Contradictions in Pakistan’s Monetary System

Posted on June 13, 2009
Filed Under >Kathay Kalame, Economy & Development
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Kathay Kalame

Here are a few facts relating to central bank anchored fractional reserve banking system prevailing in Pakistan. It ( Central bank + private banks ) has a monopoly over the issuance of money, i.e. money supply. Even though money supply is measured as currency and deposits in the banking system, new money is not created by increase in deposits, it is created only when a new loan is made out by the banking system.

So there is contradiction number one. Money is measured as currency and deposits, but new money can only be created through making out a new loan.. This contradiction is apparently resolved by arguing that since the freshly made loan immediately appears as a deposit in the borrowers account, deposits rather loans are used as a measure of money supply. In my view this is just a very clever way of masking the fact that entire money supply of Pakistan is one giant loan at an usurious rate of interest–historically ranging between 8-18%. The weighted average rate of interest on the outstanding domestic bank debt currently stands at around 13%.

This one giant loan has to be repaid with interest (13%) over an average period of about 5-7 years. At a 13% interest rate, total repayments on a Rs1, 5 year term loan would be Rs1.39, assuming five annual principal repayments.

When a loan is made the money supply increases only by the principal amount of the loan, the interest component (Rs 0.39 for every rupee) is not created as money supply at the time of lending. In other words not enough money exists to repay the interest component. Therefore the system has to make additonal loans to create the money supply to pay interest on the past loans. However, these additional loans will have their own interest component which is absent from the system. That is contradiction number two. Hence, the overall loans within the system have to keep on increasing exponentially to keep this system going. If the rate of new loans creation or the rate of growth in the money supply falls below a three year average interest rate, the economy will experience a recession brought on by a money shortage. Or more accurately, a shortage of new loans to service the old loans.

The end result is that system wide debt keeps on increasing, always as a function of its base, i.e. at a percentage growth rate. A process known as exponential growth. And this is exactly the part not grasped by most. One of the greatest failings of mankind is their inability to truly grasp the true nature of exponential growth. Allow me to illustrate this with an example.

A billon rupees compounded at a 14% interest will double every 5.29 years. In 25 years it will be 25 billion and in 50 years Rs700 billion, Rs18.530 trillion in 75 years and in a hundred years Rs490.326 trillion. Every 25 years it grows by a factor of 26 !!! Now since the economic growth rate seldom exceeds 6-7%, GDP will double every 10.25 years. Suppose the base economy was Rs1 billion as well then in 25 years it will be 5.43 billion, in 50 years Rs30 billion and in a hundred years Rs868 billion. I suppose it is clear where this trend is headed. Debt creeps intially to overtake GDP in size, and then gallops to a size no longer sustainable by the GDP within a relatively short period in the life of a nation.

The situation in Pakistan is as follows. Pakistan’s GDP in 2008 was US$160 billion, growing at an average rate of 5% for the last 60 years and its total outstanding debt, public and private, domestic and foreign was US$118 billion. The wieghted average rate of interest on Pakistan’s total debt is around 9%. In 25 years at the average GDP growth rate of 5% Pakistan’s GDP would be US$542 billion. Its total debt on the other hand would have ballooned to US$983 billion. In 50 years the situation becomes more interesting. The economy would have grown to US$1.8 trillion and the debt would have grown to about US$8.4 trillion. So between, 25-50 years from now the current monetary system would force a system wide bankruptcy. Since Rupee is not the reserve currency of the world, I doubt if the country can sustain total debt of more than 200% of GDP. At current rates that is likely to happen within 25 years. As a nation, we do need to look at least 25-50 years forward. In fact we should be looking a 100 years out. However, let make the leap from a 1 year horizon to a 25-50 years horizon first.

The crisis that US Europe and Japan are facing has been brought about by these contradictory dynamics of the monetarty system. They are at crisis point today because this system has been running in their economies for almost a hundred years now. Pakistan will reach the same crisis point in the not so far off future.

Here is a fact Pakistan’s monetary system is also the standard in almost every single country in the world. And here is the problem, the logical end point of this system is disaster. Are we then doomed. Or is there is a solution. The goods news is that there is a solution and further good news is that it is not new. It has worked remarkably well in the past and some of the evidence of the abundance it generated can still be seen standing today.

Photo Credits: Ghayour

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15 responses to “Contradictions in Pakistan’s Monetary System”

  1. Zechariah says:

    I am so glad that someone in Pakistan knows this about this sham system which has put the whole world in perpetual debt Countries have the right to print interest free currency but dont and instead the central bank lends that money with interest.

    This system also exists in Saudi Arabia and they are an “islamic country” I hope the people wake up to it as the Pakistani people I talk to they only ignore my point but also call me a conspiracy theorist – pathetic to say the least.

    Now I wonder if someone like Imran Khan knows this system deeply and wants to change it because if not (doubt he will go against the international banking system) the root cause of ills is still there.

    The whole system is about to crash at the time of this writing and the writer of this article will surely understand what I mean by that.

    The banks and the whole system is totally bankrupt. 5% of EU country defaults bankrupts the whole Euro system.

  2. Owais says:

    We know that the fractional reserve system is the biggest problem ??? Watz the solutions ???

  3. Sameer says:

    I thank you for the effort that you have put into writing this. Since your intension is to reach the masses, I would suggest that you, sort of, create a small documentary in plain Urdu for the masses to understand. We, the readers are nothing but a niche of a handful in the so called 16 Crore out there. A revolution will not be brought by 1 but yes education can be, which might induce a ripple.

    To reinstate that let me give you an example

    have a go through and think in the lines of, this is the level that is required for a Learned population to understand this concept. What about the not so fortunate. How would we convey this to them. Where I can help is in offering and asking others to join in and fund this documentary. The content will be the biggest problem, as we have to see to it that its easily digestable to the public.

    May Allah bless you.

  4. KK says:

    @ Azhar Aslam

    A follow up article will deal with the subject of solutions, shortly.

  5. azhar aslam says:

    Kathay Kalame

    can u please write abo the solution you propose ? i would be greatly interested and grateful for a dialogue. my email is rgds

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