Market Meltdown: Misery or Manumission?
The credit crunch is not a calamity but a catalyst for our liberation from a doomed form of finance. When commentators talk about the cause of the current crisis they are frequently describing its symptoms. The true source is that of a failed philosophy that demands unrelenting growth at any price; a price that will quite literally cost the earth. Nature provides many models of stable cyclicality where feedback mechanisms prevent excessive contraction or expansion. Mankind has over-ridden the safety features that ensure equilibrium, leading to boom and bust. The misplaced mantra of the corporate community is that growth is good but a downturn is dreadful. In reality endless expansion is an aberration leading to self-destruction. Nature affords ominous examples of growth-gone-bad including that of host-killing cancer cells. Likewise in the fermentation of alcohol, yeast replicates rapidly by consuming sugars, only to be poisoned by its own toxic by-product. The financial and environmental parallels need not be spelled out.
John Gardner once said ‘History never looks like history when you are living through it’. The Law of Unintended Consequences stemming from 9/11 will prove to be the turning point of the century which coincidentally occurred at its commencement. There should have been a serious recession after the tech bubble burst but this became politically untenable. The stewards of the financial system became salesmen; vividly demonstrated in 2004 when Alan Greenspan promoted high risk Adjustable Rate Mortgages; with interest rates at 1% and elections just round the corner. History may well judge that America was not brought down by the terrorist without but by the inflationist within.
The public is at last coming to comprehend that debt is destructive but requires a slogan to remember the message. The concept of a carbon footprint is already familiar so this can be copied to communicate the corrosive effect of credit and interest. We must therefore refer to our ‘financial footprint’ which measures the liabilities - rather than legacies – that we leave behind for future generations.
What we have experienced since 2002 is an unprecedented earnings expansion stemming from the falsehood of credit. It was not a price bubble like that seen in 1929 or 2000. Instead, the very benchmark of value was a bubble in its own right where the earnings or ‘E’ in the P/E ratio was the problem. It is likely that we will see a repeat of stock market patterns in the early 1930’s with prices trending lower and occasional short-lived rallies. Bonds were no safe haven and performed dismally in the early days of the Depression.
Our best hope is a reversion to sustainable stock markets, so commonplace in the Victorian era when the Gold Standard helped stabilise the money supply. Equities acted as dividend machines rather than engines of capital growth. Like the story of the tortoise and the hare, the compound effect of income generation achieved a superior result with less futile effort. Real cash flow and dividends are hard to fake and help to recycle money back into the economy. This is why a crash in prices and withdrawal of credit will ultimately be beneficial. Many conflicts of interest will be removed with the demise of capital growth. Companies will likewise benefit and be free to generate genuine wealth without the threat of being plundered by leveraged private equity pirates.
With mounting bad debts and interest rates trending toward zero it is becoming a conundrum as to how banks will operate in their current form. Their behaviour continues to be self-serving as they refuse to provide liquidity or pass rate cuts on to customers; the very people whose taxes fund their bail-outs. Rather than creating credit for their own benefit and creaming off the interest margin, in future they will have to work for a fee: match depositors with entrepreneurs to bring balance to the equation. This entails more local knowledge and stewardship which is what we had before call centres were introduced ‘for our convenience’. Like the Biblical account of swords to ploughshares the transition will make banks the servant and not the master of business in the real world.
Path to Prosperity…
We will come to appreciate that credit and interest in banking are equivalent to the pointless prescription of leeches for every ailment in medieval medicine. Its continued use is part force of habit by the patient and part conflict of interest from the quack doctor. The antidote to western woes is not further borrowing and bail-outs, which fuelled the crisis in the first place. It lies instead with a philosophy based on timeless wisdom.
As the Roman Empire receded, Europe fell into a Dark Age as its inhabitants reverted to illiteracy and subsistence survival, which was not the case in the East. The knowledge of the ancient world was preserved and enhanced by Islamic scholars who established the House of Wisdom, as custodians of centuries of study in philosophy, medicine and mathematics. History is repeating itself, this time in terms of finance. Western banking has failed to match the revolution of its industrial and technical counterparts. Instead the awareness of how money ought to be utilised has been retained in modernity through the practice of Islamic Finance. Rather than dumping debt on all parties, it matches investors and entrepreneurs in a process of symbiosis. On a bigger scale it also brings stability and halts the process of fractional banking that creates credit, dilutes currencies and elevates prices. The latter process penalises the next generation whose wages forever lag inflation in basic housing and commodities, making them poorer in the long run. Surely there can be no other species that squanders today at the expense of their offspring.
Islamic Finance is best characterised by a process of partnership in sharing risk and reward. Such institutions enjoy the gain with their customers but they also feel the pain of a failed project; whereas conventional banks are normally first in line to feast on the corporate carcass. On a purely practical level this approach offers highly capitalised and stable banking, investing in assets with substance. Other hallmarks are the avoidance of speculation, the recycling of wealth, ethical investment in communal projects and charitable donation. It is only with the meltdown in markets that the beauty of this ancient acumen has blossomed as a true alternative. The crisis may well feel miserable for many months to come but Islamic Finance will provide the ultimate manumission from a financial system that is no longer fit for purpose.
Toby Birch February 2009