for this latest bailout through higher food and gas prices (see 1 above) ... http://www.reuters.com/article/businessNews/idUSN1262150920071212?feedType=nl&feedName=usdai&sp=true
Islamic and ME Finance:
1. The UK government is thinking very carefully about raising money through a sovereign sukuk - (More commonly known as an 'Islamic' Bond) ... I wonder how Islamic it will be if the funds raised go towards the financing of their various well-known military actions ... http://www.zawya.com/story.cfm/sidZAWYA20071210043618
2. An inspired investment or more Oil money on the way down? ... Dubai entity buys 8.1% of chip-maker AMD, even though AMD has been posting losses for a while ... this buy-in may have merit though ... maybe there is a chip-fabrication plant on the table for Dubai in the near future ... http://www.economist.com/business/displaystory.cfm?story_id=10180738
Letters Edition #1
Quote of the Week:
'Arguments are to be avoided: they are always vulgar and often convincing.' - Oscar Wilde
Commentary for the Week (Letters of the week edition):
Dear Friends,
Welcome to our first 'Letters Edition' where we publish thoughts and submissions from our subscribers. I trust that you will find it enjoyable. The commentary will be back next week.
Letter No. 1:
Dear Jawad,
Comparing the bank's interest income of $50 from $1,000 with your wife's of the same amount from $100 is not comparing like items:
a) The bank is taking an additional risk on the $900 of loans that it does not have covered by her deposit.
b) Very importantly, the bank is facilitating enterprise, or even mere survival, to 10 borrowers who would otherwise remain incapacitated for lack of those funds.
Item (a) - compensation for risk - must surely also be factored into any determination of cost of capital.
Your Dear Friend,
SK
Letter No. 2:
Salam alaikum,
The problem with your analysis of the banks' profitability from the $100 deposit is that you ignore the countervailing consumer surplus generated by 10 loans instead of one. If your wife loans you the money and makes $50, you are worse off by $45, but presumably still better off in a pareto sense, or else you would not have fixed your car. When the bank makes 10 loans to earn the same $50 owned by your wife, it is presumably making nine other people better off, so overall welfare is increased manifold. Even if the bank makes the same absolute profit as your wife, its share of the increased welfare is much less in a relative sense and the net increase in social welfare is presumably on the order of 10 relative to the one transaction with your wife.
Best wishes,
Mohammad Fadel
Assistant Professor of Law
University of Toronto Faculty of Law
________________________________
My response to Letter No. 1:
Dear SK,
As you show little mercy, I respond thusly:
a. There is no $900 ... there is $1000 that only exists as debt owed to the bank, and there is a $100 deposit. The former does not exist as pre-existing wealth or deposits. The only part that is 'capital' and the bank is on the hook for to the depositor is the $100. Furthermore, if the $100 is in a chequing account, the bank would not even be paying out interest to the depositor. This is actually a very key point - the $1000 is not 'capital', the $100 deposit is. The $1000 exists only as debt owed to the bank, not as somebody's deposit that it has to manage judiciously. Of course, any repayment of the $1000 loaned out and the interest charged is profit. I hope that helps because the key to this whole picture is that the capital risk you speak of is intrinsic to the bank's use of leverage in operations, not a result of the fiduciary management of someone's deposits.
b. This is indeed quite a valid observation - something that has been brought up by another honourable genius such as yourself. He probably beat you to opening the email. Unfortunately, you will have to wait until next week for a response. This point is too important for us not to share with everyone...
Point b is quite similar to Dr. Fadel's and is addressed below:
My response to Letter No. 2:
Although I responded to Dr. Fadel's critique privately already, his astute and wise observations deserve wider readership .
As he states, the efficiency gains from having a lower prevailing interest rate are not insignificant. Indeed, if the only loans available were at 50% interest, much of what passes for commerce in today's economy would come to a halt. My wife's $100, left in her own hands it seems, would make for a poor lubricant to the wheels of Progress.
Where I disagree with the good professor however, is on whether efficiency is our only ultimate goal. One of the central problems or tradeoffs that exists in economic decision-making is whether to devote precious resources towards making gains in efficiency or towards those that enhance economic equality, which is a moral standard (I refer you to the work of the economist Arthur Okun). Whereas Dr. Fadel's critique is informed by the imperatives of efficiency, my argument was made more from the perspective of morality. Lowering the prevailing interest rate from 50% to 5% is a gain in the efficiency of the system, not necessarily its morality. What he also reminds us, of course, is that if we could figure out a way, 0% rates would not just be moral, but be exceedingly efficient as well. Again, I don't believe that either of us fundamentally wrong, just that we are not entirely Right either.
I thank Dr. Fadel for allowing us to learn from his wisdom and expertise. For those of whom that do not know of him yet, he is an active, respected and sharp contributor to debates within Islamic Finance. I am honoured to be guided by him and I look forward to many more exchanges, agreements and disagreements with him in the years to come.
Thank you to all who wrote back with their views. A special thank you to people that asked me to get married to someone that charged less interest - I thought that their concern was very touching. The word of the week is 'Hypothetical'.
Finance News:
1. A very timely story for what we have been discussing here ... if you get a chance to read a book on finance this year, try Satyajit Das' 'Traders, Guns and Money' ... it is both funny and insightful. This interview is a good introduction ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071124.r-takingstock24/BNStory/robColumnsBlogs/?cid=al_gam_nletter_maropen
2. A very interesting development in the mining sector has been the recent proposed buyout of Rio Tinto by BHP Billiton ... I encourage you to try and follow this story because there is something deeper going on ... First, at around $150 Billion, it is not a small buyout. Second, the shareholders refuse to accept $150 Billion because they know that what they have in the ground (minerals) are worth more than the dollars (paper) they are being offered today ... http://www.theglobeandmail.com/servlet/story/LAC.20071203.RBHP03/TPStory?cid=al_gam_globeedge
3. Who watches out for investor interests in Canada? The ROB discusses whether they are doing an adequate job ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071203.wimet1204/BNStory/robNews/home
Economic News:
1. How the Subprime loan mess is related to the credit crunch and how that is related to the US $ ... http://www.atimes.com/atimes/Global_Economy/IK16Dj02.html
2. Think you know the Price of Oil ... I mean the Real Price of Oil ... http://www.atimes.com/atimes/Global_Economy/IK22Dj02.html
3. How the wealth of the world has shifted towards the East, and how the new centres of power are behaving relative to the old ... http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/The_worlds_new_financial_power_brokers_2084
Middle Eastern / Islamic Finance:
1. S&P begins to question legal ownership in some 'Islamic' structures ... http://www.zawya.com/story.cfm/sidZAWYA20071126121542
2. How much is the slide in the US $ hurting OPEC? ... http://www.economist.com/finance/displaystory.cfm?story_id=10191717
Miscellaneous:
1. Ever thought about having solar power? ... Here is some inspiration for you ... http://www.theglobeandmail.com/servlet/story/RTGAM.20071203.wlsolar03/BNStory/lifeMain/home
2. The economist rediscovers that the Middle East has more than Oil ... http://www.economist.com/daily/news/displaystory.cfm?story_id=10235761&fsrc=nwl
'Arguments are to be avoided: they are always vulgar and often convincing.' - Oscar Wilde
Commentary for the Week (Letters of the week edition):
Dear Friends,
Welcome to our first 'Letters Edition' where we publish thoughts and submissions from our subscribers. I trust that you will find it enjoyable. The commentary will be back next week.
Letter No. 1:
Dear Jawad,
Comparing the bank's interest income of $50 from $1,000 with your wife's of the same amount from $100 is not comparing like items:
a) The bank is taking an additional risk on the $900 of loans that it does not have covered by her deposit.
b) Very importantly, the bank is facilitating enterprise, or even mere survival, to 10 borrowers who would otherwise remain incapacitated for lack of those funds.
Item (a) - compensation for risk - must surely also be factored into any determination of cost of capital.
Your Dear Friend,
SK
Letter No. 2:
Salam alaikum,
The problem with your analysis of the banks' profitability from the $100 deposit is that you ignore the countervailing consumer surplus generated by 10 loans instead of one. If your wife loans you the money and makes $50, you are worse off by $45, but presumably still better off in a pareto sense, or else you would not have fixed your car. When the bank makes 10 loans to earn the same $50 owned by your wife, it is presumably making nine other people better off, so overall welfare is increased manifold. Even if the bank makes the same absolute profit as your wife, its share of the increased welfare is much less in a relative sense and the net increase in social welfare is presumably on the order of 10 relative to the one transaction with your wife.
Best wishes,
Mohammad Fadel
Assistant Professor of Law
University of Toronto Faculty of Law
________________________________
My response to Letter No. 1:
Dear SK,
As you show little mercy, I respond thusly:
a. There is no $900 ... there is $1000 that only exists as debt owed to the bank, and there is a $100 deposit. The former does not exist as pre-existing wealth or deposits. The only part that is 'capital' and the bank is on the hook for to the depositor is the $100. Furthermore, if the $100 is in a chequing account, the bank would not even be paying out interest to the depositor. This is actually a very key point - the $1000 is not 'capital', the $100 deposit is. The $1000 exists only as debt owed to the bank, not as somebody's deposit that it has to manage judiciously. Of course, any repayment of the $1000 loaned out and the interest charged is profit. I hope that helps because the key to this whole picture is that the capital risk you speak of is intrinsic to the bank's use of leverage in operations, not a result of the fiduciary management of someone's deposits.
b. This is indeed quite a valid observation - something that has been brought up by another honourable genius such as yourself. He probably beat you to opening the email. Unfortunately, you will have to wait until next week for a response. This point is too important for us not to share with everyone...
Point b is quite similar to Dr. Fadel's and is addressed below:
My response to Letter No. 2:
Although I responded to Dr. Fadel's critique privately already, his astute and wise observations deserve wider readership .
As he states, the efficiency gains from having a lower prevailing interest rate are not insignificant. Indeed, if the only loans available were at 50% interest, much of what passes for commerce in today's economy would come to a halt. My wife's $100, left in her own hands it seems, would make for a poor lubricant to the wheels of Progress.
Where I disagree with the good professor however, is on whether efficiency is our only ultimate goal. One of the central problems or tradeoffs that exists in economic decision-making is whether to devote precious resources towards making gains in efficiency or towards those that enhance economic equality, which is a moral standard (I refer you to the work of the economist Arthur Okun). Whereas Dr. Fadel's critique is informed by the imperatives of efficiency, my argument was made more from the perspective of morality. Lowering the prevailing interest rate from 50% to 5% is a gain in the efficiency of the system, not necessarily its morality. What he also reminds us, of course, is that if we could figure out a way, 0% rates would not just be moral, but be exceedingly efficient as well. Again, I don't believe that either of us fundamentally wrong, just that we are not entirely Right either.
I thank Dr. Fadel for allowing us to learn from his wisdom and expertise. For those of whom that do not know of him yet, he is an active, respected and sharp contributor to debates within Islamic Finance. I am honoured to be guided by him and I look forward to many more exchanges, agreements and disagreements with him in the years to come.
Thank you to all who wrote back with their views. A special thank you to people that asked me to get married to someone that charged less interest - I thought that their concern was very touching. The word of the week is 'Hypothetical'.
Finance News:
1. A very timely story for what we have been discussing here ... if you get a chance to read a book on finance this year, try Satyajit Das' 'Traders, Guns and Money' ... it is both funny and insightful. This interview is a good introduction ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071124.r-takingstock24/BNStory/robColumnsBlogs/?cid=al_gam_nletter_maropen
2. A very interesting development in the mining sector has been the recent proposed buyout of Rio Tinto by BHP Billiton ... I encourage you to try and follow this story because there is something deeper going on ... First, at around $150 Billion, it is not a small buyout. Second, the shareholders refuse to accept $150 Billion because they know that what they have in the ground (minerals) are worth more than the dollars (paper) they are being offered today ... http://www.theglobeandmail.com/servlet/story/LAC.20071203.RBHP03/TPStory?cid=al_gam_globeedge
3. Who watches out for investor interests in Canada? The ROB discusses whether they are doing an adequate job ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071203.wimet1204/BNStory/robNews/home
Economic News:
1. How the Subprime loan mess is related to the credit crunch and how that is related to the US $ ... http://www.atimes.com/atimes/Global_Economy/IK16Dj02.html
2. Think you know the Price of Oil ... I mean the Real Price of Oil ... http://www.atimes.com/atimes/Global_Economy/IK22Dj02.html
3. How the wealth of the world has shifted towards the East, and how the new centres of power are behaving relative to the old ... http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/The_worlds_new_financial_power_brokers_2084
Middle Eastern / Islamic Finance:
1. S&P begins to question legal ownership in some 'Islamic' structures ... http://www.zawya.com/story.cfm/sidZAWYA20071126121542
2. How much is the slide in the US $ hurting OPEC? ... http://www.economist.com/finance/displaystory.cfm?story_id=10191717
Miscellaneous:
1. Ever thought about having solar power? ... Here is some inspiration for you ... http://www.theglobeandmail.com/servlet/story/RTGAM.20071203.wlsolar03/BNStory/lifeMain/home
2. The economist rediscovers that the Middle East has more than Oil ... http://www.economist.com/daily/news/displaystory.cfm?story_id=10235761&fsrc=nwl
The Question of 'Non-Usurious Interest' - An Inconvenient False
Quote of the Week:
'There's too much political freedom, too many legal rights, too much media. By contrast, I was in Shanghai recently and one day passed a bunch of huts beside the road. The next day they were all gone. The third day there were a bunch of guys rolling out sod and planting trees. And on the fourth day they inaugurated a park.' - Rajiv Singh - (Vice Chairman of DLF [India's largest Real Estate developer]).
Presumably, political freedom, legal rights and media are mere shackles to be cast off. A park, on the other hand, is Progress.
(The source is his interview with the McKinsey Quarterly -) http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Putting_a_roof_over_India_An_interview_with_the_countrys_biggest_developer_2066
Commentary for the Week:
The Question of 'Non-Usurious Interest' - An Inconvenient False:
This past week I received an excellent email from one of our dear subscribers. Her previous thoughts on Islamic Finance had led her to a point where the definition of usury and the definition of interest were complementary but not the same. Thus, it is possible in this scenario to have 'usurious' interest and 'non-usurious' interest. Non-usurious interest, in this view, is a tolerable 'cost of capital'. Without picking on my dear friend (who is indeed a genius and gets to the heart of the matter very quickly), and indeed others involved in banking / finance / regulation (whether 'Islamic' or not) - I would like to put forth a different view. As always, please remember that Truth is a very precious commodity, something that the Divine has spread among many. Similar to my dear friend, I have been blessed perhaps, with only a portion - my views are solely mine, and certainly do not carry the definitive authority of being 'Islamic'.
At the moment, traditional Islam is perhaps the only large religion where any excess charge / repayment on loans is thought to be expressly forbidden. Christianity, taking its cue from its Catholic subset perhaps, has come to define usury as 'excessive' interest. This latter view is either a very deep understanding of usury that is beyond me, or an inescapable compromise made at a time of great hardship for the Church. Traditional, pre-reformation understanding among the Abrahamic Faiths at least (I do not have any familiarity with others) was that usury is any excess charge or repayment over a loan.
But that is neither here nor there - I can quote texts and texts can be quoted against me. Let us use a simple, but illustrative example instead.
Let us suppose that my wife is rich, and I am quite the opposite (not a bad approximation of reality, but I digress). She has $100 lying around and I need $100 to fix my car. If she were to loan me $100 and stipulate that I must pay her $150 in one year, our moral sense would be revolted. That translates to a robust and definitely usurious interest rate of 50%, and a usurious gain of $50 in absolute terms. If I was to indeed agree to her terms, my wealth would be transferred to her quite quickly.
Let us say then, that in Scenario B, I refuse her terms. I go to a bank/lender who has advertised a very reasonable sounding %5 on loans instead. Let us assume that this is the bank where my wife deposited the $100 in the morning. Since her deposit, they have had an excess capital of $100, against which they can lend more money. As per prevailing regulations and business practices of the conventional system, they are now in a position to loan out 10X the deposited amount, or $1000 (a reserve ratio of 10% for the technically-minded). All day, people such as me go to the bank and borrow what they need, until the $1000 has been completely loaned out. For me, this means that I will have to repay $105 in a year, which is definitely more manageable than $150. I thank my loan officer profusely and walk (remember my car is still being fixed) away happy, feeling that 5% interest is really not that bad compared to my wife's loan-sharking.
Evaluating these two scenarios from my personal perspective, I am clearly better off monetarily in scenario B. But if I leave it at that, not only will I have marriage problems, I have also perhaps missed an important part of what actually just took place. As a concerned husband and citizen, perhaps I should ask - what of my wife, the bank, and the rest of society? If my Mrs. had been the lender, I would have paid an excess of $50 and she would have made $50 (50% x $100). In the second scenario, I would have paid only $5, but how much did the bank make off the same $100 that my wife could have loaned me directly?
I think that if you do the calculation, you will find that 'Lo and Behold!' (my only textual reference for the day), the bank also made a grand total of $50 (the total amount loaned x interest rate or $1000 x 5%=$50). Let me ask you, from a societal perspective what is the difference between my wife making $50 from a principal of $100, and a lender making the same absolute gain from the same $100? Why did we label her business practices 'usurious', but feel warm and fuzzy about the bank? If our moral sense screamed out under the first scenario, why is it so quiet in the second? In both cases, $50 has been taken from society on a principal of $100. Which $50 gain is usurious?
Of course, many will quibble with my simple example. Let me address that right up front. In Canada these days, and under the Basel II Banking Accords (which we helped develop and to which we are a sovereign signatory) - reserve requirements for lenders are actually lower than 10%. This means that lenders can actually lend out more than 10X their deposits. Also, the rates for unsecured loans are substantially higher than the 5% used in this example. In short, the only thing I have grossly overestimated is the capriciousness of my wife, who is in fact quite nice and uninterested in any interest whatsoever.
By seemingly 'saving' myself $45 by dealing with an institutional lender, I have altered the payout for myself, but have not affected the impact on society. In both scenarios, the result at a societal level has been sub-optimal. Perhaps, just perhaps, this example is a reflection of why trying to define non-usurious interest is futile - and God really does know best.
In this case, while that $45 I 'saved' will indeed come in handy for me personally, the fact that the original pain has been spread around amongst many is thin and shallow satisfaction. The sad fact of the matter is that usurious gain is still being made somewhere on God's Green Earth. Even if you and I are no longer paying it in person, our engagement with society means that we do end up paying for it personally.
Of course, in the meantime, all the other fellows who borrowed to have their cars fixed have driven up the price of mechanics and now the $100 is not enough. If only I could be a banker ... (again), but that can be a story for another day ...
Thank you to all who wrote back with their views. A special thank you to my good friend, who wrote in with her views in an articulate and tasteful manner. I apologize for making her views public but not only is pooling our knowledge and questions the way to success, it is perhaps an important measure of success itself. Of course, these views are mine alone and not designed to cause offense, just elicit dialogue on things we usually don't talk about. If you feel you have derived some value from this newsletter, please be kind and forward it to two or three people you would like to have introduced to Islamic Finance so they can subscribe (there is a link to forward the email below). I will NOT be sending advertising or purchase offers to this newsletter list unless my wife calls in the loan.
Finance News:
1. A must see video ... British humour takes on the recent banking crisis ... http://www.youtube.com/watch?v=axAjb6fDsPY&feature=related
2. Back to Portus ... remember how there were two accused co-founders? ... well, this is the prisoners' dilemma in action. For as long as one of them was out of Canada, the other did not confess. Now that both founders are in Canada, one realizes that the individually smart thing to do is to make like a canary and sing ... will this be a duet? ... over 25,000 investors lost money through fraud and Canary No. 1 gets two years ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071119.wportus1119/BNStory/Business/home
3. Absolutely and completely a bad idea ... the last thing we need is somnolent Central Bankers being put in high-pressure situations with public money ... oh wait - we already have that .... but they definitely do not need more powers. Think about it - every crisis that you think they have averted or will avert will be paid for through either inflation or tax increases ... let the market do what it does best and sort itself out ... why should everyone pay for the folly of a few? ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071120.wduguay_staff1120/BNStory/robNews/home
4. Devastating news for the lending and securitization businesses in the US ... if the institution that forwarded the initial loan and the institution trying to foreclose on that loan are different, no foreclosure is possible ... undermines the very foundation of securitization practice, which is that loans can be sold off to other institutions with no adverse effects on legal rights ... http://www.canada.com/nationalpost/financialpost/story.html?id=5ccd6db0-ed6d-45e6-af07-bb41a916d1d9
Economic News:
1. An excellent dissection and blow-by-blow account of the recent Asset-Backed Commercial Paper (ABCP) crisis in Canada ... perhaps some of you will write to the editor of the Report on Business and let him know that we appreciate good journalism ... the must read article for the week ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071116.r-cover17/BNStory/Business/home/?pageRequested=all
2. An excellent 2 page summary of where we stand in our understanding of credit markets, derivatives and money supply ... http://www.blackswantrading.com/files/b7cd13bc5373d1e/bsccc112107.pdf
3. Perilously close to parity ... after my comment last week - stay up loonie, stay up ... don't want to be eating humble pie already! ... Please note that currency markets are notoriously fickle ... they will right themselves and agree with my sentiments in good time ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071119.wloonie1119/BNStory/robNews/home
Islamic Finance:
1. Dare I say that this is a well-run enterprise? One of the few Middle Eastern companies to invest in knowledge-bases abroad ... http://www.zawya.com/story.cfm/sidZAWYA20071108111034
Management Training:
1. Harvard write-up on Moral Leadership ... http://hbswk.hbs.edu/item/5801.html
2. News to use ... How succession issues are likely to dominate operational and financial planning for small businesses in Canada over the next few years ... Not something that people should attempt without good advice though ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071113.wxsmallsuccession13/BNStory/specialSmallBusiness/home
'There's too much political freedom, too many legal rights, too much media. By contrast, I was in Shanghai recently and one day passed a bunch of huts beside the road. The next day they were all gone. The third day there were a bunch of guys rolling out sod and planting trees. And on the fourth day they inaugurated a park.' - Rajiv Singh - (Vice Chairman of DLF [India's largest Real Estate developer]).
Presumably, political freedom, legal rights and media are mere shackles to be cast off. A park, on the other hand, is Progress.
(The source is his interview with the McKinsey Quarterly -) http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Putting_a_roof_over_India_An_interview_with_the_countrys_biggest_developer_2066
Commentary for the Week:
The Question of 'Non-Usurious Interest' - An Inconvenient False:
This past week I received an excellent email from one of our dear subscribers. Her previous thoughts on Islamic Finance had led her to a point where the definition of usury and the definition of interest were complementary but not the same. Thus, it is possible in this scenario to have 'usurious' interest and 'non-usurious' interest. Non-usurious interest, in this view, is a tolerable 'cost of capital'. Without picking on my dear friend (who is indeed a genius and gets to the heart of the matter very quickly), and indeed others involved in banking / finance / regulation (whether 'Islamic' or not) - I would like to put forth a different view. As always, please remember that Truth is a very precious commodity, something that the Divine has spread among many. Similar to my dear friend, I have been blessed perhaps, with only a portion - my views are solely mine, and certainly do not carry the definitive authority of being 'Islamic'.
At the moment, traditional Islam is perhaps the only large religion where any excess charge / repayment on loans is thought to be expressly forbidden. Christianity, taking its cue from its Catholic subset perhaps, has come to define usury as 'excessive' interest. This latter view is either a very deep understanding of usury that is beyond me, or an inescapable compromise made at a time of great hardship for the Church. Traditional, pre-reformation understanding among the Abrahamic Faiths at least (I do not have any familiarity with others) was that usury is any excess charge or repayment over a loan.
But that is neither here nor there - I can quote texts and texts can be quoted against me. Let us use a simple, but illustrative example instead.
Let us suppose that my wife is rich, and I am quite the opposite (not a bad approximation of reality, but I digress). She has $100 lying around and I need $100 to fix my car. If she were to loan me $100 and stipulate that I must pay her $150 in one year, our moral sense would be revolted. That translates to a robust and definitely usurious interest rate of 50%, and a usurious gain of $50 in absolute terms. If I was to indeed agree to her terms, my wealth would be transferred to her quite quickly.
Let us say then, that in Scenario B, I refuse her terms. I go to a bank/lender who has advertised a very reasonable sounding %5 on loans instead. Let us assume that this is the bank where my wife deposited the $100 in the morning. Since her deposit, they have had an excess capital of $100, against which they can lend more money. As per prevailing regulations and business practices of the conventional system, they are now in a position to loan out 10X the deposited amount, or $1000 (a reserve ratio of 10% for the technically-minded). All day, people such as me go to the bank and borrow what they need, until the $1000 has been completely loaned out. For me, this means that I will have to repay $105 in a year, which is definitely more manageable than $150. I thank my loan officer profusely and walk (remember my car is still being fixed) away happy, feeling that 5% interest is really not that bad compared to my wife's loan-sharking.
Evaluating these two scenarios from my personal perspective, I am clearly better off monetarily in scenario B. But if I leave it at that, not only will I have marriage problems, I have also perhaps missed an important part of what actually just took place. As a concerned husband and citizen, perhaps I should ask - what of my wife, the bank, and the rest of society? If my Mrs. had been the lender, I would have paid an excess of $50 and she would have made $50 (50% x $100). In the second scenario, I would have paid only $5, but how much did the bank make off the same $100 that my wife could have loaned me directly?
I think that if you do the calculation, you will find that 'Lo and Behold!' (my only textual reference for the day), the bank also made a grand total of $50 (the total amount loaned x interest rate or $1000 x 5%=$50). Let me ask you, from a societal perspective what is the difference between my wife making $50 from a principal of $100, and a lender making the same absolute gain from the same $100? Why did we label her business practices 'usurious', but feel warm and fuzzy about the bank? If our moral sense screamed out under the first scenario, why is it so quiet in the second? In both cases, $50 has been taken from society on a principal of $100. Which $50 gain is usurious?
Of course, many will quibble with my simple example. Let me address that right up front. In Canada these days, and under the Basel II Banking Accords (which we helped develop and to which we are a sovereign signatory) - reserve requirements for lenders are actually lower than 10%. This means that lenders can actually lend out more than 10X their deposits. Also, the rates for unsecured loans are substantially higher than the 5% used in this example. In short, the only thing I have grossly overestimated is the capriciousness of my wife, who is in fact quite nice and uninterested in any interest whatsoever.
By seemingly 'saving' myself $45 by dealing with an institutional lender, I have altered the payout for myself, but have not affected the impact on society. In both scenarios, the result at a societal level has been sub-optimal. Perhaps, just perhaps, this example is a reflection of why trying to define non-usurious interest is futile - and God really does know best.
In this case, while that $45 I 'saved' will indeed come in handy for me personally, the fact that the original pain has been spread around amongst many is thin and shallow satisfaction. The sad fact of the matter is that usurious gain is still being made somewhere on God's Green Earth. Even if you and I are no longer paying it in person, our engagement with society means that we do end up paying for it personally.
Of course, in the meantime, all the other fellows who borrowed to have their cars fixed have driven up the price of mechanics and now the $100 is not enough. If only I could be a banker ... (again), but that can be a story for another day ...
Thank you to all who wrote back with their views. A special thank you to my good friend, who wrote in with her views in an articulate and tasteful manner. I apologize for making her views public but not only is pooling our knowledge and questions the way to success, it is perhaps an important measure of success itself. Of course, these views are mine alone and not designed to cause offense, just elicit dialogue on things we usually don't talk about. If you feel you have derived some value from this newsletter, please be kind and forward it to two or three people you would like to have introduced to Islamic Finance so they can subscribe (there is a link to forward the email below). I will NOT be sending advertising or purchase offers to this newsletter list unless my wife calls in the loan.
Finance News:
1. A must see video ... British humour takes on the recent banking crisis ... http://www.youtube.com/watch?v=axAjb6fDsPY&feature=related
2. Back to Portus ... remember how there were two accused co-founders? ... well, this is the prisoners' dilemma in action. For as long as one of them was out of Canada, the other did not confess. Now that both founders are in Canada, one realizes that the individually smart thing to do is to make like a canary and sing ... will this be a duet? ... over 25,000 investors lost money through fraud and Canary No. 1 gets two years ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071119.wportus1119/BNStory/Business/home
3. Absolutely and completely a bad idea ... the last thing we need is somnolent Central Bankers being put in high-pressure situations with public money ... oh wait - we already have that .... but they definitely do not need more powers. Think about it - every crisis that you think they have averted or will avert will be paid for through either inflation or tax increases ... let the market do what it does best and sort itself out ... why should everyone pay for the folly of a few? ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071120.wduguay_staff1120/BNStory/robNews/home
4. Devastating news for the lending and securitization businesses in the US ... if the institution that forwarded the initial loan and the institution trying to foreclose on that loan are different, no foreclosure is possible ... undermines the very foundation of securitization practice, which is that loans can be sold off to other institutions with no adverse effects on legal rights ... http://www.canada.com/nationalpost/financialpost/story.html?id=5ccd6db0-ed6d-45e6-af07-bb41a916d1d9
Economic News:
1. An excellent dissection and blow-by-blow account of the recent Asset-Backed Commercial Paper (ABCP) crisis in Canada ... perhaps some of you will write to the editor of the Report on Business and let him know that we appreciate good journalism ... the must read article for the week ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071116.r-cover17/BNStory/Business/home/?pageRequested=all
2. An excellent 2 page summary of where we stand in our understanding of credit markets, derivatives and money supply ... http://www.blackswantrading.com/files/b7cd13bc5373d1e/bsccc112107.pdf
3. Perilously close to parity ... after my comment last week - stay up loonie, stay up ... don't want to be eating humble pie already! ... Please note that currency markets are notoriously fickle ... they will right themselves and agree with my sentiments in good time ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071119.wloonie1119/BNStory/robNews/home
Islamic Finance:
1. Dare I say that this is a well-run enterprise? One of the few Middle Eastern companies to invest in knowledge-bases abroad ... http://www.zawya.com/story.cfm/sidZAWYA20071108111034
Management Training:
1. Harvard write-up on Moral Leadership ... http://hbswk.hbs.edu/item/5801.html
2. News to use ... How succession issues are likely to dominate operational and financial planning for small businesses in Canada over the next few years ... Not something that people should attempt without good advice though ... http://www.reportonbusiness.com/servlet/story/RTGAM.20071113.wxsmallsuccession13/BNStory/specialSmallBusiness/home
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