The complexity of global, innovative and speculative financial markets has increased pressures on the political sphere. Soon after the 2008 global financial crisis, national responses were put in place in order to save the financial markets from collapsing. In the European Union, for instance, social tensions have currently arisen since banks and investors turned out to speculate against the risk of default of public debt securities issued by Greece. Also in Latin America, Brazil has been facing a macroeconomic adjustment agenda since the beginning of 2015 so as to rescue the credibility of investors in its fiscal policy.

In order to face the public debt management challenges, the search for macroeconomic austerity turns out to overwhelm the macroeconomic policy options and subordinates the social dynamics.  Indeed, Central Banks´ and Treasuries’ actions have not been independent from private pressures and national governments have to prevent a collapse of credibility of their domestic financial systems. As a result, banks and investors, to a large extent, have proved to depend on massive government support.

The implantation of austerity programs requires new macroeconomic guidelines. Fiscal measures regarding surplus, tax increases and expenditure cuts, turn out to be highlighted in the macroeconomic stabilization attempt. However, fiscal austerity could become a risky long-term strategy as a tighter fiscal policy would certainly result in even weaker economic growth rates and higher public debt/GDP rates. In addition, entrepreneurship sustainability is particularly influenced by finance, as Keynes warned. When the speculative demand for money increase, due to high uncertainty about the future, entrepreneurs reduce the demand for capital goods. Thus, under high uncertain expectations, the expansion of productive capacity would be postponed.

Consequently, the current era of austerity certainly affects day-to-day life of citizens. Indeed, austerity programs subordinate the whole policy decision process that turns out to look for a realignment of relative prices (mainly real wages) and further structural reforms (mainly in the public sector and the labor market). The labor market has become a key variable in macroeconomic policies based on austerity programs. Longer working hours, job destruction, turnover, outsourcing, workforce displacement, job reduction and loss of rights are part of the spectrum of management practices that emerge from the austerity guidelines. This scenario, characterized by precarious jobs, enhances the vulnerability of workers, mainly young people.

Following austerity programs, countries like Greece and Brazil must undergo painful adjustments mainly through deflationary policies that favor the reduction of the relative unit of labor costs. Wage cuts may prove to be devastating, not only socially and politically, but economically as well.

As Keynes pointed out in his analysis of the monetary economy of production, there is a contradiction of money as a public good and a private good that overwhelms the central banks’ actions in periods of crisis.  As a result of the choice to adopt austerity programs and support the investors’ credibility agenda, many governments have disappointed their citizens on behalf of less spending on social policies, low growth and increasing social inequalities.

Deregulated finance has been associated to great transformations in the models of economic growth.  As Bello (2006) warned, in the 1980s, Reaganism and structural adjustment were not successful attempts to overcome the post-war accumulation crisis. One decade later, the Clinton administration embraced globalization as an American strategy. First, this strategy aimed to accelerate the integration of production and markets by transnational corporations. Secondly, it aimed to create a multilateral system of global governance centered on the World Trade Organization, the International Monetary Fund and the World Bank. In this scenario, global liquidity, stimulated by the evolution of the American monetary policy since the early 1990s, favored the expansion of private capital flows and deepened the interconnections between national financial systems (Chesnais, 1998).

Accordingly Stockhammer (2009), the notion of a “finance dominated” accumulation regime highlights that the current global financial set up has decisively shaped a pattern of accumulation where different growth models could be identified. While some countries have presented a consumption-driven growth model fueled by credit, generally followed by current account deficits, other countries have shown an export-driven growth model, mainly characterized by modest consumption growth and large current account surpluses.

In spite of the coexistence of different growth models, the financial-led accumulation regime has presented some distinctive features:

  • A redefinition of the role of the state that has been justified by the deregulation process in financial, product and labor markets.
  • Changes in macroeconomic policies that turned out to focus fiscal adjustments instead of employment goals.
  • The centralization of capital, trough waves of M&A and the expansion of sub-contracting schemes (outsourcing) that has been nurtured by short-term profit goals. In fact, one of the most important changes in investment decisions resulted from the increased pressure of shareholders. Managers and owners of firms have come to view their organizations in terms of their short-term financial performance. Assets, debts, current stock market evaluation, mergers and acquisitions have overwhelmed the practice of investment decisions. Indeed, the financial conception of investment has increased in the context where financial innovations (debt and securities) could be used to achieve fast growth with lower capital requirements.
  • The redefinition of labor and working conditions that has been at the center of increasing inequality. In truth, the evolution of the capitalist relations of production has revealed changing labor organizing principles in order to cope with the dictates of capital mobility and competition: automatic production control; redefinition of workers’ skills and tasks in the context of new management practices, job rotation and suppression of rights. Besides, attacks on labor unions and the diminishing organizational strength of collective demands need to be underlined. In this context, the deterioration of income distribution and the weak perspectives of job creation are continuously putting a downward pressure on consumption and, therefore, on economic growth.

Indeed, these world-wide evidences reinforced deep menaces to social cohesion and justice in the context of the current financial-led accumulation regime. Considering these menaces, Hobsbawm sharply notes that:

“They seem to reflect the profound social dislocations brought about at all levels of society by the most rapid and dramatic transformation in human life and society experienced within single lifetimes. They also seem to reflect both a crisis in traditional systems of authority, hegemony and legitimacy in the west and their breakdown in the east and the south, as well as a crisis in the traditional movements that claimed to provide an alternative to these.” (Hobsbawm, 2007: 137).

Definitely, teaching economic growth should emphasize the interconnections between  power, finance and global governance as related issues that shape livelihoods.


Bello, W. (2006). “The Capitalist Conjuncture: over-accumulation, financial crises, and the retreat from globalization”, Third World Quarterly, Vol. 27, No. 8, pp. 1345 – 1367.

Chesnais, F. (1998).Mundialização financeira e vulnerabilidade sistêmica”. In: Chesnais, F. (Ed.). A mundialização financeira- gênese, custos e riscos. São Paulo: Xamã.

Hobsbawm. E  (2207). Globalisation, Democracy and Terrorism. London:  Abacus.

Stockhammer, E. (2009). “The finance-dominated accumulation regime, income distribution and the present crisis”, Department of Economics Working Paper Series, Vienna: Vienna University of Economics & B.A.

The relevance of wealth and income inequality has been acknowledged by unorthodox writers for some time. The recent success of Piketty’s book (2014) shows that the wider public is also interested in this issue.  Piketty’s  15-year program of empirical research conducted in conjunction with other scholars analyzed  the evolution of income and wealth (which he calls capital) over the past three centuries in leading high-income countries. Among the lessons, he highlighted;

  • There is no general tendency towards greater economic equality.
  • The relatively high degree of equality seen after the second world war was partly a result of deliberate policy, especially progressive taxation, but even more a result of the destruction of inherited wealth, particularly within Europe, between 1914 and 1945.
  • In Europe, a “patrimonial capitalism” – the world dominated by inherited wealth – of the late 19th century is being slowly re-created.
  • Inequality within generations remains vastly greater than among them.
  • In the USA, perhaps the most extraordinary statistic is that “the richest 1 percent appropriated 60 percent of the increase in US national income between 1977 and 2007.” Indeed, one of the most striking conclusions is the rise of the “supermanager” in the USA.

Among other contributions to re-thinking inequality, Nobel laureate Joseph Stiglitz’s recent book, The Price of Inequality, argues that this division is holding the country back where rent-seeking increased.. He pointed out some relevant issues to address in any attempt the rethink the foundations of wealth and income inequality. Indeed, Stiglitz pointed out some relevant issues to address in any attempt the rethink the foundations of wealth and income inequality:

1) Distinction between wealth and capital

In Stiglitz’ opinion, most readers of Piketty’s book (Capital in the Twenty-First Century) get the impression that the accumulation of wealth — savings —is responsible for the rise in inequality.   There is, therefore,  a link between the growth of the economy — the accumulation of capital— on the one hand and inequality and wealth. Stiglitz’s recent paper, “New Theoretical Perspectives on the Distribution of Income and Wealth Among Individuals”, begins with the observation that a closer look at what has gone is necessary to apprehend the current trends.  Stiglitz suggests that a large fraction of the increase in wealth is an increase in the value of existing assets. Indeed, in addition to an increase in the wealth/income ratio, there is a capitalization of the increase in other kinds of rents, like monopoly rents supported by the market power of firms relative to workers and by government guarantees, for example. Therefore, wealth can increase, but it doesn’t increase capital.

2) The role of credit in wealth expansion

All  the recent changes are  very closely linked with the credit system.  The flow of credit didn’t go to more wealth accumulation as we normally use the term in economics, as capital goods. Through deregulation and lax standards, banks increased lending, but not for creating new business, not for capital goods. The effect of it has been actually to increase the value of land and other fixed resources (buildings, real estate, etc.). Therefore, the link is that credit affects land prices and fixed asset prices, and those go disproportionately to the rich.  While that is a major part of the increase in the wealth, the workers, who have no wealth, don’t benefit from that expansion.

3) Increased market power

The ratio of wages to productivity is going way down and  the ratio of CEO pay to worker pay has gone up suggest increased exploitation founded on increased market power.  In the current scenario, weakened worker bargaining power and weaker unions, asymmetric liberalization where  only capital moves, corporate governance laws that do not cope with abuses of corporate power by CEOs, there are certainly a number of factors that suggest an increase in market power with consequences in terms of income inequality.

Beyond inequality, the concept of capital has been a controversial issue at the heart of Economics Education since the conceptualization of capital enhances deep implications on the apprehension of the economic, social and political dimensions of reality.

Thomas Piketty’s book has been worldwide discussed on behalf of his data sets and explanation for increasing disparities in wealth and income in the context of neoliberalism. Among critical readers of Piketty’s analysis to explain growing inequality, David’s Harvey concern pointed out that his argument relies on a mistaken definition of capital. In short, although there is much that is valuable in Piketty’s data sets, his explanation seems to be founded on a neoclassical theoretical background where capital is mainly a factor of production.  Indeed,  Piketty defines capital as the stock of all assets held by private individuals, corporations and governments that can be traded in the market (no matter whether these assets are being used or not).

Under Harvey’s approach, the definition of capital as a stock of assets excludes the idea of capital as a social process where money is used to make more money often, but not exclusively, through the exploitation of labor power.

Following Harvey’s concern, we need to highlight that the nexus between the current global scenario and inequality encloses inner tensions between the hypertrophy of finance and the expectations of society about citizenship, labor and income. In the current historical context, labor markets have become a key variable in macroeconomic and business adjustments.  In truth, capital mobility has favored the regulation of social relations based on growing flexibility. In contemporary capitalism, the global institutional architecture has favored capital mobility and short term investment decisions – increasingly subordinated to the decision of the “supermanagers” and the rules of portfolio risk management. While recent changes in productive organization have been based on competitiveness and corporate governance criteria, job instability and fragile conditions of social protection have forced the reorganization of survival strategies. Thus, workers must redefine their skills or become informal entrepreneurs. Given the decreasing power of workers in recent decades, it is not surprising that both the globalization process and its outcomes have favored  the concentration of wealth and changes in social behavior.

Definitely, the field of economics needs to come to terms with  inequality. Concerns with inequality extend well beyond issues of justice and fairness, since the degree of economic inequality also affects social cohesion and political stability, and can also have negative implications for economic growth and sustainability.


Harvey, D. Afterthoughts on Piketty’s Capital,2014,

Piketty, T. Capital in the 21st century, 2014,

Stiglitz, J. The Price of Inequality: How Today’s Divided Society Endangers Our Future, 2013,

Wolf, M. ‘Capital in the Twenty-First Century’, by Thomas Piketty (review),  Financial Times,  April 15, 2014.

Originally published in Express Tribune, 15th June 2015.

Harvard professor Julie Reuben has documented an important historical transition in the life of US universities over the period 1880-1930 in her book entitled, The Making of the Modern University: Intellectual Transformation and the Marginalization of Morality. Rueben describes a variety of intellectual and historical developments that led universities to abandon their longstanding tradition of building character as well as imparting education, and makes the argument that universities’ abandonment of morality caused great social damage to Western society.

Most colleges in the US started out as religious seminaries. The concept of the unity of knowledge led them to embrace scientific and technological teaching within their curricula. Since all knowledge illuminates the Divine, in teaching physics, astronomy etc., teachers were expected to attend to the beautiful truths to be read in the works of God. Many difficulties arose in the execution of this educational programme. One source of difficulty was the conflicts among different denominations of Protestant Christianity.

To resolve such conflicts, scholars with an implicit faith in unity of knowledge proposed a purely scientific approach to morals in the hope that this would lead to scientific support for traditional Christian morality. Courses were developed to “arouse in (the student) a consciousness of his relationships and a realisation of his responsibilities,” in many universities. The promotion of social sciences became, on this view, a moral mission. In the early 20th century, social scientists portrayed themselves as agents of moral progress. World War Ireinforced these views as many thought that these awful calamities were a result of ignorance about the social and political sciences. The phenomenal growth of social sciences provides evidence of the university reformers’ strong desire to continue the traditional association between higher education and moral leadership.

The development of the philosophy of logical positivism dealt a deadly blow to the desire to integrate moral, spiritual, intellectual and scientific traditions within the university curriculum. According to this philosophy, which became widely accepted, facts and values are sharply separated. Science is based only on facts, while there is no empirical basis for values. The moral, spiritual and humanitarian traditions fall outside the boundaries of science. As an additional blow, the philosophy of emotivist ethics relegated all such human concerns to being mere emotional responses, not subject to intellectual discussion. Under the influence of these ideas, social scientists hid normative concerns within apparently objective frameworks. Increasingly, specialisation and fragmentation of knowledge became the norm for a university education.

Reuben describes the multidimensional efforts made by the universities to retain an element of character building, moral and spiritual training within their curricula. All such efforts failed, and gradually and reluctantly, universities chose to focus solely upon providing technical knowledge, abandoning moral goals.

Hilary Putnam, and other contemporary philosophers, have shown that facts and values are inextricably entangled — they cannot be separated. Logical positivism has collapsed. Since the effort to find a scientific basis for morality has failed, it is necessary to re-think the university curriculum and to re-introduce spiritual and moral training alongside the scientific and technical. Failure to do so has led to university graduates who have committed great crimes against humanity without recognition or remorse. David Halberstam’s classic, The Best and Brightest, shows how graduates of elite universities bombed Vietnam and Cambodia, killing more than two million civilians without compunction. Loss of a moral compass is also illustrated by the secret Congressional testimony of the physicist Oppenheimer who described the brilliant fireworks that would result from atom bomb first, and the carnage in terms of human lives later. Jonathan Glover’s book Humanity: A Moral History of the Twentieth Century documents genocide, mass killings and levels of barbarism unparalleled in human history. The necessity of re-introducing moral training is evident from the fact that elites educated in the finest universities have participated in, and crafted, strategies for killing millions of innocents. The key to the lost knowledge for character development lies in recognising that the ties of shared humanity which bind us all are much stronger than the crafted identities (ethnic, national, linguistic, religious, and others) which separate and create hatred.  These lessons are available in a rich literature which has been dropped from university curricula in favour of technical training.


Original article ends as above. For the Pedagogy Blog, it is important to point out that the exclusion of normative concerns from social science had serious consequences. In effect, normative concepts were hidden into apparently objective frameworks, and excluded from examination and discussion. For an example of this process, see my article: “The Normative Foundations of Scarcity,” Real-World Economics Review, issue no. 61, 26 September 2012, pp. 22-39

reprinted from Express Tribune, 8th June 2015

We live in a world awash with money. Not only can the banks create 20 times more money than the amount they receive as deposits, but an enormous shadow banking system has come into existence which creates massive amounts of credit without any regulatory restrictions. At a time of the global financial crisis, the value of financial instruments was more than 10 times the world GDP. Daily trade in foreign exchange is around $4 trillion, while actual merchandise trade is only $50 billion. This huge excess clearly represents speculation and gambling, rather than currency exchange for the needs of trade.

The ways of the super-rich Lords of Finance are far beyond the ken of ordinary mortals like you and I. Winning and losing bets in millions of dollars daily are just a small part of the thrill of living. One of the important tools they use is buying on margin. This means that you can buy $50 worth of stocks or foreign currency by paying just $1. In effect, the dealer loans you the remaining $49 by using your stocks as collateral. If the stock goes up to $51, you can sell and get out with a quick 100 per cent profit on your investment. If the stock declines to $49, you again sell and get out of the market, losing your marginal payment of $1.

In the 1970s, the dollar was de-linked from gold officially by former US president Nixon. Distrusting the unbacked dollar, the Hunt brothers decided to buy up all the silver in the world. By 1979, they had nearly cornered the global market, taking possession of nearly three million kilograms, about a third of the entire world supply. In the process, they drove up the price of silver from $6 to $50 an ounce, and became richer than the fabled King Croesus. The eight-fold price increase created a dire situation for jewellers around the world. Tiffany’s took out a full page ad in The New York Times, condemning the Hunt Brothers and stating “We think it is unconscionable for anyone to hoard several billion dollars worth of silver and thus drive the price up so high.”

The fates intervened to prevent the Hunt brothers from becoming the kings of silver. The Hunt brothers angered the Reagan Administration in the US, which played dirty to bring them down. COMEX, the regulatory body for commodity exchange, suddenly changed the rules for trading in silver, doubling the margin requirements. This required the Hunt brothers to put up about double the cash for the silver they had purchased on the margin. At the same time, the FDIC changed the rules to prevent banks from lending to purchase commodities. The bear trap closed around the Hunt brothers, who watched helplessly as silver prices started sliding and crashed on “Silver Thursday” on March 27, 1980. Although they lost billions, and eventually had to declare bankruptcy, we need not feel pity for the Hunt brothers. Their rich daddy had foreseen this possibility and created protected trust funds for both brothers amounting to $100 million each, more money than common folks see in a lifetime of earning.

One of the favourite games played by the super-rich is speculating in foreign exchange. Buying on margin provides enormous leverage; one can buy a billion dollars worth of currency for a paltry $20 million. This allows you to attack weak currencies and take them down, making an enormous profit in the process. George Soros created the Quantum Fundto attack the British Pound, speculating on its devaluation. The Bank of England tried to protect the pound with all the means at its disposal, but was eventually forced to yield, creating billions in profits for Soros. Similarly, big money forced open the doors of the East Asian Miracle economies to foreign investors, and crashed these economies while yielding tremendous profits to the investors.

The use of leveraging, derivatives and other complex financial tricks within the unregulated shadow banking system creates a huge amount of excessive credit, which actually changes the rules of game. As the Global Financial Crisis of 2007 demonstrated dramatically, the conventional textbook theories currently being taught in universities throughout the world, do not apply to the modern economy. The most radical change has been the failure of the quantity theory of money. Professional economists were very surprised when huge increases in the money supply did not result in proportional increase in prices, in violation of the quantity theory. The US printed trillions of dollars for the Iraq War and for bailouts and quantitative easing following the Global Financial Crisis, but there was no corresponding increase in consumer prices. Similar phenomena were observed throughout the world. In Pakistan, there has been a 350 per cent increase in the money supply, but only a 250 per cent increase in prices over the past decade.  Professor Richard Werner has solved the mystery by showing that the excess money goes into creating price bubbles in land, housing, stocks and other speculative financial assets. Prices of these assets do rise, but these do not enter the consumer price index, and hence do not cause inflation. Interestingly, Werner’s theories are not well known among economists.

Another serious consequence of excessive money supply being held in the form of inflated assets is that the concept of an equilibrium exchange rate is no longer well defined. Previously, the equilibrium was defined by matching supply and demand for currency, which was based on the real trade balance between exports and imports. Now the speculative transactions, being done at whims of the super-rich, overwhelm the real economy. What controls the exchange rate is largely expectations. The topic of self-fulfilling expectations has gained prominence in the recent literature on monetary theory. If rumours are spread that a currency will decline, people will sell the currency and cause it to decline. Equilibrium theories do not show any significant misalignment of the Pakistan rupee exchange rate, as current popular accounts would have it. The ultimate test today rests on Central Bank interventions. If the State Bank is intervening in the markets by selling dollars to prevent a fall in the price of the rupee, then the rupee is overvalued. However, State Bank Reserves are steadily growing, showing that the rupee is actually undervalued, contradicting the views of leading economic pundits in Pakistan.

The target of economics education is the comprehension of the reality in its economic dimensions, that is to say, the understanding of the practices and ideas that support the evolution of the reproduction of material life. However, following John Kenneth Galbraith, we can say that economics is overwhelmed by an “uncorrected obsolescence”.   Consequently, each generation faces many new economic and social challenges. As Alfred Marshall wrote in the preface to his Principles of Economics, economic conditions are constantly changing and each generation looks at its own problems in its own way”.

Indeed, the current political, economic and social features of  globalization configures a rupture in relation to the Bretton Woods institutions. The contemporary institutional set up is the result of deep transformations that characterized the outcomes of the crisis of the accumulation pattern in the 1970s and 1980s.  The financialization of the global economy produced great transformations in the growth dynamics since the decisions related to investment, production and employment are increasingly subordinated to the short-term financial commitments of big corporations.  Besides, further deep structural changes have involved increasing capital mobility and the growing importance of institutional investors as managers of “financial savings”.

As a matter of fact, the current developmental scenario is completely different from the “Golden Years” where national states were supposed to reduce social inequality by means of economic growth. Under the current global order, there is a trend to the corporatization of national policies on behalf of the implementation of government actions  that turn out to reinforce the concentration of corporate power. In particular, as most Western national states give support to the increasing competitiveness of corporations outside their national frontiers, these competitiveness’ strategies could turn out to be dissociated from the needs and vulnerabilites of their populations.  In other words, public policies happen to be subordinated to global financial and trade private strategies, instead of mainly facing social needs.  Consequently, the interaction between economic growth and development policies reveals new social conflicts that have arisen from the dynamics of global capital reproduction.

Considering this background, two main questions should be addressed to students of economics: Which are the main examples of policy resistance to the neo-liberal agenda? Which policy recommendations should contribute directly to economic and social development within national frontiers?

Newspaper article published in Express Tribune, on 25th May, 2015 Pakistan. It explains the defects of the fractional reserve banking system, and suggest switching to 100% reserve banking.

A long time ago, Ibn-e-Khaldoon noted the tendency of conquered nations to unthinkingly imitate the conquerors in all dimensions of life. After achieving freedom from colonization, the former colonies have tended to imitate or retain the colonial institutions, without reflecting on whether or not these institutions are suitable for them. In his classic, “Small is Beautiful,” Schumacher showed that appropriate technology for developing countries was often small and low-tech production techniques which empowered the people. Imitating the highly capital intensive and large scale industries of labor short capitalist countries is like trying to run before learning to walk. Today, large dams are being built all over the world at enormous financial and environmental costs, while smaller scale agile energy producing technologies which deliver quick results cheaply are being ignored. Similarly, we have retained colonial institutions which were designed to be top-down, hierarchical, and non-democratic; people being heavily taxed and exploited cannot be allowed to have a vote in the matter. Transiting to democratic institutions requires many reforms. For instance, the “police force” which maintains order by force, needs to be re-conceptualized as the police service, responsible for the security and protection of citizens.

Banking is another institution that has been copied without a cost benefit analysis. The Great Depression of 1929 was caused by a banking crisis which wiped out lifetime earnings and led to prolonged misery for millions. Stringent banking regulations prevented major crises for fifty years. Financial liberalization in the 1980’s led to the Savings and Loan crises; the bailout was more than the profits of banks for the entire century. Since the 1980’s financial de-regulation has been extended and globalized, resulting in more than 200 banking crises globally, with huge economic costs. The latest and greatest is the Global Financial Crisis of 2008, which cost trillions of dollars, and led to the highest levels of homelessness and hunger seen in the USA since World War 2. Overall, when we add up the benefits and subtract the costs of current banking systems, the net result is tremendously negative.

Many have analyzed the reasons for repeated banking crises, and found that the root cause is the fractional reserve banking system. In this system, banks holding a billion Rupees can freely create a large multiple – like five or ten billion Rupees – from nowhere. They only need to have a small fraction of the money that they create to give to lenders. The inherent injustice of a system which allows certain wealthy private parties to create money at will is hidden from public view. Henry Ford said that “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.” An inherent feature of the system is that the claims on banks are far greater than their assets. When too many depositors wish to withdraw money, there is bound to be a crisis. In the words of Lord Mervyn King, the former Governor of the Bank of England “Of all the many ways of organizing banking, the worst is the one we have today – change is I believe inevitable. The question is only whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crises.”

The excellent documentary “Inside Job” shows that Iceland was badly mauled in the GFC 2008. Financial de-regulation crashed a small stable and robust economy, due to wild and excessive lending. Iceland Bankers, utilizing their powers of money creation, expanded the money supply by a factor of twenty over the decade leading upto the GFC 2008. The bloated money supply led to soaring prices of stocks and lands, and ultimately crashed the economy. The Central Bank of Iceland found that, contrary to what is written in monetary theory textbooks, it was completely unable to control the money supply. It utilized all the tools at its disposal, including raising the discount rates to extremely high levels, but could not prevent the private banks from creating excessive money.

Chastened by the experience of helplessness, watching an impending crisis without being able to do anything about it, the Iceland government has recently formulated a plan for monetary reform. The key ingredient of the plan is that the power to create money is taken away from the private banks. The proposed system of “Sovereign Money” puts the power of money creation in the hands of a panel of specialists at the Central Bank. They would use economic theory to create money in quantities which would allow for full employment without creating inflation. Specialists can download and read the Iceland proposal for monetary reform, full of fascinating details and information about the defects of our current banking system. The question of ‘why only Iceland?” when this reform is needed everywhere was addressed briefly in my previous article on The Shifting Battleground. A much more detailed historical explanation of the power and craftiness of the financial lobby is given in the writings of Ellen Brown.

The main problems of current banking system are that it is unjust, crisis prone, and anti-growth. Private money creation leads to a rentier economy, where the largest profits are made by owners of wealth, who invest in stocks and land, and earn interest on bonds. The producers, laborers, and farmers who make up the real economy, get very little reward for their labors. Instead, rewards accrue to the financiers who provide money – created from nothing – to all the real sectors. Not only is this unjust, but it causes growth prospects to shrivel, since all investment is directed towards financial sectors, and away from the productive sectors. Studies show that growth of GDP is very strongly correlated with the amount of investment in the real sector, and in human beings. This is only natural: growth is directly tied to how much we invest in our future. Although it is radical, the Iceland Plan for monetary reform offers the possibility of a dramatic increase in real investment and real growth, very much needed today in Pakistan.

1. See also an intelligent critique of the Iceland Proposal at Re-inventing Money

2. See also my paper on “An Islamic Version of the Iceland Plan for Monetary Reform” — this extends the plan by adding the elimination of interest from the banking system.


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