Wednesday, 17 November 2010

Where Does Debt Come From?

As the Government looks to cut funding to Higher Education Institutions, graduates are instead being asked to pay for the void Messieurs Cameron and Clegg have left them with. With the possibility of student debt rising to £40,000, students have been vociferous in their response against the hikes in tuition fees. The previous article called to students to make a rational response against the proposals and tackle the issue by confronting the core problem of debt. But before addressing this key matter, it is important to understand why we have debt in the first place.
There is a common saying that ‘money makes the world go around’, yet it is astounding how little the general public know about it. We generally see money as a means by which to purchase commodities, and something readily available to us from the ‘hole in the wall’. However what does our money really represent and where does it come from? Only once we are able to answer these questions can we move on to understand why debt is so ubiquitous in our current economic system.
The roots of our modern banking system can be traced back to the 17th century, where a customer would deposit his gold coins (which was state money at the time) to the goldsmith for safe keeping, and in return the customer would receive a paper ‘bearer receipt’ for this. The goldsmiths would charge the customer a fee for keeping the gold in their vaults, and upon presentation of the ‘bearer receipt’, the goldsmith would have to give the customer their gold.[1]
Rather than going to the bank to obtain their gold deposits for purchasing goods, customers found it more convenient to purchase commodities by handing over the ‘bearer receipt’ to the vendor of the goods so that they could withdraw the deposits if they wished to do so. This system of purchasing became quite popular, and so, more people began depositing their state money with goldsmith, and then trade with the ‘bearer receipt’. As these receipts remained in circulation for a long time, they eventually became money. Thus, a situation emerged where two types of money began to exist; ‘state money’ being that of gold coins, and ‘bank money’ consisting of paper receipts issued by the goldsmiths.[2]
The goldsmiths realised that with so many people depositing their gold and trading in receipts, they had large amounts of gold sitting idle in their vaults. They decided that it would be in their favour to lend this gold to people of reputable stature at interest, so that they could obtain some return on their deposits. When lending gold to investors at interest, the goldsmith had to be cautious on the amount of gold he was lending. He would have to keep enough gold to meet the requests of depositors who wanted redemption of their receipts. Naturally, there would have been instances where customers would make huge withdrawals in one day, forcing the bank to close its doors to the public. This would then lead to a lack of confidence in the system, causing the infamous ‘bank run’. The key word here is confidence; so long as the public believed that they would get their money on demand, confidence in the system would remain high.
Most of the time, however, withdrawals would generally be relatively small, and so, banks could afford to lend most of the deposits in their possession. The amount of money the bank should keep against the value of receipts it issued is what is known today as the ‘fractional reserve’. Some argued that this ratio should always be 100%, in which the amount of gold in its possession would equal the value of receipts it issued. This meant that the bank would have always been in a position to meet requests for withdrawals. Others however were tempted by the lucrative nature of having a reserve as low as 20%, such that if a bank had £1000 worth of gold, it would keep £200 for honouring withdrawals, thereby allowing it to lend £800 at lucrative interest rates.
It later became apparent to bankers that they didn’t have to physically loan out the gold in their possession, as the receipts they issued equally had the power to purchase goods. Therefore, supposing a banker had £1000 of gold in his vault, if he operated on a reserve of 20%, he could print receipts to the value of £5000, giving £1000 worth of receipts to depositors, with the remaining £4000 being used for loans. This was a crucial development, as it gave the banker the power to ‘manufacture’ money out of nothing, and at little cost. It also illustrates how the bankers had a firm control on the supply of money in circulation.
In 1844, Robert Peel passed the Bank Charter Act which aimed to prevent banks from printing money in excess of their gold reserves. However, the banks tried to side-step this piece of legislation by creating the cheque and account system, which would allow them to retain the power of creating money. Let us assume there are two customers of a bank, A and B, each of whom has a zero account balance. A wishes to buy goods to the value of £100 from B, and so writes him a cheque for that value. The bank credits customer B with £100, whilst customer A is in overdraft to the value of £100. In this way, the bank again has created £100 out of nothing. From this we can see that one group of customers must always be in debt to an amount that equals the supply of bank money. Moreover, if A repays his debt by depositing a cheque of £100 drawn on customer B, then money is essentially destroyed.[3]
By understanding the evolution of modern banking, we can appreciate the situation today in which the Bank of England prints paper money and the commercial banks create money in the form of electronic credits. Modern day currency is not associated with a commodity such as gold, but in reality is just a piece of paper. Thus, we have gone from a situation in which state currency was in the form of gold and bank currency in the form of paper, to today where the central bank prints money is in the form paper and commercial banks create money in the form of electronic credits. The principle theories, upon which early banks operated however, remain the same. Banks still operate on the fractional reserve system, they lend money and profit from lending through interest, and they have the ability to create money out of nothing. Furthermore, the amount of bank money in circulation must balance with amount of customers in debt. As we have illustrated above that banks create money through debt, repayments of loans are not in the bank’s interest as this destroys money, and a decrease in money supply leads to recession. Hence, debt must always exist.
With such an economic model, the cycle of economic boom and bust cannot be prevented. It is a fact that we will have periods of a false sense of security leading to ‘economic growth’ when money supply is high only for such periods to be followed by periods of recession in which people struggle to repay debts ultimately due to a lack of money supply.
Such an economic model can have serious consequences, not only to the individual, but also to small businesses, larger ones, and even nations. The dangers of such an economic model were highlighted by Thomas Jefferson:
If the American people ever allow the banks to control the issuance of their currency, first by inflation then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers occupied. The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs. I sincerely believe that banking institutions are more dangerous than standing armies.[4]
Relating this to the situation of British students, it should be apparent that merely calling for the abolishment of planned hikes in tuition fees does not answer their problem of debt. Even if they manage to have the motion repealed, they will still be in debt when they graduate, and will continue to be forced into further debts when they start their climb on the housing ladder. Having students start their adult lives with high levels of debt works in favour of the current economic model, and also helps to understand how debt has become the norm, and not the exception, in our society. Perhaps the problems of our current banking system are best summarised by Robert Hemphill:
We are completely dependant on the (centralized) commercial banks. Someone has to borrow every dollar in circulation, cash or credit. If the banks create ample synthetic money (through the fractional reserve system) we are prosperous; if not we starve. We are absolutely without a permanent money system…It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon”[5]
When one takes time to reflect upon the nature of our current banking system, it should become quite clear that the issue of debt is something which affects us all. But with students being amongst the most vulnerable in this economic system, the nature of their response against the hikes is quite important. Protesting against the hikes, whether performed peacefully or violently, will not lead to an end in debt. The ultimate solution to putting an end to the huge sums of personal debt we all face is to question our current economic model which essentially functions on the creation of debt. Students should initiate a public debate by putting our current economic model on trial against an alternative paradigm which isn’t based on debt creation. By doing so, they will be taking the first steps to help ease the suffering of many throughout the world who have been crippled by debt.
[1] Tarek El-Diwany. Travelling the Wrong Road Patiently. Viewed on 14th December 2010
[2] The Problem With Interest. Tarek El-Diwany. (London:Kreatoc, 2003) pp36-37
[3] Tarek El Diwany. Why Are We All in Debt (youtube Video). Viewed 14th December 2010
[4]Thomas Jefferson. Autobiography, Correspondence, Reports, Messages, Addresses and other Writings. the Writings of Jefferson, vol. 7. 1861, p. 685
[5]Irving Fisher. 100% Money. 1935, p. Foreward

Monday, 1 November 2010

Tutition Fees and Student Debt. Are Students Asking the Right Questions?

Current protests by students have managed to revive student activism reminiscent of the 1960s when ‘student power’ was at its peak. This is of course all thanks to the recent proposals to increase university tuition fees which has ignited the anger of the UK student population, the results of which is clearly evident across various news stations. The National Union of Students (NUS) have issued a number of statements against these proposals; the current President of the NUS, Aaron Porter, accused the Government of betraying a generation saying that the NUS will “resist proposals to increase student fees” based upon the ‘principle of fairness within and between generations.[1] Even prior to Aaron Porter, the Federation of Student Islamic Societies (FOSIS) represented the Muslim student viewpoint highlighting the negative attitude Muslims have towards usury which in turn will ‘derail accessibility to higher education.’[2]
Many higher education establishments have, however, welcomed the proposals citing that they will help maintain and enhance their world-class status. Aside from hiring the finest academic staff, universities also need to have funds available to pursue innovative research with the ultimate aim of bettering the society that we live in. 
Although such aims sound noble, a balance must always be maintained, and thus, the anger from the student population is quite understandable. In the current climate, graduates are leaving university in debt only to find themselves confronting a lack of graduate jobs. Combined with the ever increasing material pressures such as scaling the property ladder, how can graduates possibly negotiate the turbulent seas of the property market without a decent income which allows them to save for the dreaded down payment, only to be told that they are going to have to pay even more for their education? Put another way, is it fair for a graduate to start off in debt, and then seek debt only to be told that they are going to be put in even more debt?
The argument against the hike in tuition fees centres around the notion that universities will become a place for the elite few, and for everyone else, they’ll simply have to calculate what the alternatives to higher education are. Ultimately, there may even be a near-complete stagnation in social mobility, as people from poorer backgrounds may be put off from pursuing a higher degree due to the price tag associated with it. Mr Porter, in an article for Channel 4 news[3] stated that the proposals to increase tuition fees will leave students starting their adult life with debts in excess of forty thousand pounds. Mr Porter’s argument centres around the injustices to the new generation, with cuts in child benefit, poor job prospects for graduates and difficulties in getting on the housing ladder. From his article, one concludes that it appears as if the upcoming generation are being forced to shoulder a significant proportion of the National debt, which is the result of the irresponsible behaviour of the generation preceding them. 
The student population must evaluate its response to the proposals put forward by government very carefully. They’re quite right to be questioning the proposals put forward by the Coalition Government, as the very people who are putting forward these proposals were themselves paid to go to university in the form of grants. A few years later, the grants were withdrawn and loans became available to students. A further few years later a flat rate university fee was introduced and more recently, top-up fees were added to the bill. If the student voice does not identify the crux of the issue, then indeed, things are likely to get worse. By ignoring the core underlying problems associated with an economic system based around debt and money creation, cuts to public spending will continue and the public will be asked to pay.   Universities are renowned as places where students can freely discuss political ideas and develop their own views on the way society should be run. Perhaps the time has now come for university students to seek a solution by highlighting the problems with our current debt-based economic model, and how an alternative economic paradigm might address some of these issues.  
Although the emotive nature of the situation is understandable, leaders of Student Unions need to closely analyse the problems facing them by firstly asking, why has the Government proposed to raise tuition fees and how is this a problem to students? The answer, as the Prime Minister repeatedly states, is the national deficit. This clause has been the justification of a number of cuts in public spending, including cuts to higher education. In return, the Government are asking graduates to plug the hole that they are leaving Higher Education with by paying more fees. 
But why does the deficit even exist in the first place? The response to this lies in the continually increasing national debt that requires the Government to strike a fine balance between paying the debt off whilst keeping enough of a fiscal stimulus (where the government borrows money and spends it) to keep the economy growing. Based upon this very simple principle it is quite clear to see that the central problem is that of debt. The Government has substantial money owing, and some of the ways in which it intends to pay it off is by cutting spending and raising tuition fees, which in turn will put students into deeper amounts of personal debt. Based upon the current state of affairs, it is prudent to ask what students are aiming to achieve by campaigning against the agreed hike in tuition fees. If one supposes that their campaign is successful, will that solve their problem of personal debt (let alone everyone else’s)? Furthermore will such success be a significant actor in reducing the issue of national debt which continues to hound even the poorest of citizens?
When campaigning against the proposed increase to tuition fees, students need to focus their argument on the issue of debt as it seems quite evident that focusing on the key issue may bring about a lasting change as opposed to temporal solutions, and thereby encouraging the rest of the public to begin asking questions about an economic system which is based upon the concept of constantly owing monies. Why is it that we have now reached a point where being in debt is considered to be the norm instead of an exception? Is it right, for example, that a house should have an ever increasing price tag which overburdens graduates and others alike, and that the only way in which one can own a home is through a financial vehicle which not only places the buyer in arrears, but with the lending institution profiting from the buyer’s lack of wealth? 
A large amount of graduate debt is a bleak reality for many students, including the vast majority of Muslim students, and so, perhaps students as the next generation who shall reside and govern this country need to take the lead role in asking us to re-examine our perspective towards debt, that it should be a last resort and never the norm. Students must address this issue amongst themselves before raising the issue with the wider public so as to produce a unified response. An article from the Times’ education supplement in 1997 talks about how “expenditure on leisure is now considered an essential part of being a student and the increased credit available has made this possible.”[4] Whilst it is perfectly acceptable for students to enjoy their time in education (in a way that upholds the superior Islamic morals and values of course), they must do this within their means and not through credit. For the rest of us, there is no harm in enjoying the pleasures of life, provided of course we are not putting ourselves into debt by doing so. Adopting such an attitude leads to moderation and avoids the dangers of excess. God, with His most divine wisdom commands, 
“O Children of Adam; wear your beautiful apparel at every time and place of prayer: eat and drink: But waste not by excess, for Allah loves not the wasters.”[5]
Perhaps it is a little ironic for the student population to be clamouring about the ills of a debt-based economic model, when in fact for years students have tolerated being in arrears during their studies. With such an emphasis on having a good time at university, which obviously costs money (let alone the physical and spiritual impact on themselves), many students have to add all those nights out to their education bill alongside their books and stationary. A loan in combination with an interest free overdraft existed to take care of this. However, a decade ago, the student voice remained silent about the so-called need to take out such loans and overdrafts; perhaps the reason for this was that they had the comfort of knowing that there were plenty of jobs available which would help them to pay their overdrafts and loans off in a relatively short space of time – a perception that even then was self-defeating. Accordingly, I strongly assert that one of the reasons for the rise in tuition fees could be the result of silence from student voices on the issues surrounding starting life as a graduate in arrears, and then continuing to be in debt throughout life. Their silence may have been deemed to be tacit approval of such a system, and moreover, the attitude of the student population at large that living in debt is acceptable may help to explain why we have seen a paradigm shift from being paid to going to university to the current situation of paying ‘top-up’ fees. 
Indeed, the issue of debt is something that affects every member of society – we are all coaxed into the system, from house buying and car financing to credit cards and personal loans. One may argue that given the fact that debt has become such an ubiquitous entity – essentially the norm, we need to learn to live with it. Students too, must learn to be part of this system. A response to this viewpoint can be answered with the analogy of our recent swine flu epidemic. Here was a virus which affected a huge number of people, although the majority of adults with robust immune systems were able to withstand the effects of the virus. Children with weaker immune systems however suffered greatly in this epidemic. Our current debt crisis can be likened to an epidemic which is affecting us all, but more so our students and graduates – or children who do not have the robust immune system of the older generations to overcome it. They should be calling for a solution to these problems, and the solution to overcoming debt is not (and can never rationally be) to create even more debt. 
Muslim students have to negotiate all the dilemmas mentioned above alongside maintaining their theological stance that interest is a major sin. It is quite right for Muslim students to air such a concern although perhaps Muslim students too are as guilty as their non-Muslim colleagues in remaining silent for too long. The issue of Muslim students taking student loans isn’t a new phenomenon, indeed, many Muslim students have been forced to take out such loans in previous years. Furthermore, if banks began to offer fraudulent shari’ah compliant student loans (in which interest was hidden under an Islamic guise) to Muslim students in response to hikes in university fees, would that be deemed as an appropriate way in which to address their disapproval in dealing with interest? Perhaps Muslim students need to start promoting an interest-free economic paradigm, and possibly collaborate with other groups on this issue who also understand the dangers of a system bathed in debt and interest. Only by pushing to raise awareness about this dirty bath can we begin to discuss how to cleanse it.
The next article shall discuss the current economic model and how it immorally relies on the mass populace to remain in debt, God willing. Subsequent articles shall, by the will of God, discuss the depravity of such a system as well as tangible and systematic ways in which we can bring about change.

[1] Aaron Porter. Higher tuition fees: a generation betrayed and a case not made. Viewed on 14th December 2010
[2] FOSIS Press Release. FOSIS disappointed with Government Proposals for Higher Education Funding. Viewed on 14th December 2010
[3] Aaron Porter. Student debt: the £40k question for Lord Browne. Viewed on 14th December 2010
[4] Hannah Baldock. Students Prefer Bar to Rally (Times Higher Education). Viewed on 14th December 2010

[5] Surah al-A’raaf 7:31