Our Funny Money

November 20, 2009 at 6:36 am (Economics, Pakistan)


By Atif F. Qureshi

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” – Henry Ford

The curse of price inflation haunts us. There seems to be no respite for the common man. Everything is becoming more and more expensive and yet nobody can come up with a satisfactory explanation. This phenomenon is causing acute pain to millions of households who are struggling to survive on what little money they have. We are finding that our static incomes are failing to keep up with the massive increases in the cost of living. The price of food, fuel, energy, housing and everything else is rocketing far beyond our means to keep up. The middle classes are being wiped out. God help us, the poorest are in an even worse state. But why does this happen? Why don’t rupees go as far as they used to?

It is really much simpler than most people imagine it to be. The rupee, like the dollar and every other currency in existence, is a mere political currency, unredeemable for any real asset. The rupee is not a certificate of real wealth, but a ‘note of credit’, based on a trust and promise from the central bank and politicians that it will retain its future value. The currency is not based on any real and valuable commodity like gold or silver. It is based on nothing.

Depending on the whim of the State Bank of Pakistan, extra rupees are printed and issued to pay for shortfalls in the government budget or to pay off debt. Remember, these notes are just pieces of paper with ink designs on them and for the State Bank to print more is an easy matter. But every extra rupee issued diminishes the value of every other rupee in the economy and thus weakens its buying power for the public.Hence goods and services become more expensive with time.

In effect, this ‘fiat’ monetary system destroys the wealth of the poor and middle classes who suffer most from price rises. When this inflationary money is created out of thin air, it is injected into the economy through private and government owned banks in the form of credit and new paper notes. Through the ‘fractional reserve banking’ process, the new money is multiplied even further and lent for bank profits based on interest rate returns from borrowers. These credit markets keep business and consumer activity churning over. The key to the manipulation of the system is the ability of the State Bank of Pakistan to artificially price the base interest rate.

A low interest rate means cheap credit, an increased money supply, more borrowing, and a consumer boom. A higher interest rate results in more expensive credit, a contraction in the money supply leading to less borrowing, and a slowdown in growth. ‘Monetary policy’ comes in the form of central bank decisions that are euphemistically known as ‘loosening and tightening’, where interest rate cuts mean loosening and hikes mean tightening. It sounds eerily similar to having a noose around someone’s neck.

It is not such a bad analogy. By changing base interest rates, the State Bank of Pakistan can constrict or ease the financial situation for the entire country. Thus an immense amount influence over the lives and properties of hundreds of millions is vested into the hands of a tiny group of individuals who are politically motivated in their actions. It is no surprise then, that prior to elections, politicians will pressurise the State Bank governor to lower interest rates to supply cheap credit to the masses and thus fuel an artificially generated ‘feel-good’ boom.

The problem is that inevitably, every boom eventually turns to bust, causing havoc for millions of ordinary families. But since when did the interests of the ordinary people ever get in the way of short-term political expediency? In The Communist Manifesto, Karl Marx laid out his ten tenets of extreme socialism. His fifth is especially relevant: “Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.” Why the global monetary system is based on the degenerate ideas of this man is a complete mystery. Yet here we are.

When interest rates (the price of money or credit) are changeable at the whim of the central bank, booms and busts are the unavoidable result. No matter how hard the State Bank tries to engineer ‘safe landings’ for the economy and avoid recessions by tinkering with the base interest rate, they always happen. The problem is that there are too many variables involved and these people are only under the illusion that they know what they are doing, besides which, when the economy goes awry they can always pass the buck and blame ‘external factors’ or ‘global conditions’.

Interest rate cuts and cheap credit is always seen as the quick and easy answer. When interest rates are artificial and credit is distributed according to a arbitrary rate that is lower than a ‘natural’ equilibrium market rate, i.e. if monetary policy is ‘loosened’, excess credit often engulfs the economy, creating ‘bubbles’. This gives the illusion of prosperity. But in reality the new found wealth is concentrated in the hands of very few through the ‘bubble’ stock market, ‘bubble’ house price increases, and the profiteering corporations who have direct credit lines with the government.

Only a minority of the population benefit through cheap loans, stock market bubbles, or corporatist subsidies. The vast majority only suffer the consequences of the profligacy. The apparent new-found prosperity in the form of shiny new cars on the streets and new shopping malls is therefore not based on real production and wealth but in fact on mountains of cheap debt, and as every debtor knows, the bills always catch up with you in the end.

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