Islamic banking is not "interest-free"

But it does present some challenges

One of Pauline Hanson’s (I know, *groan*) latest crusades is against Islamic Banking – something that she refers to as providing “interest-free” loans to Muslims while Australian families struggle to pay their mortgages. Sorry to burst your bubble Pauline, but that’s not how it works. Even though charging interest is technically forbidden under Islamic law (interestingly, the Christian Bible forbids it too, but this is conveniently overlooked in most ‘Christian’ countries), borrowers still have to pay an equivalent premium/ mark-up. It is simply that Islam does not consider money to be a commodity and therefore should not have additional charges on top of it, but the ASSET that the money is financing CAN have a premium/ mark-up attached to it. Consequently, in the case of a mortgage, whereas a conventional Western bank will lend someone money to buy a house and the money is paid back over time plus interest, an Islamic bank would buy the house FOR the person, then sell the house to the person for a mark-up/ premium, to be paid back in instalments over time – a semantic difference that allows compliance with Islamic law. It is NOT interest-free in the way Pauline Hanson is trying to suggest.

Furthermore, Islamic CORPORATE banking actually focuses more on a borrower’s investment intentions from an economic, social and environmental perspective before lending to them, rather than focusing on the borrower’s credit rating as is done in conventional Western banking. This is arguably a more efficient means of allocating financial resources to their most valued uses.

The government has already started adjusting the tax system so that Islamic banking is treated consistently with other banking and not given any unfair tax advantages. Nor do I see any reason why non-Muslims wouldn’t be able to use Islamic banking services too, if it suits their circumstances better than conventional Western banking. After a quick Google search, I couldn’t find any example of non-Muslims being refused access to such financial services. But even if there were such examples, I’m sure Australia could arrange it so that everyone is allowed access. And surely a bit more competition in Australia’s financial industry would be a good thing.

Islamic Banking is also a relatively ‘small’ ($1.4 trillion – yes, trillion – in global assets) but rapidly growing market internationally. Australia would be foolish not to accommodate such a market – think of the foreign investment we’d be able to attract, the major infrastructure that could be financed. I know, I know, I can already hear the people saying “what if it finances terrorism? … what about how Australia is selling off too much of itself to foreign powers … etc. etc. etc.”

First, money laundering and terrorist financing is actually a legitimate concern with Islamic banking (even the IMF recognises this) – not because Islam is associated with terrorism so often, but because so much of the international anti-money laundering and counter-terrorist financing standards are tailored to the structure of conventional Western banking systems, not Islamic banking systems. Consequently, there may be loopholes in Islamic Banking that can be exploited by money launderers and terrorists – Muslim and non-Muslim alike. Again, not because of any association between Islam and terrorism, but because Islamic banking is an emerging, less well-understood and less well-regulated (or rather, regulations haven’t been tailored to their unique features and arrangements) industry. There remains no evidence that money laundering and terrorist financing risks in Islamic banking are any higher than in conventional Western banking. Even so, for the above reasons, this is something that regulators in Australia and internationally would need to investigate further, and I have confidence that any loopholes in Islamic banking for money launderers and terrorists could be identified and mitigated.

Second, we have government institutions responsible for assessing foreign investment bids on the basis of security, competition, etc. Therefore, if you’re worried about Australia selling its soul to foreigners, your anger should be directed at these bodies, not Islamic Banking specifically. And if, like most people I believe, you are not opposed to any and all foreign investment in Australia, then you can’t treat Islamic investment any differently. And if you’re entirely opposed to foreign investment, full stop, then that’s a conversation for another time.

One possible interesting challenge I do foresee is for the RBA to accommodate Islamic Banking. At the moment, the RBA manages economic activity by (among other things) trading short term assets so as to adjust interest rates. The benefit of interest rates is that they, directly and indirectly, affect such a wide range of economic activity that they can be quite effective at managing economic activity. The challenge with Islamic Banking, especially if they become a significant component of the economy, is that they may not respond to interest rates if they don’t use interest explicitly.

However, it may be a simple matter of the RBA just trading in Islamic securities in the exact same way, which will affect the size of the premium/ mark-up on Islamic debt in the same way as with interest rates on conventional debt. And Islamic financial institutions could arguably be subject to the same regulatory oversight and capital reserves requirements as other financial institutions. Again, potentially just semantic differences, but something the RBA would have to account for, lest a significant section of the economy grow beyond their influence and oversight, and risk endangering the whole country if it crashes (remember the US sub-prime mortgage market?).

Islamic banking holds great promise, but also presents challenges that must be addressed. But it should not be hindered by the misunderstandings of Pauline Hanson.

Donald Trump makes me a special kind of nervous

And he just won't go away

Most of us know how unreliable individual election polls can be. That’s why I prefer to look at what the polls are saying over an extended period of time (like the graphs here, here, here and here).

After Donald Trump first joined the presidential race in mid-2015, his popularity against Hillary Clinton in the polls rose quite rapidly. But despite this, and even though individual poll results fluctuated plenty, Clinton appeared to maintain a consistent general lead over Trump, even if it wasn’t enormous. However, in late July this year, after the Republican and Democratic Conventions, Donald Trump’s popularity in the polls took a big hit. And yes, I gave in to temptation and started believing that this represented a new solid underlying trend - that the Trump train had finally been derailed. But he quickly recovered in the polls again. Woops!

A lot of politicians have made me nervous before, but it’s usually relating to social issues – their attitude towards women (e.g. abortion, contraception, or just general snide remarks), the influence of religion in public policy, LGBTQ and other minority rights, etc. And while it’s easy to note the times Donald Trump has met this criterion, my quickness to grasp on to anything that suggests the Trump phenomenon is over is because he is the first ‘politician’ to truly make me nervous from an economic perspective.

Let us review:

• He has sympathised with the idea of the US returning to the Gold Standard – the Creationism of economics (more to come on this in subsequent blogs)
• He plans to reduce the top income tax rate from 39% to 33%, followed by just two other rates – 25% and 12% (see video here). This is a policy which will worsen the US’s debt situation by incredible magnitude. Seriously, it is delusional to think that cutting US tax rates like this (the US is already the 4^th lowest taxed country in the OECD), in a way that further benefits the rich, will give the necessary boost to economic activity and not cause government debt to balloon. This kind of ‘trickle down economics’ simply does not work
• He has threatened to walk away from the North American Free Trade Agreement (NAFTA) if he doesn’t get it re-written the way he wants, and criticises Mexico and China for taking American jobs – and one has to consider whether this is just an objection to specific aspects of specific agreements, or part of a wider anti-globalisation push that will make the US more insular
• He has threatened to partially default on the US’s debt obligations, or as he puts it (in my best Trump accent), “make a deal” with the US’s creditors – I don’t even know how to begin explaining why America defaulting, even partially, on its debt obligations is a very very very bad thing
• And if this fails, they can just “print the money” – that’s right, Trump actually suggested instructing the Federal Reserve to just print money to pay off government debt. That is called ‘helicopter money’ – and not even the ‘good’ kind that is transferred from the Federal Reserve to the government and spent on good productive things like infrastructure. Even the Federal Reserve, during the height of their unprecedented quantitative easing measures, weren’t bold enough to go as far as helicopter money
• He has had a go at NATO and threatened to stop supporting the US’s allies unless they meet their financial obligations – who does he think he is, the mafia, charging the local shopkeeper for protection money? Such hostility to one’s own allies could not only violate international treaties and seriously mess with global stability, but also sour current and future trade and investment relations
• And then, of course, there’s the deportation of about 11 million illegal immigrants, on whose labour a significant amount of economic activity is dependent – hundreds of billions of dollars potentially (a significant chunk in agriculture, construction and service occupations), not including the additional hundreds of billions needed to deport them (immigration agents, lawyers, support staff)

And what’s worse is that he’s dropping these comments as the potential leader of the wealthiest and most powerful country in the world. An economic stuff-up (or several) in the US has far greater implications that one in, say, Bhutan. America, you may be disenchanted with the current political establishment and desperate for a ‘new kind of politician’. Just remember how many other lives would be affected by this ‘change’.

Brexit

I hope Britain knows something that the rest of us don’t

I have to admit I received a dark satisfaction watching the Brexit saga unfold – not out of any malice towards Britain, but rather from the fact that this was yet another major global development that could make this period in time – and my youth – one the most (academically) fascinating economic and political periods in the last century. And while I may be a little late to the party in terms of my own analysis of Brexit, the past 2+ months has allowed cooler heads to start prevailing in their assessment of what this event could really mean for Britain’s economic and financial place in the world, and for the world itself.

Let’s get the obvious out of the way – I still maintain that Britain made a mistake in electing to leave the EU. While the immediate panic following the Brexit announcement appears to have been an overreaction (the British stock market recovered fairly quickly), the long term impacts are, in my opinion, very real and very significant.

London risks losing its global financial centre status to a mainland city such as Brussels (which is already the unofficial capital of the EU), Frankfurt or Paris. London used to be THE major financial centre in the world (after Antwerp in Belgium), and still arguably remains the most significant, but there are many other competitors, including New York, Singapore, Hong Kong, Tokyo and Zurich – and London’s status is not necessarily set in stone. London’s financial centre status does have history on its side, and as it stands, all that financial services activity in London can do business directly with Europe without barrier. For many, London is merely the headquarters for their wider European and global operations. Until now, there was never really a reason to LEAVE London. But now that Britain is leaving the EU, all that activity has a reason to leave and set up somewhere else where they are guaranteed access to Europe.

These losses to Britain could be far larger (albeit harder to quantify) than the losses just from having to renegotiate trade likely onto less favourable terms, which the IMF estimates at around 3% of real GDP, the OECD at 5%, The Economist at 6% and the London School of Economics and Political Science at 8% (quite a spread here and elsewhere, but pretty unanimously in the negative). But I don’t think these estimates account for the longer term impacts of financial services activity (reaching 10% of British GDP in 2009 – more than any other G7 country – though declining in recent years) actually leaving London altogether.

It may take decades, but this could turn Britain back into a traditional manufacturing and agriculture economy – great for these industries (and possibly also tourism on the back of a weaker exchange rate), but by their nature, they are lower wage industries (to compete with developing countries who can do such activities just as well) and therefore, will bring a permanently lower standard of living to Britain than the white collar/ service/ technology/ knowledge based industries to which Britain should be home. And this reality may remain unless/ until there are higher-wage industries to replace them.

Even if Britain somehow stays in the EU (referendums are, after all, not always legally binding – recall Greece’s recent referendum), these higher-wage finance businesses are possibly now sufficiently spooked about Britain’s future hostility that they may start leaving anyway. And I don’t think the EU will let Britain back in for a long time. Or if they do, it will be with big punishments to deter other countries from trying the same – just like Greece had a referendum to reject one of the EU’s bailout packages (they deemed the attached terms and conditions to be too harsh), but ended up accepting it anyway, along with even harsher terms and conditions for playing that defiant card.

I don’t like to bet against Britain, but they are taking a tremendous risk with this decision, in the hope that outside the EU, they will be able to achieve something great – greater than they would be able to within the EU. Within the EU, Britain already had the best of both worlds – an independent currency, its own central bank and interest rate policy, access to the European common market and the power and influence to encourage the EU to become even better. To be fair, the EU is a big inefficient lumbering beast – but it will get better (surely it can’t get worse). And when it does, Britain had best hope they have re-discovered some serious mojo for themselves – because the EU may not be in a forgiving mood.