INEVITABLE INFLATION - THE HALLMARK OF CAPITALISM

SHAMSUL GHANI
(feedback@pgeconomist.com)
Apr 5 - 11, 2010

The recently released 2nd quarterly SBP report, besides prophesying a higher fiscal deficit vis-a-vis the estimate, forewarns the comeback of inflationary forces triggered partly by the international market developments and partly by the administered energy price hikes on domestic front. The headline CPI inflation, after bottoming out at 8.9 percent in October 2009, resurged to 13 percent on YoY basis in Feb 2010, while the core inflation (Non-Food Non-Energy) stood at 10.1 percent for the said period.

The report predicts a second-round effect of inflation after the current price hikes are transmitted into higher costs of production and increased cost of living. With the almost entire world having single-digit inflation and therefore having sufficient cushion to tackle the backlash, the task of our economic managers and the SBP becomes uphill in the face of an already threatening level of inflation. The SBP has already responded by denying any cut in the policy rate.

The unhindered forward movement of market capitalism in a unipolar world with little or no government intervention has given the developed economies a reason to believe that the fruits of free market economy are immense and that no other system is capable of handling the huge global economic potential to expand. This is why the free market economists like Milton Friedman and Alan Greenspan, the ex-Fed-chairman, have had their sway over the world economy. Dubbed as the 'Master of the financial universe' by William Keegan of Observer, Alan Greenspan ruled the world economy for almost two decades: 1987 to 2006. The following comment by Raymond Seitz of Sunday Telegraph is an incisive description of the powers of this man: "When Alan Greenspan cleared his throat the world economy trembled."

Alan Greenspan, in the epilogue to his book The Age of Turbulence, has concluded: "Inflation overall may be contained for a while by weakness in the world economy, induced by the credit crunch. But the respite, if it can be called that, won't last. Inflation is returning, if anything more quickly than projected in these pages a year ago. As the gradual unwinding of post cold war disinflation makes way for pervasive inflationary forces, keeping these from getting out of hand will become the primary challenge for the world's central banks.... It is to this challenge that economic policy must now turn. Economic bubbles, the phenomena that have so shaped and shaken our lives in recent years, will for the foreseeable future be of less concern. The reason is simple. Bubbles form in periods of ample credit and low long term interest rates-circumstances the world is unlikely to encounter again for years."

The future scenario predicted by the proponent of free market economy and the most powerful Fed chairman after Paul Volker, portends the return of pervasive inflationary forces. This doesn't bode well for our economy which is already reeling under the burden of interest and inflation rates that are highest in the region. The study of the recent decades' world economics suggests that the post cold war era and the evolution of new world order gave the US free market economists a free hand to develop and impose on the world an economic system that promised maximum return to the US in the shape of new markets and lucrative contracts. The Friedman theory of dumping excessive US production in the markets of developing economies instead of cutting back production to stabilize domestic prices added a new dimension to the market capitalism which is primarily based on the concept of expansion. The fiat money system, the interest based finance, and banking systems' ability to create credit money all contribute to the expansionary efforts of free market economy.

The fiat money system that endows a small piece of paper- a government's official currency -with huge purchasing power, without the backing of equivalent gold or any other precious metal, has immense capacity to expand economies. Any government can print any quantity of currency - certain economic limitations in certain cases notwithstanding. The fiat money system ensures unlimited expansion of real stock of money and therefore acts as an inflationary force.

Banking system's unfettered powers to create credit money afford bankers a unique position in the overall economic and financial system. They create additional money through writing of loans on the strength of customer deposits accumulated from individuals, companies and organizations. They do this under the oversight of the central bank that allows them to use customer deposits for raising of loans up to a certain limit. The continuous process of deposit-acceptance and corresponding loan-writing results in the creation of huge credit money that is many times more than the real stock of money. Presently, Pakistan's real stock of money that is the currency in circulation is Rs.1.4 trillion, while the total bank deposits are Rs.4.4 trillion. The loans created against bank deposits currently stand at Rs.3.3 trillion. According to the statute, the banks can write loans up to 80 per cent (or so) of their deposits. The credit money - or the ample credit money as described by Alan Greenspan - is the patent and potent inflationary force. Incidentally, the ratio of our monetary assets (total deposits and currency) to currency issued is little more than three to one. This ratio in developed and other developing economies could be as high as twenty to one which means that our economy has great capacity to expand.

The interest based lending system provides continuous fuel to the inflationary fire. The leverage-based business and industry, the world over, have to depend on this system. The targeted business profits factor in the cost of borrowed money which results in constantly rising costs and therefore prices of goods and services. The interest cost is not a one-off item rather it is a cost that recurs on an annual basis.

There is a certain relationship between the interest rate and the rate of inflation. The interest charge also gives rise to the stock of credit money.

Islam has forbidden the use of interest in all types of business or personal transactions. We all take pride in this Divine proclamation, but have hardly been able to come up with our own interest-free system.

What is being currently done in the name of Islamic finance and banking is simply the creation of a differently designed workplace on the western economic plane. It will take centuries' hard work to evolve a competitive economic system that is free of interest and most importantly, practicable.

To sum up, we will have to learn to live with the curse of inflation. Fiat money, credit money and interest system provide sustenance to the market capitalism which hugely relies on the theory of continuous expansion. It focuses on consuming natural resources and producing goods and services irrespective of their utility to the mankind. The expansion euphoria generates false money that keeps on reducing the purchasing power of the real money. The process inevitably keeps wages and prices on a rise without any material value addition to the quality of human life. The entire system ensures continuous degradation of man and money besides creating a false sense of rising standard of living. How can I feel better off when I have to spend Rs250 today to buy a kilo of beef that I used to get for just Re.1 while I was a 10-year school boy?