Posts Tagged ‘Time Value of Money’

Consider this post in reference to the concept of derivatives.

I feel that if anyone wants to attempt any critique of the derivatives market in its entirety, one has to move past any continued emphasis on ‘casino capitalism’, as this is an oft repeated line which, whatever its merits or otherwise, has become an easy reply for those who favour such practices.

I believe one needs to concentrate on debunking the notion of risk management in order to effectively retort.

Many supporters of derivatives would rightly point to their use is not just to speculate with (as in Investment Banking), but as a valid means to manage risk, especially in Insurance, and it is this aspect which deserves further attention in my humble opinion

The above linked post brilliantly draws together the notion of colonising time as an integral commodity, matching any such physical asset, thereby shinning a much needed light on the important and neglected aspects of this discourse of, post colonialism and global racial financialisation.

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I find it remarkable how many non-familiar observers can quite easily spot the obvious spade in Islamic Finance practices, and call it a spade. However, for them to then completely ignore the issue that the source guidance (the final proclaimation and criterion; The Qur’an) never accepted any favourable position on RIBA (not interest, in any form, simple or compound), and that the deceit or falacy here should be put only at the doorstep of the commercial banking industry and its proponents who invented this fraud.

There seems to be too much of an impression that underlying islamic principles are in someway contradictory; with one hand they oppose ‘interest’ and with the other hand, it is condoned in another form, under another name.

This post will not go into the essential issue of what RIBA is (a more fuller all encompassing term) and not interest, however suffice to say, those who are of the above opinion have only a crass, superficial understanding of what they reject whilst at the same time, plenty of effort is put into unearthing great myths from other elements they wish to debunk – that is what I find odd.

One such guilty party would be the Adam Smith Institute. Their article found here, which references Islamic Finance practices makes this obvious mistake. In a partial response to the issue of time value if money and the innate nature of things, I would also like to refer readers to this piece by Tarek El Diwany

But I want to instead highlight an aspect which once again exposes the current industry for its flaws in constructing alternatives which are not too different from the products they are based upon;

For they all (things like Sukuk bonds and so on) depend upon the absolute rejection of interest, that very thing that we insist is part of the fabric of our reality. The reason we so like Islamic finance is because all of he (sic) successful forms of it are actually constructs that, in the face of the religious insistence that there should be no interest, actually operate in a manner to ensure that there is a time value to money and that there is an interest rate, interest which has to be paid 

Another cat let out of the bag, but wait there is more. The article referenced in the above quoted piece, by Jon Fasman reading a book by Harris Irfan, also provides us with more of the truth;

Yet by the end of the book, Irfan seems genuinely conflicted about his industry. Most of these instruments were reverse-engineered from their secular counterparts, and so devised to comply more with Shariah’s letter than its spirit. His protests against such moves echo those of American politicians who condemn “tax inversions”

….Many of the instruments Irfan discusses were sold by major banks that saw them as just another opportunity. This is not surprising: Governments and wealthy individuals wanted financing that complied with their religious requirements, and banks gave it to them….

Central banks have been mandated to keep the level of consumer prices rising at modest levels. In the UK, this level is set at 2% per annum; what this means is that it is their duty to destroy the value of the money you hold by a small amount each year.

But have you ever wondered why economists favour the need to have any inflation at all, even at modest levels? What are the theoretical reasons taught to all pupils of this field which enforce the desire to do this as opposed to doing nothing?

Consider this extract from Wikipedia, stating just one of the positive effects of Inflation

Financial market inefficiency with deflation The second effect noted by Tsaing is that when savers have substituted money holding for lending on financial markets, the role of those markets in channeling savings into investment is undermined. With nominal interest rates driven to zero, or near zero, from the competition with a high return money asset, there would be no price mechanism in whatever is left of those markets. With financial markets effectively euthanized, the remaining goods and physical asset prices would move in perverse directions. For example, an increased desire to save could not push interest rates further down (and thereby stimulate investment) but would instead cause additional money hoarding, driving consumer prices further down and making investment in consumer goods production thereby less attractive. Moderate inflation, once its expectation is incorporated into nominal interest rates, would give those interest rates room to go both up and down in response to shifting investment opportunities, or savers’ preferences, and thus allow financial markets to function in a more normal fashion.

Let us decode this

The role of the financial markets is undermined when savers choose to hold funds. We shouldn’t hold our own cash, why would we not trust the ‘Markets’ (the elite, the powerful, the manipulators)? If we hold our cash, prices can’t rise – the prices of goods we don’t need, that we have been told to want, and have been hoodwinked into consuming as if they are a scarce resource, enabling corporate shareholders to profit at our demise.

No price mechanism, perverse movements in physical asset prices. As is arguably happening with property prices in certain regions, particularly London. But the effect of these has not been caused by consumers hoarding their cash, and we are still experience positive inflation rates – it has been the commercial and central banks creating too much money through additional debt, flooding assets with funds which are chasing a higher yield than available from deposits. This is not to mention the decades of under investment by the public and private sector to increase the supply of new homes, and of the government to liberalise planning red tape.

When have price mechanisms ever been wholly reliable? With so much behavioural science at play, larger institutional players able to sway bigger portions of the market with their heavyweight capital, ratings agencies rubber stamping firms with a questionable seal of approval, on top of an Efficient Market theory which took a huge bruising in the wake of the 2008 crises. We all have to question what fair value really means? If reality isn’t as rosy as some make out, then how can a price accurately reflect the fundamentals.

Consumer goods less attractive. God forbid we arrive at a point in time when producers truly act upon what is needed, not what we are told and coerced into buying. True freedom would dictate that we should be free to not consume if we choose, regardless of the loss of ever-increasing profits, the loss of tax generated and the freeing up of labour to put our minds and talent to use doing what we are best suited to, not being part of a workforce until we die in service, or develop chronic mental and physical issues directly related to our lifetime of fruitless effort.

Rates have room to go up or down, thus allowing markets to function in more normal fashion How do we define what is ‘normal’ There is huge subjectivity in use here. I can’t help but think the normal function has more to do with setting the pieces on a game board, dictating the rules of play, and watching it all unfold, bust after boom, after almighty bust. Play on…

A fast growing industry estimated to already be worth over approximately $1 Trillion in total global assets, is one which requires much closer examination as to its actual workings and what the real differences are with so-called ‘conventional’ finance practices (ie overtly interest based financing).

A long standing prominent expert in this area is Tarek El Diwany, and I highly recommend his website as an excellent introduction and beyond, into this fraternity;

I would note a number of articles which make for valuable reading from someone who has had an intimate insight into the workings of the industry. Tarek’s knowledge of both theory (Fiqh) and practice ensure his opinions are well founded and concrete.

Tarek has also prepared a short online course which is covers a number of key areas of the industry, details are on the site.

Recently, Tarek appeared on the mainstream news channel Al-Jazeera, with his opinions on conventional/islamic finance;

My brief comment; One must always consider the macro view of this or any other industry/system, in order to place it into context. Can two competing and divergent systems of ‘Islamic Economics’ and Capitalism co-exist, or is one being co-opted and submerged to fit into the other? Which is prevailing and dominant?

All money is created as interest bearing debt – this is an established fact. Any business venture or activity is always assessed by interest based criteria such as the cost of capital or inflation adjusted returns, the time value of money is prevalent, therefore interest based factors are implicit in all the operations of ‘money’ based activity and especially money services such as any form of banking.

Given the above, how can this industry be an alternative to interest based finance when all the services are modeled on existing concepts and practices. I believe it is simply alternative based interest.