- Home
- About Us
- Contributors
- Departments
- Topics
- Back Issues
- Weekly Archives
- AmSpecBlog
- Subscribe
- Newsletter
- Advertise
- Donate
- Contact Us
- Daily Digest
- Templeton Essays
The Pursuit of Knowledge
The Long Run
The "credit crunch" has raised the question of whether it could have been prevented by a better use of our rational powers, or whether on the contrary it hasn't been just a long-term consequence of the normal forms of rational risk-taking. The tendency to blame Wall Street, the bankers, the hedgefund managers, and all the others who rewarded themselves with such hefty bonuses as their businesses sank is understandable. But does it reflect any real understanding of the problem, and did those people do anything that you or I would not have done, had we been in their shoes?
After all, people invest in stocks when they anticipate a profit in doing so; the profit results from an increase in value of the quoted company, and this in turn results from the firm's profitability. Firms become profitable when consumers demand their product. In this way the movement of money on the stock exchange both reflects and facilitates the free economy, being simply one part of the process whereby prices respond to demand and profits reward productivity. And those who take the big risks in order to keep the money flowing also deserve the big rewards: why else would they do it? Any other policy is stupid and benefits no one.
In the wake of the credit crisis the call was made, here and there, for the adoption of something called "Islamic banking," operated according to principles laid down in the sharia. Now the Prophet Muhammad certainly objected to taking interest. But he did not object to borrowing, and was familiar enough with the credit mechanism, since without it the longrange trading across the Arabian Peninsula, in which he participated, would have been impossible. And of course the rule against interest has been circumvented from the earliest days of Islamic jurisprudence by the use of convenient legal fictions.
What Muhammad objected to, however, lies deeper than the practice whereby a lender compensates for the temporary loss of his money by demanding a rent. He objected to the growth of what one might call "unreal estate." It seemed to him, as it has seemed to many before and since, that you don't make a contribution to the economy merely by owning things. We flourish as a community because goods are produced and distributed among us, and because each person is able to satisfy his needs by contributing his labor. But the person who is simply sitting on a pile of money is doing nothing, so why should he be rewarded? Let him spend his money by all means, since this is a stimulus to production. But why should he be rewarded for not spending it?
Moreover, suppose we allow people to earn interest on loans. Does there not arise a strange spectral economy, in which people trade in debts—John lending to Bill, and then selling Bill's debt to Henry at a profit? What kind of trade is this, in which the subject matter is simply a negative cipher in a bank statement? Furthermore, and this was particularly objectionable to Muhammad, John can insure his debt against Bill's failure to pay, so that, whatever happens, he will make a return on his capital, having used it for no other purpose than to create a rent on Bill's labor. To the Prophet this seemed like the Devil's work: to make the whole productive process dependent upon the trade in unreal goods, and furthermore to preempt the will of God by insuring against failure. Contracts of insurance were there- fore forbidden by the original Islamic jurists, along with any loan that involved a rent on another's production, rather than an offer of deferred payment for a service.
Islamic law has gone further, refusing to recognize either the rights or the duties of corporations, which are—from the moral point of view—mere fictions. It has therefore never accepted the idea of a "limited liability company." Many argue that the development of this idea by the Dutch and English in the 17th century is responsible for the expansion of world trade and the lasting prosperity of capitalist societies. Be that as it may, it is also responsible for the legal protection that enables company directors to ruin their employees and shareholders while rewarding themselves with massive bonuses. In a sense there is no more vivid example of "unreal estate" than the limited liability company. And what we are witnessing, with the collapse of Wall Street, is the sudden disappearance of a dream.
SUPPOSE WE HAD FOLLOWED the Islamic model— would we have avoided the current crisis? There is no knowing exactly. But one thing is sure: we would not have witnessed the irresponsible trade in debts that has crippled the American banking system. Nor would we have encountered the kind of insane proliferation of risks that comes about when people are not personally liable for failure, and think that they can insure against risk in any case—putting out of mind the obvious fact that insurance companies can collapse like any other, and are the more likely to collapse the more risks we transfer to them. And maybe it is this habit of preempting God's will—of thinking that we can always transfer the cost of our risk-taking—that has led to the crazy notion that, when all else fails, the government will step in to save us. Don't governments fail? And are they not more likely to fail the more they borrow from the taxpayer? It surely matters little that their borrowing is coercive, and that they can shift things around for a while in order to cover up the hole in their accounts. In the end this escalating trade in unreal estate will come to a halt, and everybody will look down at what he has been holding in his hands and furiously trading with his neighbors, to discover that it is just a piece of paper, on which there is nothing written save an empty promise.
The Islamic way of seeing things is incompatible with a modern economy. For one thing, if taken seriously, it would dry up the flow of credit. It would compel people to trade only in what is already produced and provide no motive to put their spare money (itself the result of savings and therefore of production) into circulation. Economists are well aware of this. In the modern theory of the market interest appears simply as the price of money, and debts are treated as commodities that can be traded like any other. Those deep spiritual intimations that caused Muhammad and many others in the prophetic tradition, from Ezekiel to Marx, to warn against the trade in unrealities and against the mirages and illusions of a money economy have no place in the account books of economists, and are canceled out from their final calculations. So should we ignore them entirely?
There is no greater contrast of character than that between Muhammad and John Maynard Keynes, the flippant aesthete, homosexual lover of Lytton Strachey and Duncan Grant, and leading light of the Cambridge apostles, who was also the greatest influence on economic policies during the first half of the 20th century. And since we are now seeing a revival of Keynes's ideas, it is worth comparing them with Muhammad's, if only to sound out their real spiritual worth. Muhammad warned against interest and insurance, because each involves transferring a debt to the future, which belongs not to men but to God. Keynes took the opposite view, famously declaring that "in the long run we are all dead"—in other words, the more we can postpone to the future, the less will we have to account for it. In the face of an economic downturn governments should stimulate demand, embarking on large-scale projects that will bring employment to the millions, who will spend their money here and now, so creating more demand which will in turn create more jobs which will…
Is this just another example of one of those "money illusions" against which the prophets warn? Is this just building one promise on another in an infinite regress of transferred liability, so that no one is really committed? Keynes did not see things that way. Governments can stimulate demand by borrowing money against their own credibility, and nothing is more credible than a government. And when the time for payment comes, the government can borrow more, so constantly shifting its obligations to future generations who, after all, are not part of any long run in which we will exist. And the strange thing is that a government's stealing from the next generation in order to buy the votes of the present one is supposed to be perfectly acceptable, while Bernard Madoff is now facing many years in jail, accused of doing the same. The contrast with Muhammad's religious view, based as it is on the eternal liability of all of us here and now, could not be more telling. But it is Keynes who has carried the day in America, with a government borrowing $800 billion from future taxpayers without the faintest intention of paying it back.
THE PRESENT CRISIS was brought about precisely by postponing liabilities to the future. For the future has a habit of catching up on you, turning profitable mortgages to bad debts and equity to bankruptcy. A credit economy depends at every point on trust, and trust exists only between virtuous people who are in the habit of taking full responsibility for their debts. At a certain point someone, somewhere, realizes that in an economy where everybody buys by borrowing no one is really taking responsibility for his present consumption; hence no one can really be trusted. Once one person sees this, within days everybody has seen it. And the flow of credit ceases. The future has arrived. So what do you do? President Obama's policies, like those of his European counterparts, are those that Keynes would recommend: find a way to make credit available, once again removing the responsibility to balance the books from the existing generation and transferring it to the next. After all, in the long run we are dead, and in the short run we are out of office. If the future arrives unannounced, tell it to come back tomorrow.
There are those who argue that the adoption of this strategy at the time of the New Deal caused the Depression to deepen, and postponed by 20 years the recovery of Western economies, meanwhile making war in Europe inevitable, as Germany chose the quick route out of recession. I don't know whether this is true. Indeed, I don't know whether anything that economists say is true. For almost all of them argue as though it were not human beings who are the subject of their discipline, but "profit maximizers," acting according to the principles of cost and benefit, and never troubling to make the distinction between real and unreal products, between right and wrong ways of behaving, and between responsible and irresponsible attitudes to future generations.
Nevertheless, it does seem to me that a middle road between Muhammad and Keynes ought to be available, that this road would encourage the responsible use of our powers, and that it would teach us to bear the full cost of our own mistakes and pleasures, and not to transfer them to people whom we shall never know.
Comments
Leave a Comment
- Obama's Vision Through History
- The Right of Conscience in the Age of Obama
- ‘Call Fox’
Are you in a mob?
The Democrats say Obamacare opponents are a mob. Are they right?
Participating in this survey will subscribe you to the American Spectator email newsletter. You may unsubscribe at any time.
Ryan| 4.9.09 @ 8:19AM
The key line in the article:
" A credit economy depends at every point on trust, and trust exists only between virtuous people who are in the habit of taking full responsibility for their debts. "
Is what became the problem in all strata of society, from the rich to the poor. Where responsibility lacks, there can be no trust in the system.
jerryofva| 4.9.09 @ 9:35AM
This article is way off on the reason we pay and receive interest. Interest is the price paid to defer consumption on the part of the borrower and price paid by the borrower to get something today and pay for it over time. In the long run we are all dead. Therefore, it requires compensation for a person to defer spending his money now. If interest didn't exist there would be no investment and no advance in society. Without interest we would be like the Islamic world stuck in the 12the century.
Pingback| 4.9.09 @ 10:24AM
Quick Rewards - BMW Car Club of America Launches Affinity Credit Card Program Through links to this page. Here’s an excerpt:
Max| 4.9.09 @ 10:28AM
jerryofva "If interest didn't exist there would be no investment and no advance in society."
Not true. Investment would still exist, but people would be much more careful about their investments since the risk would be greater.
On youtube there is a lecture given by Imran N Hosein entitled "Prohibition of Riba", and he explains it much better than I could.
jerryofva| 4.9.09 @ 11:02AM
Max:
Investment in cutting edge technology is very risky. I am sure that there would be investment capital in say agricultural implements but investing in things like microprocessors and software wouldn't happen because nobody is going to risk his capital on some geek like the young Bill Gates or Steve Jobs on the slim chance that they will get their money back.
Why do you think that computers evolved in the West and not in Islamic countries? Ask Iman Hosein that question.
Pete| 4.9.09 @ 11:12AM
Excellent observation: "And the strange thing is that a government's stealing from the next generation in order to buy the votes of the present one is supposed to be perfectly acceptable, while Bernard Madoff is now facing many years in jail, accused of doing the same." Madoff promised profits, and as long as he could attract more suckers over time, earlier investors would get paid and so on until, in the long run, he died and then what does he care? Obama is promising all sorts of ridiculous things, stealing from future generations to pay for them. He doesn't even have to convince anyone of future benefits as Madoff must have had to, he just takes what he wants via taxes. What does he care? In the long run, he is out of office or dead. Please, let's make his long run into a short run before it is too late. Tell a friend.
jerryofva| 4.9.09 @ 11:39AM
An additional comment that pertains both to Max and the article itself.
The interest rate is not the price of money, as John Maynard Keynes said; and it is not the price of credit as the late Karl Brunner or Alan Meltzer would say; it is the price of time. The longer it takes for an investor to recover his money the higher the cost of time because in 10 or 15 years governments change, economic conditions vary and the health and vigor of the creditor declines. Without the promise to pay more in the future then you can get today it is eat, drink and be merry for tomorrow you die.
Ray| 4.9.09 @ 12:02PM
"Capitalism hasn't served humankind well."
That's not true, capitalism HAS served mankind well, for it has lead to EVERY modern labor (mechanization and standardization), general health and longevity (increased food production, clean water availability, and health care diagnosis and treatment advancement, to name but a few), and time (and labor!) saving process (modern data processing and records storage and retrieval in particular), let alone the general technology (from the Telephone to the Jet, the Car to the Microwave Oven) that we enjoy today. Without that Capitalism, those advancements would have never been made. The "stressed, addicted to drugs and consumerism, morbidly obese hyperconsumers" you describe are all due to individual, PERSONAL, choices, and that has NOTHING to do with capitalism. It's not capitalism that is to blame for these human follies, these individual acts of stupidity, it is a lack of personal responsibility by certain individuals that is to blame.
Max| 4.9.09 @ 1:44PM
jerryofva Thank you for your replies.
Your are very likely correct when say that the riskier investments of cutting edge technology wouldn't have got the necessary initial funding to go forward successfully as they have using a system such as that. I didn't mean to come off as advocating we adopt it either if that is how it came out. I was pointing folks toward it because I found the talk interesting.
I meant to add to my initial post, and I'll blame that slip of the mind on my lack of sleep, that I think the Austrian economics would be better suited to our modern society since it seems to have the best of both. I know I definitely don't like the road we are heading down now.
I am still pretty new to economics with only 3 years of study under my belt, but I am still young an look forward to learning more about the various schools of thought.
fundamentalist| 4.9.09 @ 2:03PM
“We flourish as a community because goods are produced and distributed among us, and because each person is able to satisfy his needs by contributing his labor. But the person who is simply sitting on a pile of money is doing nothing, so why should he be rewarded?”
How does a community produce and distribute goods without savings? It’s impossible, except in a subsistence level economy. If a community lives on fish caught by hand and someone has the idea to make a net so that he can catch more fish, the inventor of the net will need food to live on until he has finished his net. He will have to save dried fish to sustain him. All production starts with savings because more productive processes take time to complete and require savings to sustain people until the process begins to produce. Nothing at all changes when money becomes the store of savings instead of fish.
But why would anyone invest hard earned savings in a new venture that might fail and will require years before he gets his savings back if all he gets back is the exact amount of the savings he invested? He would be stupid to do so. Who would invest a thousand dollars of hard earned savings in a risky venture with only the hope of getting his thousand dollars back? Why not just keep the original thousand dollars safe where it is? Clearly, people will need some kind of incentive to risk money on more productive processes that increase the standards of living of us all, and that incentive is profits.
Profits justify interest because the owner of savings has two choices: he can invest directly in a new venture as a partner, or he can loan the money to the entrepreneur. If he invests directly as a partner he might earn a small profit. But what if he just loans the money? According to Mohammed he should risk the loan with no compensation. But common sense says to allow him to earn as interest on his loan what he might have received had he partnered with the entrepreneur.
John Calvin, commenting on the prohibitions of usury in the Bible, compared interest to renting out property. Calvin concluded that the prohibitions of usury were intended for loans to poor people, not bans on renting out money since the Bible condones renting land.
Muslim countries never developed economically because of Mohammed’s poor understanding of economics, in spite of his experience as a merchant. In the 16th century, the Muslim Ottoman Empire was the world’s superpower and the wealthiest empire in the history of mankind. Western Europe was poor, dirty and backward. By the 17th century the two had traded places. Why? Not because the West converted to Islam.
The Dutch Republic was the first European nation to break out of the cycle of famine and dramatically increase the standard of living of its people. It did so by applying the teachings of the Church on economic matters through the creation of new institutions to protect property and individual rights. In other words, the Dutch invented capitalism.
For America to return to prosperity, we don’t need to adopt the morality of Mohammed. We need to return to the morality of the Bible, which protects individual property from the state and other criminals. But the Biblical morality that relates to this crisis has to do with honesty in measures. The Bible forbids false measures and multiple measures used to cheat people. Money is our only measure of wealth. The Fed violates the Biblical principle every time it reduces interest rates below what they would have been in a free market. That reduction in rates expands credit, increases the volume of money and thereby changes and devalues money. The Fed is the biggest counterfeiter in the history of mankind and the people suffer from its sins, not from failing to follow an ignorant 7th century Arab.
Big Leo| 4.9.09 @ 3:41PM
Property rights were crucial in establishing the prosperity and innovativeness of capitalist societies over the static Moslem world. When large properties were held only at the whim of a totalitarian ruler, there was no incentive to invest or even save, since a change in political favor meant financial disaster and death. In Europe, money could be safely left in the control of a monastery, a Jewish money lender, and later the Lombard bankers. And legal undertakings were necessary to remove property from a person.
For example, in the Battle of Lepanto, the Ottoman admiral had all his money with him. There was no safe place to leave it. And so, when his ship was damaged, he was reluctant to leave it. That is only one of many reasons why the battle was won by the European alliance. The Ottoman response eventually was to close their eyes to Jewish and Armenian financiers and their unIslamic activities.
L. Ross| 4.9.09 @ 6:19PM
It seems to me that a big problem with our current banking system could be the fact that banks are required to hold only a vanishingly small amount of cash to loan a tremendous amount of money. Why you pay a bank on a 5% interest on a 100,000 loan, they only have to have a small portion of that, say $5,000 of their own money to make the $100,000 loan. In reality, the bank is making 100% interest in the above example.
Interested Conservative| 4.9.09 @ 7:21PM
But L. Ross - that's the key to fractional reserve banking - the fraction.
Now - there are reasonable arguments as to where to draw the line, and who should draw the line, and whether Messrs. Greenspan and Bernanke have done either well. But the public central banking process generally works well, including through downturns.
Dave C| 4.11.09 @ 1:11AM
Capitalism has served society exceptionally well. Capitalism is not about loaning money, it's about INVESTING money in new ideas, new people and new ways of increasing productivity. The constant improvement in productivity, of people, machinery, and even use of capital has enabled people to move from hunter gather societies, to farming, to a division of labor that allows some of us to become scientists, politicians, pundits, academics, by allowing more and more of us to concentrate on something other than where we will get our next glass of water or bite of food. Greed and excess, while abhorrent moral terms actually help drive the engine and actually benefit us far more than they harm us. The current meltdown occurred because new financial instruments, made possible by brilliant mathematicians and interconnected computers, grew to fill the marketplace too quickly for risk managers or regulators to truely comprehend the systemic risks they were creating. Political pressure to increase the number of low income and minority homeowners collided with creative bankers, inept rating agencies, asleep at the switch regulators (at least their political bosses), and the exquisite accident of all coming together at the end of a government manipulated economic slowdown to blow up in our faces. (Bush tried to prop up the economy after 9/11, and then continued to prop it up to prevent a party change in the 2008 election cycle). Even with all that, this is still a serious but not catastrophic situation, and we should be growing again within two or three years. No system can do so much for so many. All other forms of market economies are manipulated to engineer outcomes rather than opportunities, and slow growth in productivity. Without productivity growth, those benefits are lost to everyone.
There are trillions upon trillions in open risk derivitive contracts. How can we liquidate these from the system? Are all the bets on one side, or is it balanced like a bookie balances his bets to reduce risk? How can we cancel both sides of these contracts to flush much of it out of the system? At the same time, securitized debt and risk insurance are wonderful instruments used in the right way, that frees up enormous sums to be loaned again without actually raising bank capital requirements. The ready availability of money to fund business growth, and yes, even consumer spending benefits millions. Yes, companies, all companies, need to find a way to reward long term rather than short term performance of individual employees and leaders. Sadly those employees desiring the greatest security and willing to take on the least risk share the smallest rewards. Lately those same people seem to think they should be paid like the risk takers, or that the risk takers should be paid the same as risk avoiders. We mush somehow disabuse them of their fantasy.
Lloyd| 4.12.09 @ 1:41AM
The problem with Roger Scruton's argument is that he thinks that "real" economics is based on real tangible goods which can be touched, weighed, and objectively valued. Everything else - trade, finance, money, etc, - is a spurious epiphenomen that tends to hide our connection with the "real" economy of tangible goods.
And he's half-correct, unfortunately. An economy based as much as possible on tangible goods, a barter economy, wouldn't have financial crises, inflation, deflation, or many of the diseases seemingly endemic to post-barter economies. It would, however, be a damn sight POORER than our modern credit and money-dominated economies - to the extent that third-world conditions would be the norm. So all those "unessential" aspects of our modern economies seem to be doing something for us and Professor Scruton might like to do some thinking about why this should be the case. He might begin by musing about the problem of the double-coincidence of wants.......
Capitalist| 4.13.09 @ 2:22AM
All this talk of whether capitalism "serves" us seems to assume that capitalism is a man-made system. Certainly capitalism is a system, and it does deal with human interactions, but capitalism is not man-made; no mere person or even nation ever invented it. Capitalism is a force of nature, and the economists studying capitalism are scientists just as physicists and mathematicians are. To ask whether capitalism is serving us well when our economy is suffering is just like asking whether gravity or long division are serving us well when our interaction with them produces results we don't like. ("What do you mean the math says this thing won't fly? I don't like your numbers, boy! Change them!")
Capitalism is merely the workings of human nature by which the price of goods (regardless of the medium of exchange used) varies with the wants and needs of each individual. Socialism, in contrast, is indeed a man-made system, one of many different kinds of efforts to manipulate and coerce people into making sales and purchases they would rather not make. In places where a lot of socialism is practiced, capitalism invariably continues to operate within each individual, repricing in another medium of exchange the goods and services the socialists have mispriced in their medium. Hence, the value of any product worth having in the USSR was priced more by the amount of time one had to stand in line to get it than by the number of rubles the commissary charged people for it.
What some of us are calling "capitalism" here ought more accurately to be called the free market, the system by which we follow the laws of capitalism rather than attempting to manipulate them. Property rights and a few other basic regulations of commerce are necessary to keep thieves and con-men and other socialists, great and small, from appropriating our goods and services via their "five-fingered discounts" and other tricks, but nothing else. Interestingly, the surveys showing that a bare majority of people liked "capitalism" also indicated "the free market" has the approval of a far greater majority. My speculation is that we have not educated people adequately about the meanings of these terms.
As gravity punishes the inventors of inadequate flying devices with a loss of altitude, capitalism likewise punishes the foolish fantasies of incompetent buyers and sellers with the loss of their invested capital. The outcry against capitalism over our economy's most recent correction is very much the same as an incompetent physicist's complaints when his inadequate flying machine crashes back to earth after having been launched from a cannon. The difference is that very few governments would be insane enough to attempt to legislate a repeal of the laws of gravity for the physicist's sake. It's a pity we have--so far--not been able to make people realize the laws of human nature (of which capitalism is only one) are just as real and immutable.
Slumlord| 4.17.09 @ 7:03PM
There is nothing wrong with Capitalism, there is however something wrong with Capitalists. Capitalism only works if people are honest in their dealing and are made to take the consequence of their actions. The old bourgeoisie would have looked in horror at the spectacle of the Government bailing out incompetent and dishonest bankers. The Panic of 1907 was averted when J.P. Morgan put up large sums of his own money in order to stave off financial ruin; the men that govern our finance industry have no such morals.
Keynes never argued that we should borrow in a crisis and pass the debt to our children, he basically said once the crisis was averted and the economy was sound again, the borrowing should be paid back again. The blame for the endless deferral of debt repayment should be placed on the politicians who control taxation and the purse strings.
Still, in the midst of the housing boom while everyone was making money, what politician would have been elected on a platform on "putting the brakes on unsustainable prosperity"? The public would have voted him out. There is the problem people, democracy. Responsible politicians would not have been voted in as nearly everyone from the top down is engaged in this Keynesian buck passing. Everyone banker, accountant, homeowner wants to privatise profits and socialise losses and elects politicians who will do just that. Any politician who attempts the hard solutions gets kicked out. If you want to know who is responsible for this financial crisis go walk out into the street or look into a mirror.
dropshippngwatch| 8.31.09 @ 9:07AM
Replica Watch
Fake Watches
Replica Watches
Replica Watches
Replica Watch
Fake Watches
Replica Watch
Replica Corum Watches
Replica D&G Watches
Replica De Witt Watches
Replica Ebel Watches
Replica Emporio Armani Watches
Replica Fendi Watches
Replica Ferrari Watches
Replica Fortis Watches
Replica Franck Muller Watches
Replica Graham Watches
Replica Gucci Watches
Replica Guess Watches
Replica Harry Winston Watches
Replica Hermes Watches
Replica Hublot Watches
Replica Hugo Boss Watches
http://www.dropshippingwatch.com
Wholesale Lingerie| 9.5.09 @ 10:12PM
http://www.charmingirl-china.com
Wedding Dresses| 9.9.09 @ 8:57AM
Very good article written byWedding Dresses
Designer Wedding Gowns
ah