Solutions to the Global Financial Crisis

The Edge, 11 May 2009

The world economy is expected to shrink for the first time since the Great Depression. Business confidence in major economies, like the US, Europe and Japan keep plummeting while more and more jobs are being lost. The Asian Development Bank forecasts the economy of the developing Asia to grow at a mere 3.4 percent in 2009, while in 2007 the rate was close to 10 percent. The outlook for the global economy is indeed not so good.

Solutions to the Global Financial CrisisNonetheless, the leaders who met at the recent G-20 Summit in London hailed the meeting as a great success. Recognizing that conventional monetary measures are no longer working, the leaders basically adopted a Keynesian-style of fiscal stimulus to rejuvenate the ailing global economy.

The economic stimulus packages basically included the loosening of credit restrictions and tax cuts, to offset the decline in the industrial and export sectors. Malaysia announced a stimulus package of RM7 billion last November and another massive RM60 billion in March, the largest it has ever done. Other neighbours too put in similar packages; Singapore USD$13.5 billion and Thailand USD$1.1 billion. So long a nation is not in a liquidity trap – like Malaysia and its neighbours – such stimulus packages may work.

For the developed nations that are, however, in liquidity traps, like the US, Europe and Japan, such stimulus packages may not work. The reason is that in a liquidity trap conventional interest rate measures would not stimulate economic growth through increased borrowing. This is because the economy, in that state, would have been highly leveraged and unable to take on more debt. Hence what these countries need is not so much of economic stimulus packages but rather of debt relieves. Debt relief, in the form of debt write-off or debt write-down is what is so necessary in the current context of global financial crisis. It is particularly important for the US to give debt relief to its real economy sector, firstly because the global crisis emanated from there and secondly the size of its economy matters, being a significant trading partner to the rest of the world. I hope President Obama recognizes that it is in debt relief where the solution lies and not in bank mere bailouts or through further military adventures, like in Afghanistan etc.

For the poorer nations, the G-20 Summit decided that the ‘wealthier’ nations would beef-up the IMF to about USD$1 trillion, to be forwarded to those poor nations as loans; over and above the already suffocating levels they are already in. Again, what these countries need is debt relief and not further debt.

Without debt relieves, my prediction is that, firstly the world would experience serious inflation in the coming years, affecting all economies, with the poor nations being the hardest hit. Price of all commodities, including grains like rice and wheat, can be expected to skyrocket even though the recession itself may bring down the price of things like properties, cars, financial assets etc.

Secondly, the crisis would continue to spread worldwide. Hence, the decision reached at the G20 Summit – i.e. bailouts and economic stimulus packages but minus debt relieves – seems not a truly economic solution but rather a political one, that is likely to continue pull down the global economy.

Below I provide what I perceive as more viable measures, which nations including Malaysia can emulate in order to protect themselves from the coming economic ‘catastrophe’. The needed actions are divided into immediate short-term actions and long-term actions.

First and foremost we need to recognize that at the root of the entire monetary fiasco is the characteristic of the monetary system where fiat money is mostly issued in the form of debt with compounded interest imposed on it. This places an exponentially growing debt burden on the real productive economy. Being unable to match the exponential character of it, the real economy ultimately succumbs and falls into a liquidity trap where even low interest rates cannot encourage borrowing that can stimulate the economy. The major economies – US, Europe and Japan- are currently at this stage.

Immediate Measures

Debt Relief. Following the above argument, for the developed nations, the first and most important immediate action needed is to give their real economy relief from ‘overpowering’ debt obligations. The exponential-part of interest obligations needs to be just written-off, requiring only the principal portions to be repaid. This action would first and foremost release the economies from the liquidity trap they are in. Countries that are not in liquidity traps, sooner or later would also have to do a similar thing.

Next, new money need to be injected into the economy through expansionary monetary policies. New fiat money is not of my preference but rather is necessary given the current ‘flawed’ system that we have; basically to counter the destruction of money that takes place during a meltdown. This, nonetheless, most economies are already doing, and constitutes what bailouts essentially are. The bailout money should, however, be injected into productive sectors in order to revive the real economy, prevent layoffs etc.; and not distributed as bonuses.

Nationalize Commercial Banks. This is to ensure that newly created fiat money is not privately owned. The power of money creation should lie with the government alone and all new money creation should, therefore, be publicly owned. Hence the recent spade of nationalization of financial institutions in the US, UK and Europe is justified.

Less affected nations, like Malaysia, should plan and embark on nationalization now and should not wait until things get worse before acting. Indeed, observing the nature of the global monetary system, nationalization was something I proposed in my book The Theft of Nations, Pelanduk. 2004.

Complementary Currencies: Governments should put in place complementary currencies and payment systems, to supplement the scarce national currencies. This, I would say, is an extremely important measure that nations concerned about the welfare of their citizens should do immediately. The monetary meltdown that is spreading globally entails simply the destruction of money, which in turn translates into recession. Hence all the observed events, i.e. from high debt levels, collapse of the mortgage markets, recession etc. are fundamentally monetary phenomenon. The real productive sector, however, suffers due to the fallacies inherent within the monetary system.

But this time what we are observing is not a normal economic cycle, but rather the breakdown of a system. The world needs an immediate replacement – a new global monetary order.

For this purpose, it helps to note that the monetary system is indeed an information system. Hence we can effectively introduce a new global monetary system and thereby mitigate the monetary meltdown using the existing electronic money and payment systems infrastructure, without having to rely on physical money, interest charges etc. Money can be made available freely just like any other public good. There is no reason for anyone to borrow money at interest for it is merely an information. The WIR Bank of Switzerland works on this principle. Let me illustrate this point.

Let’s say due to recession, X an individual becomes unemployed, Y a supermarket owner finds business sluggish and Z the government, accordingly, collects low tax revenue.

Z is unable to keep the city clean, rubbish being littered all over. X, on the other hand, goes hungry without food while Y stocks up food on shelves, unable to sell them. This scenario simply manifests the breakdown of the exchange system.

In the conventional method, to ‘jumpstart’ the economy someone needs to borrow money from the bank, which creates it out of thin air. Let’s say the government, Z, borrows money from the bank at interest and uses it to employ X to clean-up the streets. X uses this money to patronize Y’s supermarket and buys himself things that he needs. Y is happy to see his business improve, gratified to see a clean city environment and pays his taxes gladly with the money earned. Yes, the economy starts to function again but the catch is, the government owes the bank the virtual principle borrowed plus the interest charged on it, which grows exponentially by the day.

The same result, nevertheless, can be achieved treating money merely as information, i.e. without any borrowing on the part of the government. It goes like this. First, the government simply employs the jobless X to clean up the streets. Once the work is done, a credit is given to X in an information system while Z is given a debit entry. Such a system can take advantage of the advanced information and communications technology available today. Hence even the Mycard and mobile phones can be used for this purpose.

X then uses the credit earned to patronize Y’s supermarket, who in turn pays the government the taxes due, all through the information system only. The credit entry for the government in the last transaction cancels the initially created debit entry. Hence the economy operates but without any debt obligations on the part of the government.

The above method is better than the borrowing method for a number of reasons. Firstly of course there’s no borrowing on the part of the government. Hence there is no unnecessary burdening of the future generations and also one does not sow the seed for future bubbles and bursts. Secondly, money in the information system is created only when a good or service is created. Hence it’s non-inflationary. Thirdly, unlike credit card transactions, the ‘money’ here is created by the individual as and when necessary without having to borrow it. And there is no time lag for money to disperse into the economy as is the case in the first method and the dispersion is wider and deeper as it can cover every individual. Hence the recovery would be faster.

Such an information system would allow individuals and businesses to continue to transact even though the meltdown causes a lack of money in circulation and the recession can, therefore, be contained. If the system is based on gold as a unit of account, the gold numeraire would also place stability into the system.

Commercial Trade Exchanges (CTE). The establishment of commercial trade exchanges, also known as barter exchangers, to facilitate both domestic and international trade. A trade exchange stimulates trade by brokering members’ merchandise, keeping account of members’ transactions and trade balances and acting as a clearing house. The netting process minimizes the need for cash while generating extra sales. Currently there are very few trade exchanges in Malaysia. Chambers of commerce can effectively employ this method to stimulate business among members.

Multilateral Payment Arrangements (MPA). Similar to the CTE, the central banks of countries can use multilateral payment arrangements in order to spur trade among member countries while significantly reducing the need for foreign exchange reserves. It would even be better if the MPA is gold-based since central banks can leverage on their gold holdings. Hence in this way even countries with low international reserves can trade effectively. The need for cash or gold for settlement can be very much reduced by increasing the membership size and lengthening the settlement period.

Malaysia has bilateral payment arrangements with about twenty countries. The structure can be made more efficient by inviting more countries to join and transforming the agreements into a multilateral payment arrangement. Now is an opportune time to implement the gold-based MPA as proposed by Tun Dr. Mahathir Mohamad after the 1997 East Asian economic crisis.

Long-Term Solutions

Real Global Currency. As for long-term solutions the most important thing that governments should do is to establishment a global currency that is anchored to commodities like gold. A global currency backed to gold would be a politically-free money. Such money of course would eliminate volatility, speculation, manipulation and arbitrage in the currency markets. In fact, it would effectively be a fixed-exchange-rate regime that would bring about monetary stability and hence encourage international trade.

Such a currency can play the role of international reserve currency that is not under the control of any one nation; unlike the dollar which is controlled by the US. Recently, the Governor of China’s Central Bank, Zhou Xiaochuan, made a proposal for the adoption of such an international reserve currency, i.e. global money, to be managed by the International Monetary Fund (IMF).

The recent G-20 Summit agreed to support a Special Drawing Rights (SDR) allocation which will inject some USD$250 billion into the world economy. It’s this SDR, an instrument created by the IMF to replace gold as international reserve asset, the most likely candidate for a global currency. Currently the SDR is based on a basket of currencies, but it is still fiat in nature. Arkady Dvorkevich, Russia’s chief economic adviser, suggested the inclusion of gold in the basket-weighting of the SDRs; a good suggestion but short of calling for gold redemption.

To make it to be truly political-free and stable, the SDR got to be made redeemable for some real commodities like gold. Only such an action could place back the missing numeraire into the global monetary system, consistent with what Sir Isaac Newton once remarked regarding fiat money, that in applied mathematics one got to define one’s units.

In this aspect the world got to be careful not to allow the IMF to create SDRs out of thin air and thereafter lend it to nations at interest. Such an authority can render the IMF to become the global central bank that creates money for the whole world, and thereby effectively hijacking global political power, to become the world government. Even a simple authority to create SDR in the form of overdrafts for nations is enough to make the IMF to assume such stature. Hence the world should insist on an SDR that is redeemable for gold or other commodities, even oil, in order to prevent abuse.

Low Tax. In order to stimulate economic activity, particularly during the current recessionary environment, governments should keep taxes as low as possible. In fact as suggested by the Laffer-curve, nation’s can obtain a particular level of tax revenue using two different tax rates; one low and one high. Low rates encourage business activities and do not encourage tax evasions while high tax rates discourage business activities while increasing tax evasions. Hence, governments can obtain good tax collections with low tax rates, through higher volume.

Negative Interest Rates. For sustainable economic developments, governments should move towards imposing negative interest rates. This suggestion may sound strange, but nonetheless, the General Equilibrium theory in economics has been shown to collapse whenever a positive interest rate is imputed into the model. And indeed the compounded nature of interest rates brings economies to unbearable debt levels and thereafter causes them to collapse. Indeed, such times have been historically associated with booms and busts, and fall of nations and empires. The US is now experiencing this.

Accordingly, experts have shown that sustainable economic development requires negative interest rates. By this we mean, unlike in the current system, annual savings should be ‘taxed’ rather than being rewarded through interest. Negative interest rate is also consistent with the natural order of entropy and is also a characteristic embedded in the Islamic principle of zakat.

Other Measures. And of course, as learned from the current crisis, the banking sector must be monitored carefully with more regulation, requiring more transparency. Such monitoring and regulating should also be extended to rating agencies and hedge funds that are also responsible for the current crisis.

Speculative gambling in the derivative markets must also be checked. The derivatives market has grown into a huge bubble, estimated to be in the vicinity of USD$1 quadrillion (that’s a thousand trillions!). It is the derivatives markets that are accelerating the current monetary meltdown, starting from the credit default swaps (CDS) that failed during the subprime mortgage crisis. The sheer size of the derivative market cannot be supported in an environment of global recession. Hence, it’s worrisome for there is a likelihood of huge sums of money leaving that market into the commodities markets, thereby sparking the rise of commodity prices to unprecedented levels.


  1. Muhammad Jumah says:

    The Idea raised here especially of debt relief can be supported by the words of Allah which are saying in Surat Albaqara

    “O ye who believe! Fear God, and give up what remains of your demand for usury, if ye are indeed believers. 2.278

    If ye do it not, Take notice of war from God and His Apostle: But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly. 2.279

    If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew. 2.280

    And fear the Day when ye shall be brought back to God. Then shall every soul be paid what it earned, and none shall be dealt with unjustly

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