I recently signed up to Stratfor ($99 offer). I’ve become a bit of a ‘financial crisis’ junkie, partly because following the news and events on such an issue is a little like missing an episode of a serialised cop/crime drama – miss an episode, and you miss out. There are also few out there that fully comprehend what’s going on. I don’t count myself as such an individual, but I have a little sway. I’ve helped my local masjid in North London to organise two events discussing the gold standard and capitalism going awry. The topic is certainly a crowd pleaser, and more importantly it helps preserve within the minds of the Ummah the idea of Islam being an alternative and comprehensive way of life.
The real problem is all the jargon. Even if you’re literate in finance and economics, you can find yourself scratching your head in dismay. LIBOR rates dropping? Anyone care to explain? Beyond the jargon lie some critical theories upon which the whole sector is premised. So to start off with, think of bank runs…
Bank runs are not a new phenomenon. Inherently they are the product of a financial system that market capitalism has helped build, of which one of the mainstays is the use of fractional-reserve banking. Fractional-reserve banking is the practice where banks only hold a small portion of their deposits, and use the remainder as capitol for loans. This is supposedly an important function that allows for the expansion of economies. Though universally accepted as a part of modern banking, fractional-reserve banking is no more than fraud and theft.
Banks historically began as money warehouses where customers would typically deposit their (then) gold for safekeeping, and the money warehouses would charge a fee for the use of their services. Over time, these warehouses generally acknowledged that customers would only rarely withdraw their full deposits, and the warehouses soon discovered that the fraction of unused deposits could be used to generate profits, through the use of interest bearing loans. In a greater effort to generate profit, these warehouses – or banks – eventually began to issue receipts of non-existent deposits, all of which resulted in the increase of money supply beyond the actual deposit holdings.
If someone was involved in the counterfeiting of coins, or the theft of stored property, they would generally be proscribed in any society. Not so for fractional-reserve banking. It is the largest heist that gets pulled every day, and eventually runs its course to a devastating effect on the normal hardworking citizen.
Today’s world of credit-crunches and bailouts is the natural cycle for boom-bust economies. Fractional-reserve banking is responsible for the increased inflation that is the result of an increased money supply. Combine this with the temptation of easy credit that fractional-banking facilitates, and the picture of today’s financial crisis becomes clearer. Put simply, easy credit punishes the caution of investors. In the case of the US, money was poured into the real-estate sector, unscrupulous brokers took further advantage of unlimited credit, and banks continuously pumped and primed more credit through the power of fractional-reserve. The overheated real estate market fizzled and then crashed, bringing down with it the rest of the financial markets.
When markets get bowled over like skittles, naturally people worry. When they hear terms like ‘liquidity crisis’ or ‘insolvency’ affecting the banks in which their life savings are held, the first reaction is to withdraw their money – the money that is their decades of work, their retirement and the future for their children. This is the bank run. The banks had prayed to their false gods of capitalism, that such a day would never come. That ‘fraction’ they hold, is merely that, a fraction, a small holding of the rest which was pilfered away.
