The credit crisis which started in 2007 has brought into light many defects in the current economic system. One of them, which I will discuss in this post, is the intricate relationship between economic condition and fiscal spending power (of Government).
The major source of revenue for government’s fiscal spending comes from taxes on:
1) Revenue generated (by individuals and corporations).
2) Taxes on real-estate property and other fixed-assets.
In an economic downturn, the decline in economic activity leads to a decrease in:
(1) Individual incomes as well as a decrease in corporate revenue.
(2) Devaluation of fixed assets.
All this factors lead to decrease in government’s tax revenue.
However, this is the very time when people lose jobs and start to depend on government’s public welfare schemes. Government’s expenditure shoots up and is in dire need of money. The tax-revenue (as we discussed above) falls sharply and government goes into huge deficit. In short, the current fiscal structure is designed in such a way that an economic downturn becomes a double whammy for the country and sharply raises the fiscal deficit and decreases the standard of living.
Let us compare this with the Islamic system. In an Islamic system, apart from the regular taxes, a major source of revenue for the Government’s public welfare fund (baithul-maal) comes from Zakat. Zakat is an Islamic principle of contributing a percentage of a person’s wealth (not income) towards public welfare. It is mandatory upon eligible Muslims to give out this charity and in an Islamic system this becomes a law.
Apart from the generous charitable aspect of Zakat, there is another beautiful aspect that I want to bring out. And that is, the fact that this charity is independent of the economic cycle. In fact, in some cases the charity goes up during bad economic times. The reason is that Zakat is based on an individual’s total liquid assets and not the yearly income. Liquid asset is anything which is available or can be readily converted to cash. One of the features of economic downturn is that people flock to cash and pull out money from the economic system. This increases the liquid asset of an individual which should lead to an increase in the amount of money that gets collected as Zakat.
In other words, while the modern fiscal policies lead to a dearth in fiscal revenue during an economic downturn, the Zakat-based Islamic system generates consistent (if not excess) charity for the welfare of poor and needy in the most needed time. This in turn protects the economic system from catastrophic collapse.
Indeed, this type of policy (Zakat) is something which modern nations of the world have to learn from Islam.
Monday, December 29, 2008
Modern Fiscal Setup Versus Zakat-Based Islamic System
Sunday, December 14, 2008
Functioning of Fractional Reserve System
Ever wondered how our fractional reserve system works. How $100 printed by Federal Reserve (Fed) can generate a $1000 worth of economic activity (assume a 10% reserve requirement). Fractional reserve requirement is the percentage of money that a commercial bank has to keep with Central Bank as reserve (Currently it is 10% in United States). In this post, I will try to briefly explain how this "borrow from Peter to pay Paul" type system works.
Lets say the Feds decide to float $100,000 in the market. They do this by writing a blank check against themselves and buying Treasuries in open market worth $100,000. This buying releases $100,000 in the banking system.
Lets say Bank-B1 decides to sell $100,000 worth of Treasury bill to Feds.
* The result would be B1 will have $100,000 to loan.
* B1 lends $90,000 to Paul who wants to buy land from John. ($90,000 because $10,000 has to be kept in reserves due to reserve requirement).
* John deposits the amount $90,000 that he received in bank-B2.
* B2 lends $81,000 (keeping $9,000 in reserves) to Peter who uses it to buy a fleet of cars from Mary
* Mary deposits $81,000 in bank-B3. B3 in turn lends $72,900 (Keeping $8,100 in reserves) to Jim who wants to upgrade his kitchen by contracting the work to Home Depot.
* Home Depot then deposits $72,900 in bank-B4 and the chain continues.
The total worth of economic activity generated (in dollar terms) can be computed by summing up all the activities described above. All these activities can be expressed as a geometric sequence whose sum can be computed by using standard geometric progression formula:
100,000*(1 + 0.9 + (0.9)^2 + (0.9)^3 + .....infinite series) = 100,000/(1-0.9) = 1000,000
The overnight lending between the banks and Central Bank keeps the capital fully tied up (in terms of loan) and keeps the economy flowing. Any stagnation in lending between the banks will cut that geometric series (described above) short and hampers the capitalist economy.
Lets say the Feds decide to float $100,000 in the market. They do this by writing a blank check against themselves and buying Treasuries in open market worth $100,000. This buying releases $100,000 in the banking system.
Lets say Bank-B1 decides to sell $100,000 worth of Treasury bill to Feds.
* The result would be B1 will have $100,000 to loan.
* B1 lends $90,000 to Paul who wants to buy land from John. ($90,000 because $10,000 has to be kept in reserves due to reserve requirement).
* John deposits the amount $90,000 that he received in bank-B2.
* B2 lends $81,000 (keeping $9,000 in reserves) to Peter who uses it to buy a fleet of cars from Mary
* Mary deposits $81,000 in bank-B3. B3 in turn lends $72,900 (Keeping $8,100 in reserves) to Jim who wants to upgrade his kitchen by contracting the work to Home Depot.
* Home Depot then deposits $72,900 in bank-B4 and the chain continues.
The total worth of economic activity generated (in dollar terms) can be computed by summing up all the activities described above. All these activities can be expressed as a geometric sequence whose sum can be computed by using standard geometric progression formula:
100,000*(1 + 0.9 + (0.9)^2 + (0.9)^3 + .....infinite series) = 100,000/(1-0.9) = 1000,000
The overnight lending between the banks and Central Bank keeps the capital fully tied up (in terms of loan) and keeps the economy flowing. Any stagnation in lending between the banks will cut that geometric series (described above) short and hampers the capitalist economy.
Sunday, December 7, 2008
Misconceptions about Islamic-Organizations
Islamic-organization is one word which not only alarms Non-Muslims but also repels many Muslims. In this post, I will try to bring some of the fears that Muslims have about Islamic-Organization and try to evaluate their genuineness.
1) Many Muslims feel there is no need for organization. There favorite punch line is “We as Umma’h are an organization”.
2) Some other Muslims feel: Organizations create a division and hence Fitna’h.
3) Others feel Organizations are necessary but are “scared” that they will come under government’s radar.
Let us examine these conceptions.
Claim (1) looks more like an excuse of not willing do any positive work and a way of discouraging people who are trying to contribute towards the welfare of Muslim community. One should ask him/herself what he/she has accomplished out of his individual effort. Has he/she run any successful project for the community? Even if an individual has run a project in his local community, does he/she have any macro-vision of how they could make a difference on a larger scale? In many cases, that I have seen, such people don’t even feel that a change is needed in the world. Most of them are indifferent to events happening around and at max they have casual opinions.
Attainment of any goal requires a group of individual who share a common vision. It is not enough for a group of individuals to share a common vision but also to put effort in an organized way and hence the need to have an organization. The favorite punch “we as Umm’ah are an organization” is an incorrect statement because neither all people in Umma’h share a common view nor will they put efforts in attainment of his goal.
Claim (2) is again an excuse of laziness because any work that is initiated will be disliked by few in the community. If a person starts to satisfy everyone in the community, he will end up doing nothing. Indeed, some low caliber individual of an organization may create differences in the community, but that does not justify stopping work for the welfare and revival of Islamic work. It is a way of stereotyping based on acts of few (bitter) individuals who are way far from the spirit of Islam.
Claim (3) is due to Nifaq in the heart (May Allah save us all from this!). One should read surah al-Tauba (Chapter-9) to see how Allah has addressed the Munafiqs who held back from helping Prophet Muhammad (PBUH) and Islam. Indeed the claim of a person is incomplete (rather false) if he doesn’t consider Allah and his Prophet dearer than anything in this world. Islamic-Organizations in US and many parts of the world are well-registered and work in a COMPLETE lawful way. If someone is scared even after this then it is nothing but a psychological phobia.
1) Many Muslims feel there is no need for organization. There favorite punch line is “We as Umma’h are an organization”.
2) Some other Muslims feel: Organizations create a division and hence Fitna’h.
3) Others feel Organizations are necessary but are “scared” that they will come under government’s radar.
Let us examine these conceptions.
Claim (1) looks more like an excuse of not willing do any positive work and a way of discouraging people who are trying to contribute towards the welfare of Muslim community. One should ask him/herself what he/she has accomplished out of his individual effort. Has he/she run any successful project for the community? Even if an individual has run a project in his local community, does he/she have any macro-vision of how they could make a difference on a larger scale? In many cases, that I have seen, such people don’t even feel that a change is needed in the world. Most of them are indifferent to events happening around and at max they have casual opinions.
Attainment of any goal requires a group of individual who share a common vision. It is not enough for a group of individuals to share a common vision but also to put effort in an organized way and hence the need to have an organization. The favorite punch “we as Umm’ah are an organization” is an incorrect statement because neither all people in Umma’h share a common view nor will they put efforts in attainment of his goal.
Claim (2) is again an excuse of laziness because any work that is initiated will be disliked by few in the community. If a person starts to satisfy everyone in the community, he will end up doing nothing. Indeed, some low caliber individual of an organization may create differences in the community, but that does not justify stopping work for the welfare and revival of Islamic work. It is a way of stereotyping based on acts of few (bitter) individuals who are way far from the spirit of Islam.
Claim (3) is due to Nifaq in the heart (May Allah save us all from this!). One should read surah al-Tauba (Chapter-9) to see how Allah has addressed the Munafiqs who held back from helping Prophet Muhammad (PBUH) and Islam. Indeed the claim of a person is incomplete (rather false) if he doesn’t consider Allah and his Prophet dearer than anything in this world. Islamic-Organizations in US and many parts of the world are well-registered and work in a COMPLETE lawful way. If someone is scared even after this then it is nothing but a psychological phobia.
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