Fall Of Capitalism and Rise of Islam by Mohammad Malkawi

Before describing the aspects of the virtual economy, let me draw a parallel concept which exists in computer systems. Analogy helps understand the scope and the significance of the problem.

In the earlier days of computer systems, memory devices were very expensive and their sizes were relatively small. For example, 1 megabyte of memory (RAM) cost more than $10,000! It was almost impossible to build a computer system with say 100 megabytes (memory would cost more than $1 million). The smart architects of computer systems invented the notion of virtual memory. The idea was to create the illusion that the memory was virtually large (say 100 gigabytes). The illusion is made possible by using the relatively inexpensive and large storage provided by hard disk space.

The concept of virtual memory works under the assumption that user programs do not need to reside in the main (expensive) real memory all the time. A small portion of the program will reside in main memory, while the rest of the program and its data reside on the cheap but large disk space. Over time, pieces of the program and data will be swapped back and forth between the memory and the disk. The user will never know that the memory is too small to hold her program. For the user, the memory has a virtually large size. She is happy and can execute larger programs using much smaller real memory; it is an illusion, but a nice one. Of course the computer system may crash when a greedy program begins to use more real memory than the system actually has. This concept is known for computer architects as thrashing and they are well aware of it and have come up with different ways to cope with it or prevent it altogether. Now, where is the analogy in the economic system?

The simplest financial economic analogy to the virtual memory concept is the credit card system. Take the example of a family with a monthly income of $3,000. The family pays $2,500 as a minimum payment on their debt balance, which could be $360,000 including the payments on a house, two cars, and holiday shopping. The actual real wealth of the family is $36,000 a year (36 megabytes in computer analogy); this amounts to $360,000 over ten years (similar to 360 megabytes of virtual storage). Instead of using the real wealth of $36,000 a year, the family uses the extended (virtual) wealth of ten years ($360,000). In reality, the $360,000 does not exist at the time when the family begins to use this large virtual money.

The bank supported by the Federal Reserve steps in and allocates the large amount of money in anticipation that this money will actually be generated over time. If all goes well, the family continues to earn $3,000 a month and continues to pay their minimum payments; then everything goes smooth and the difference between what is virtual and what is real will not surface to cause any problem. The family continues to happily live with the illusion of $360,000 virtual wealth.

But when something goes wrong, such as a layoff of the working member of the family, which is not uncommon, or a serious health condition occurs and consumes more money than what the insurance company pays resulting on more healthcare debt, or any other reason, then thrashing will take place. The virtual capacity of the family evaporates, and the assets acquired with virtual memory may also vanish. In fact, the collapse of the virtual wealth of the family may affect the absolute real wealth of the family, such as a land owned through inheritance! This type of scenario occurs all the time, and we all know many real-life examples. One outstanding example, which was reported in the media, is the case of the billionaire Donald Trump. He is used to running projects sizing in billions of dollars, and when he fails to meet the demands of the creditors, he files for bankruptcy135.

Figure 22 shows the growth of the virtual wealth (proportional to the debt), while the real wealth (proportional to income) remained almost steady for more than thirteen years. Note how the home-related debt has increased from $120,000 to $183,000 per family while the corresponding income remained unchanged over the same period.

At the larger scale of the economy, where corporations, factories, and all types of enterprises interact and function, the concept of virtual wealth is similar to the examples above but much larger in scale. Over the years, the virtual economy under capitalism became the most dominant part of the economy which has almost totally masked the real economy. In fact, the virtual economy has become so prominent that the political leadership warns against the possibility of pushing the economy down from the virtual values to its more real values.

In a statement made to a congressional committee on April 3, 2008, the Fed Reserve chief Bernanke said99,

If Bear Stearns had been allowed to fail, it would have led to a chaotic unwinding of Bear Stearns investments held by individuals and other financial institutions. Moreover, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability.

Note how Bernanke alludes to the protection of the real economy as the objective cited for protecting Bear Stearns from failing.

In an article published by the Newsweek, October 11, 2008, Daniel Gross writes100, “Back in 2002, Apple’s stock was trading far below the level of cash on its books, ascribing a value of zero to its brands and products, compared with several billion at the height of the boom.” Note how the statement refers to the existence of two views of the economy: a real economy which is reflected by the level of cache on corporate books and an inflated, exaggerated view which is reflected in the current stock values of the market; in this case the virtual value was observed to be below the real value.

Virtual economy (VE) is strongly related to the failure of the financial capitalist system as being witnessed today. VE allows the economy to appear much larger than its real size. As in the case of virtual memory computers, virtual economy is based on the assumption that the real money will not be tapped into, and therefore, it is possible to deal with an assumed larger (virtual) value for the money.

Recall that one of the main principles of capitalism is related to the definition of value of products. Product value under capitalism is a measure of the relative benefit of a given product or its relative exchange value compared to the benefit of other things; in case the exchange value is relative to money, the value is known as the price. Hence, the foundation of capitalism allows the existence of a virtual relative value for products instead of a real value which people can always refer to. As such, in the market economy, it is possible for the value of a given segment of the market, such as oil, to fluctuate between two extremes in a short period of time. The definition of value under capitalism allows for this fluctuation to occur depending on the current conditions. Economic, political, and social conditions would act as a trigger which causes the values of various products and market segments to fluctuate and create turbulence which potentially can cause a total collapse.

Virtual economy organization (similar to virtual memory organization) provides two views of the economy. The first is the real value of commodities and services in a given economy which corresponds to the real economic growth and production. The second view of the economy represents the virtual imaginary value of the market. The virtual values of the market are typically measured by the exchange value which is the monetary value or the price.

A virtual economy system, similar to virtual memory systems, is bound to crash (thrash) when the instant demand for finance at any given time exceeds the real value of the real economy. The current financial crisis in the United States and the world at large is a striking example of virtual economy crashing or (thrashing). Conditions which facilitated the current crash include the overwhelming expenses of multiple wars, the unexpected high cost of hurricanes, and the unexpected high rate of defaults on house loans. The total cost of wars in Iraq and Afghanistan is approaching $1 trillion. Hurricane Katrina added more than $150 billion to the burden of the economy136. The cost of defaults on house loans exceeded $1.5 trillion137. A combination mix of these conditions caused the bill to exceed the real value of the economy which in turn deflated the virtual economy and caused the collapse.

The phenomenon of virtual economy, where the money in transactions appears much larger than the real money, began to surface at the level of state economies at the end of the nineteenth century when financial markets began to take shape in New York. This phenomenon grew to be an integral part of capitalist economies, especially in the United States and Europe, due to four major factors, namely, the stock markets, interest-based economy, the removal of gold as a basis for the monetary systems, and the detachment of monetary growth from real economic growth. At the political front, the cold war between the capitalist and socialist camps in the second half of the twentieth century further strengthened the virtual economies in the West. These conditions are further analyzed in the next subsections.

The stock market activities at the start of the twentieth century created a new phenomenon in the economy, where the wealth associated with stock values grew at much higher rate than the wealth associated with the real economy. When the stock market collapsed in New York in October 1929, the economists attributed the crash to the great difference between the inflated values of stocks and the values of the real assets of the economy. Although economists may not agree on the cause of the 1929-1932 stock market crash, they all admit that the utility stocks prices drove up too high.

The Economist magazine insisted on November 2, 1929, that the stock prices were too high and wrote134, “There is warrant for hoping that the deflation of the exaggerated balloon of American stock values will be for the good of the world.” In other words, the stock values were highly inflated. To elaborate further on this issue, it was found that the stock values in the financial market increased during the period between 1925 and 1929 by 120%, while the economic growth for the same period has not exceeded 17% (an average of 3.5% per year). In 1932, when the market finally collapsed, it lost over 90% of its value. The market returned to its real value which was obviously much lower than what the stock market indicated (101, 134).

President Herbert Hoover concurred that the prices of the stock market were extraordinarily high and that they were nothing but a speculative bubble caused by the mistakes of the Federal Reserve Board. Hoover explained, “One of these clouds was an American wave of optimism, born of continued progress over the decade, which the Federal Reserve Board transformed into the stock-exchange Mississippi Bubble”102. Thus, the common viewpoint was that stock prices were too high.

One similarity between the crash of the 1929 and the current crisis is the rush of economic analysts and politicians to falsely declare the end of the crisis. Leading economists of the first half of the twentieth century such as Irving Fisher and Maynard Keynes declared the end of the 1929 crisis only six months after the crash. Both managed to lose a large portion of their wealth in the subsequent stock market crash.

Aside from all the postanalysis of the 1929 crash, one fact stands straight. That is of the existence of two views of the market: a real one which measures the production rate and the real economic growth; the second is the virtual view which represents the speculative values. In reference to the real economy and its performance, Harold Bierman concludes in his article on the 1929 crash, saying, “There was little hint of a severe weakness in the real economy in the months prior to October 1929.” The high productivity rate during the period preceding the 1929 crash was evident and easily observed by economists. The problem is that the virtual value of the stock market grew at a much higher rate than the production market. The virtual view of the market provided a much higher value than the real one. In the case of the 1929 crisis, the virtual value of the market was more than 90% higher than the real one. The crash (thrashing as known in computer systems) brought the market back to the levels indicated by the real economy before the crash.

Much like the force of gravity which pulls every object back to the center of gravity, there will always be a tendency for the market to return to its real value, which represents the center of economic gravity. A continuous and strong force will always be required in order to sustain a much higher value of the market than its real one, in much the same way a force is always required to keep an object elevated against the force of gravity. The market forces which are used to raise the virtual values of the stock market include speculations, public trusts and confidence, among others.

In 1987 the market collapsed again. Observers noted that the prices of stock market had inflated significantly compared to the real size of the economy. Prior to 1987, the stock prices increased at an exponential rate, where the real economy continued to increase at a more normal rate. The Dow Jones Index rose form 776 points in 1982 to 2,722 points in 1987; that is more than 300% increase over five years’ period. In the same period, the (real) economic growth rate was about 15%, which is roughly 3% per year. The difference between the virtual and real economies was very large. Overvaluation of the stock market has been cited as one reason for the 1987 crash103. The 1987 crash was global. Stock markets around the globe collapsed. The market was pulled back by its own gravity towards the base of the real value of the market.

By the end of the twentieth century, the virtual economy climbed again to reach new peaks which were several times larger than the size of the real market value. The advances in computer technology and Internet led to the creation of what has been known as the “Internet bubble.” The Internet bubble is by far the best example which illustrates the disconnect between virtual and real economies. All a company needed to trade on the stock market at an incredibly high price was the prefix e—for electronic or the postfix.com to indicate its relation to the Internet.

The Internet bubble caused the market to inflate beyond control. Between March 2000 and October 2002, the dot-com bubble crash wiped out $5 trillion in market value of technology companies104. The stock value for some companies plunged from above $100 to below $1. One of the drastic examples is InfoSpace, whose stock dived from $1,305 to $22 per share105.

The most recent crisis which peaked in 2008 was given several labels, the most prominent of which is “economic meltdown.” The meltdown term refers to the loss of more than $15 trillion over a very short period of time. The Dow Jones Index reported a loss of more than $500 billion in one single day. John Phelan, chairman of the New York Stock Exchange, called the collapse a near meltdown caused by a confluence of factors: “the market’s inevitable turnaround after its long climb, heightened anxieties over rising interest rates and future inflation, and the impact of computerized trading”106. Bear Stearns Bank lost more than 90% of its value, diving down from $16.7 to $1.7 billions. Lehman Brothers Bank lost more than 93% of its value and ended up filing bankruptcy. Washington Mutual Bank lost more than 60% of its value before being acquired by J.P. Morgan; the list goes on to include large banks, insurance companies, auto industry, and more. When Lehman Brothers collapsed, the British Guardian newspaper noted that “a fundamental fissure opened up in capitalism”106.

The end result of the split view of the economy is a virtual value of the economy provided by the stock market, which does not reflect the production reality of the economy. Lucent Technologies (currently Alcatel-Lucent) delivered world-class telecommunications products and services when its stock traded at more than $100 a share. After its stock price has fallen to almost $0.5, it continued to provide same superb products and services. Productivity and stock values under capitalism have become two distinct animals. The stock value of some company may grow up and increase at the time when its production or profits remain unchanged or in some cases decrease. Similarly, the stock value may remain unchanged or even go down when its production or profit is increased. Amazon.com, for example, traded its stocks at more than $300 a share when the company did not generate any real profits. The cases of Enron and Arthur Andersen are striking examples in this regard. As a result of the massive fraud at Enron, shareholders lost tens of billions of dollars. The Enron scandal44 was a corporate scandal involving the American energy Enron Corporation based in Houston, Texas, and the accounting, auditing, and consultancy firm Arthur Andersen. The scandal, which was revealed in October 2001, eventually led to the bankruptcy of Enron, at that point, the largest in American history. Arthur Andersen, which at the time was one of the five largest accounting firms in the world, was dissolved.

The value definition under capitalism allows the creation of two faces for the economy: a real face and an imaginary virtual one. The real face is associated with the economic growth and production. This side of economy is the true measure of the strength of the economy; this is the benefit value of the economy. The imaginary or virtual face reflects the image seen and observed by the local and global communities. When the difference between the virtual and real value of the economy remains small, there does not appear to be a serious problem. However, when the difference becomes very large, the consequences can be seriously damaging; the collapse of the markets in 1929, 1987, 2000, and 2008 are real-life examples of such danger.

The collapse of the virtual market and its turnaround after a long climb is almost imminent and inevitable. Analysts can cite all types of reasons and conduct all sorts of analysis to explain the “crash,” “collapse,” “meltdown,” or any other term they choose to use for the same phenomenon. But in all cases, one thing is certain: it is impossible to convert the virtual value of a certain segment of the market into real wealth larger in size than the real value of that segment. The mere thinking that Bill Gates, for example, may convert his huge amount of Microsoft stocks into say $20 billion in cache is insane!.

As an example, assume that the real value of some company is equivalent to 10% of its total virtual value; this is not uncommon in the realm of virtual economy world. Practically, the amount that can be turned into real money can be no more than 10% of the total virtual capital given by the stock value of the company; the rest is equal to none. When the owners of the company shares (or stockholders) notice that a major investor begins to sell his possessions (to convert them to real money), a panic among shareholders begin to propagate; they rush to sell their possessions hoping to cache in some real money before their stocks lose value. Then a collapse takes place and brings down the virtual value of the company to its more realistic basic value.

Let’s work out the example more thoroughly using simple analysis and calculation so as not to confuse the readers (figure 23). Assume that there are one thousand shares in a company. Also, assume that each share is worth $100. So the virtual stock value of the company is $100,000. For the sake of argument, assume that the real value of the company based on its assets and production is $10,000. In other words, the real value of the company is 10% of its virtual value. Now assume that a major investor sells fifty stock shares at $100 and caches $5,000. If the rest of the shareholders start selling their shares hoping to get real money from the company, they will be able to get no more than $5,000 at best, which is the remaining portion of the real value of the company. This translates to 5,000/950, which is approximately $5.25 per share. Now if one more person was able to act faster than the rest and sell fifty shares at say $50 and caches $2,500, then the rest of the crowd will have to share the remaining nine hundred shares for no more than $2500; that is $2.75 a share if all shares are sold at once. Say that two hundred more stocks were traded at $10 a share which amounts to $2,000. What remains of the company value is $500 distributed over seven hundred shares. The stock value of this company will be dropped down to $0.71. Eventually when all $10,000 are gone, the share will go to zero. The remaining stocks will lose their value completely.

This is how the stock values of Enron, 3Com, Martha Stewart companies collapsed and were tarnished when senior executives began to sell large amount of stocks in attempt to convert their stocks into cache. The first few individuals who manage to sell a large portion of their stocks get lucky and transfer part of their virtual wealth into real one. Those who come late or wait for a short while lose. In the final analysis, a company will never be able to translate its virtual value into real cache equal to its virtual value. Just as in virtual memory computer system, it is impossible to stack all the virtual memory pages into the real RAM memory pages! When a program attempts to do that, the system crashes; the difference is that in the case of computers, they call it thrashing instead of crashing. The result is the same.

Usury is the second major cause for the creation of virtual wealth which causes the economy to appear much larger in size than its real value. Usury is defined in Merriam-Webster dictionary as “the lending of money with an interest charge for its use”; this comes from the Medieval Latin usuria, which means interest. A modification was made to the meaning of usury to indicate the interest rate charged above a predetermined rate. This modification was made in order to legitimize the charging of interest on money. In the Islamic culture and religion, the word usury is mapped to the word riba. Riba comes from the word increase. When applied to the concept of usury, it means the increase of money at the expense of the money of other people. This definition is based on the Quranic verse:

That [usury-riba] which you lay out for increase through the money of other people will have no increase with Allah. (Quran 30:39)

Usury, or the interest rate as most frequently referred to, is a cornerstone of the financial policies under capitalism. It is used by the Federal Reserve to adjust market and economy fluctuations. During a recession, the Federal Reserve Bank reduces the interest rate (usury value) in order to encourage borrowing and increase the demands on goods and services. Conversely, it increases the value of usury to curb inflation during excessive economic growth. The point here is to understand that usury in the capitalist political economy is one of the most important tools used for the control of the ups and downs of the economy. Perhaps the single most unique characteristic of capitalist economy is the widespread use of financial institutions that offer loans to individuals, companies, institutions, and even governments themselves.

In this section, we are interested in the role of riba-usury in the creation of virtual wealth. More on the subject of usury will be addressed in the second part of this book when we discuss the Islamic economic system, which is usury free in contrast with capitalism which is based on usury.

The main usury organ under capitalism is the banking financial institutes. Within this usury-based economy, money flows in two directions. In one direction, the money flows from the investors and customers towards the banks in a form of deposit payments. The other direction of flow is from the banks towards the investors and customers in a form of loan payments or withdrawal from customers’ accounts (figure 24). Except for rare cases where the inflation rate is higher than the interest rates during the repayment period, the amount of money going towards the bank is steadily more than the amount of money going towards the investors.

The money which flows from the banks towards investors and customers is related to the real economy of production. It is responsible for the increase of production; it is used to maintain price stability as required by the fiscal policy, and it is responsible for creating the supply-demand balance in the market.

The amount and rate of money which flows in the direction of investors and customers will certainly be less than the amount and rate of money which flows in the direction of the banks. Over time, the banks accumulate more wealth than the total wealth collected by the market either through loans from the banks or through production of goods and services. The difference between the wealth accumulated by the banks and the wealth sustained by the market provides another reason for the dual views of the economy: the real and the virtual. To further illustrate this phenomenon, consider the following two cases.

Consider the loan case, where the bank provides a loan for an investor. Let’s assume that the bank provided a loan of $100 million with 5% usury for one year. Let’s assume also that the inflation during this period was 2%; the actual value of the interest rate becomes 3% after inflation adjustment. Assume further that the investor who borrowed the money was able to use the borrowed money to produce goods and services and generate 2% profit at the end of the loan period. Now the total amount of money to be paid back to the bank is $103 million, while the real available money due to the loan, investment, and profit is $102 million. This means that there is $1million in the bank account which does not correspond to any real value on the ground. This surplus is the usury; it represents the pure growth of money which does not correspond to any growth in the economy. The economy grew by $2 million; the money grew by $3 million. Only $2 million of the money growth corresponds to economic real wealth growth. This is what the Quran refers to as money growth at the expense of other people’s money: “That [usury-riba] which you lay out for increase through the money of other people will have no increase with Allah” (Quran 30:39).

Note that the biggest borrowers in the world are governments which borrow money to pay for their operation and not for profitable production. Consequently, the accumulated pure usury will be much higher than the ratio of (1%) as indicated by the above example. That is why, in a short period of time, usury money grows to several hundreds of billions of dollars and becomes much greater than the size of the real economy. It is worthwhile to know that the real economic growth rate in United States was no more than 3.5% during the last thirty years, while the actual interest rate (after inflation adjustment) was more than 8% per year. On the average, 4.5% of the wealth increase was on the virtual side, which did not correspond to the real economic growth. This means that the virtual money over thirty years was (135%) of the actual value of the economy. So if the real value of the US economy was $5 trillion, then the usury-related excess wealth was $6.75 trillion. The total virtual wealth will appear to be $11.75 trillion instead of $5 trillion.

The second case which leads to an increase in the virtual money is the case when investors invest their money in the banks for a given usury/ interest value. Assume that an investor invests in the bank $100 million for a usury of 5% rate averaged over ten years after taking into account inflation. After ten years, the value of the invested money becomes $150 million. For the bank not to lose money, it in turn invests the $100 million. Let’s say the bank gets an average 7% return on the reinvestment of the $100 million. The bank now has $170 million; it made $70 million profit over ten years. Let’s say that $50 million of the profit generated by the bank (5%) was a result of investment in real production projects; the rest ($20 million) was usury gained through the reinvestment of the money in other banks. The end result is that the initial $100 million have become $170 million. Only $150 million correspond to real growth of the economy; the remaining $20 million represents usurious money which does not map to any real value on the ground. The reality is that most banks do not invest their money in production processes, but rather by reinvesting in other banks and by recycling the loans to other borrowers. As a result, the virtual money increases at a rapid rate repeatedly until its value becomes extremely high.

In either case, the resultant quantity of the money accumulated in the banks is much more than the quantity of the initial real money that represents the base money and the profits due to real production. However, what encourages and motivates the continuation of the increase in the virtual money is the absence of the urgent need to withdraw large amount of funds from many banks at once. When one of these banks gets exposed to pressure from investors and depositors to withdraw an amount of money that exceeds the amount of the real money, the bank may face the possibility of collapse for being unable to meet customer needs; such was the case with the Bank of Boston in the 1980s. If the government does not intervene to save the bank and back it up with guarantees and funds, a collapse of the bank becomes imminent.

When the problem becomes severe and has the potential of affecting several financial institutions, the big countries such as the United States begin to print and pump money that could possibly match the amount of virtual money. This would lead to a massive inflation, decline in prices, and weak production and may lead to huge financial disaster. Perhaps this was the main motive of the massive bailouts for Bear Stearns, Freddie Mac, Fannie Mae, and other financial institutions as clearly expressed by the Fed Reserve chief Bernanke when he said, “If Bear Stearns had been allowed to fail, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability”47.

Besides the interest/usury money generation in excess of the production-related profit, the banking system under capitalism allows for money printing and pumping by certain banking authorities. The symbol of such banking operation is the Federal Reserve Bank in the United States. The Federal Reserve Act was passed in the United States in 1913. Today the Federal Reserve Bank is a consortium of several private banks which are not part of the United States government. These banks, under certain arrangements with the US government, create paper or digital money; lend the money with interest to the people as well as to the government through the member banks. The profits generated from the interest goes back to the accounts of the banks and their shareholders. The primary members of the Federal Reserve Consortium include Rothschilds of London and Berlin, Lazard Brothers of Paris, Israel Moses Seaf of Italy. Kuhn, Loeb & Co. of Germany and New York, Warburg & Company of Hamburg, Germany, Lehman Brothers of New York (no longer exists after its collapse), Goldman Sachs of New York, and Rockefeller Brothers of New York It has been recognized early on that giving some banks the power of issuing money and making profit on interest generated from lending this money to people is very detrimental to the economic well-being of any society. Thomas Jefferson believed that “the banking institutions having the issuing power of money are more dangerous to liberty than standing armies.” According to Jefferson, “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”108. Today and after two hundred years, the banks continue to control the money dynamics and the majority of the people own debts to these banks.

President Andrew Jackson also recognized the dangers of banks when they are allowed to control the monetary system of the nation; he even viewed the banks charging people usury on money as vipers and thieves109.

Abraham Lincoln went even further than his predecessors and ordered the government to issue what was called greenback notes in the amount of $450 million to avoid a massive interest bearing loans from banks. The bankers were intending to charge between 24% and 36% interest rates for loans to finance the civil war. Recognizing the power and adverse impact of the banks on the nation, Lincoln stated in 1865 in a statement to Congress, “I have two great enemies, the Southern Army in front of me and the bankers in the rear. Of the two, the one at my rear is my greatest foe”109.

It was during the presidency of Woodrow Wilson in 1913 when the Federal Reserve Act was passed in the United States. Regretting his approval of the act, Wilson later made the following comments: “I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men”110.

In the most recent history, President Kennedy tried to restore power to the US government by issuing a decree enabling the government to issue silver-based money. On June 4, 1963, President Kennedy signed Executive Order 11110, which virtually stripped the Federal Reserve Bank of its power to loan money to the United States government at interest111. This order gave the Treasury Department the authority to issue silver certificates against any silver in the treasury. There is no evidence that this order has been revoked or amended by any administration after Kennedy, although the decree has never been activated since the assassination of John F. Kennedy five months after the decree was signed. After the assassination of Kennedy, all US Treasury Department silver-backed notes were withdrawn from the market. Had the Kennedy decree been acted upon since it was created, the national debt of $11.9 trillion would have been nullified. Today, US government pays close to $400 billion in interest every year to the Federal Reserve Bank. This is a recipe for failure.

The Pennsylvania congressman McFadden who served as chairman of the Banking and Currency Committee for more than ten years summed up his view on the Federal Reserve Bank in his remarks to Congress in1934:

Mr. Chairman, we have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks, hereinafter called the Fed. The Fed has cheated the government of these United States and the people of the United States out of enough money to pay the nation’s debt. The depredations and iniquities of the Fed has cost enough money to pay the national debt several times over . . . This evil institution has impoverished and ruined the people of these United States, has bankrupted itself, and has practically bankrupted our government. It has done this through the defects of the law under which it operates, through the maladministration of that law by the Fed, and through the corrupt practices of the moneyed vultures who control it.

Figure 25 shows how the Federal Reserve Bank pumps money into its own account without consideration to the economic growth on the ground107. The data shows how the money reserves multiplied more than four times between 1994 and 2008; the total cache currency and reserves doubled in less than four months after the collapse of the Lehman Brothers Bank. The currency reserves rose from $850 billion on September 10, 2008, to $1,702 billion on December 31, 2008. It is needless to say that during this period (112 days), the economy could not have grown 200%.

The practice of the Federal Reserve contributes to the explosion of virtual wealth instead of working to control it. Instead of containing the phenomenon of virtual wealth growth at the expense of real economy growth, the Fed aggravates it.

Worldwide, the interest baring debt of states and governments is shocking. The total amount of debts for sixty countries exceeded $65 trillion at the end of 2008112. The interest paid on this debt exceeds $3 trillion a year; this interest alone is more than the amount of money required to pull the world out of the deep recession it plunged in.

At the world level, the International Monetary Fund (IMF) and the World Bank (WB) practice similar role to the one played by the Federal Reserve in the United States. The IMF and the WB grant loans with interest to almost every country in the world; the IMF and WB impose on many of the recipients of their loans conditions which impact the real economic growth of each country as well as the currency reserves and values. The external debt to IMF of twenty-five poorest countries reached $129.3 billion at the end of 2008.

The stories of IMF wrecking nations’ economies are repeated in Argentina, Jamaica, Latvia, Ukraine, Hungary, Ethiopia, and many more. In an article published by the Center for Economic and Policy Research (CEPR)113, the impact of IMF policies on the economic downturn of Ukraine, Latvia, and Hungary is detailed. These countries turned to IMF to help them cope with economic downturn. In all three countries, there were mistakes in economic policy that increased their vulnerability to external shocks. The governments’ responses to the downturn, along with IMF conditions for assistance, have caused harm with procyclical policies. In Hungary, for example, a surge of foreign borrowing caused the country to run large account deficits in 2006 and 2007 (7.5 and 6.4% of GDP, respectively).

Latvia also suffered from a large reversal of capital flows due to a combination of procyclical fiscal and monetary policy—supported by an IMF agreement as well as funds from the European Union. By some estimates, the Latvian economy contracted by as much as 18% in 2009.

The decision by the Latvian government, in conjunction with the European Union and the IMF, to maintain Latvia’s pegged exchange rate with the euro, has made recovery much more difficult. With the currency fixed rate, the only way to reduce the country’s account imbalance was through shrinking the economy, which reduced imports faster than exports and reduced real wages.

This is similar to the IMF-sponsored policies in the deep Argentine recession of 1998-2002, where a fixed, overvalued currency worsened and prolonged the downturn until the Argentine currency collapsed in 2002.

Despite the ill practices and flawed policies of the IMF, the G8 group leader committed more than half of the allocated financial bailout money to IMF. In April 2009, the G8 leaders allocated $750 billion out of $1,170 billions (65%) to be spent by IMF on projects presumably aimed at alleviating the poor conditions of poor nations. The previous history of IMF practices raises serious doubts that IMF loans will produce anything positive for the plight of the poorest nations in the world.

The IMF has always placed conditions on loans given to nations, which have deepened the nations’ severe economic conditions. It has been noted almost without exception that when poor countries receive IMF loans, the GDP growth rate of these countries decline and the poverty rate increases. Pakistan is a good example of such trend114, where the government is taking fiscal measures such as increase in general sales tax, increase in efforts in tax collection, removal of subsidies on domestic petroleum products, higher electricity tariffs, and effective measures to solve the issue of circular debt. These measures are ordained by the IMF so that the country may repay the interest charges of the loans it has borrowed from the IMF and its member states.

Ironically, when a nation declines to borrow from the IMF or to adhere to its policies, it risks the consequences of sanctions and political pressure from the main shareholders in the IMF such as the United States, UK, and France.

In summary, the practice of usury and interest accumulation on money investment contributes to the creation of virtual economy far greater in value than the real economy. It drives the wealth of nations accumulated via complex taxation systems towards the ever-growing accounts of local and international banks. The end result is a relatively small handful of people end up in control of a vast amount of wealth, most of which is virtually usury and interest.

Gold/silver standard refers to the monetary system where the currency of a nation is backed by a precious metal such as the gold and/or silver. When the currency such as the dollar is backed by gold or silver, it would be almost impossible to grow the finances of the country to such high limits where the country risks the depletion of its gold or silver reserves. The virtual economy, which thrives in the world of capitalism today, could not have become a reality, if main currency (e.g. US dollar) remained linked to the gold standard.

Until World War I, gold ruled as the monetary standard of all the major trading countries in the world. Each country pegged its currency to gold at a constant and unchanging rate. Under the gold standard, the international monetary systems enjoyed a period of unprecedented stability and prosperity. In essence, the gold standard provided monetary discipline. The amount of currency a country could print was limited by the amount of gold in their reserves, because countries could have faced the requirement to convert their money to gold. Exchange rates between currencies of different nations remain fairly constant in the classical gold system.

The gold standard era was abruptly interrupted in World War I. Warring countries decided to print money without backing it up with gold in order to finance the extremely high costs of the war. An enormous amount of cache was poured into the markets without a solid backup for the money, giving rise to high inflation. This situation continued throughout the war and beyond. Germany had to repay under a reparations plan 132 billion marks and was required to back this amount by gold. Evidently, this requirement could not have been met by Germany; Germany could not spend its gold to pay for war crimes. The Europe allies have borrowed too much money from the United States, which demanded its loans be paid. The inability of Germany to comply with the postwar reparations plan and the failure of the allied countries to fulfill their loan obligations to the United States constituted a pretext for the Second World War.

In the mid-1920s, the gold standard was partially restored. However, the currency exchange rates were scrambled to reflect imbalances between the monetary power of the United States and the relatively weak currencies of European states, both victors (Britain and France) and defeated (Germany and Italy).

The restoration of the gold standard did not last for long. The world began to sink in a deep depression in 1928; and in 1929 the stock market in the United States crashed, leading to a worldwide economic panic. By 1931, major banks in Austria, Germany, and Hungary collapsed; the UK and many other countries decided to take their currencies off the gold standard. The world monetary system faced the same fate of inflation and lack of confidence for the second time since the beginning of the twentieth century.

Major industrial nations convened a “world monetary” conference in London in 1933 to discuss the possibility of restoring the gold standard; the participants failed to formalize any significant agreement. The world economic conditions fell under the pressure of a deep depression, coupled with a floating monetary system detached from gold, and as a result, high inflation, high unemployment, and high poverty rates. A second world war was imminent in 1939. The war and the massive military spending helped in stimulating the global economy and ending the Great Depression.

It is interesting to note that a by-product of the Great Depression was the introduction of the Keynesian brand of capitalism, in reference to ohn Maynard Keynes139. Keynes argued that during economic crisis, the market laws of the price mechanism, product value, and relative scarcity cannot regulate the market by themselves; the government must intervene to stabilize the market. This marked the first major deviation from the original theories of capitalism, known as laissez-faire capitalism. Another important outcome of the Great Depression and the subsequent world war was the strong desire among the United States and European allies for economic cooperation and international monetary stability. Negotiations, debate, and serious talks resulted in what has become widely known as the Bretton Woods Agreement115.

Bretton Woods Agreement established clear bases for currency exchange into gold within fluctuation rate not to exceed 1%; it also set the bases on how to convert currencies into gold. Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar. The dollar itself was designated to be convertible into gold. The US currency was now effectively the world currency, the standard to which every other currency was pegged. As the world’s key currency, most international transactions were denominated in US dollars.

In 1944 the United States used its superior power relative to other European states, particularly Britain, to enforce the US dollar as the currency of choice for international trade. Moreover, the United States was given a veto power over the IMF decisions and operations by virtue of its voting power relative to its quota in the IMF which exceeded one-third of the IMF shares. The IMF was given ultimate authority to monitor the currency values of participating members. It made sure that there are sufficient gold reserves or US dollars in support of the local currency reserves.

The gold standard of Bretton Woods provided monetary stability, which prevented any economy from becoming virtually much larger than its real size. Building a virtual economy by any country would cost its stockpile of gold to deplete under the gold standard. There would not be sufficient gold to match the fictitious wealth of the virtual economy.

The aftermath of World War II and the principles put forth by the Bretton Woods Agreement exposed the deteriorating conditions of largely devastated and ravaged countries. Seventy percent of the world gold reserves accumulated in the United States, which became the world’s largest creditor. Countries had sold off most of their gold and dollar reserves, as well as their foreign investments, to pay for the war-generated debts mostly to the United States. Practically, this brought the world economy to a standstill. Europe was unable to produce due to finance shortage, while the US products could not be exported due to shortage of dollars and gold at the other end. In order to stimulate the world economy, especially in Europe, the United States introduced the Marshall Plan . In 2

his historic speech at Harvard’s graduation ceremony in June 1947, George Marshall announced the US plan to give additional economic aid to Europe for security, humanitarian, and economic reasons116. The Marshal Plan confirmed the position of the United States as the world’s strongest economy, de facto leader of the Western world, and the legal inheritor of Europe supremacy and dominance.

The Marshal Plan, US international aid, and massive investment on cold war expenses provided dollar liquidity, eliminated its shortage, and fueled world economy. By the end of 1950s, most of the Western European currencies were convertible to dollar and then to gold. The dollar-gold exchange standard, based on fixed exchange rates overseen by the IMF, could finally be realized.

The increase in liquidity enabled the international economy to grow at a record rate. The 1950s and 1960s experienced a rapid growth of world economy fueled by US dollars. This required a constantly expanding supply of monetary reserves to increase total liquidity. Gold, the primary reserve asset, could not be mined fast enough to meet this demand. A subsequent result would be high inflation in the world’s largest economy in the United States and a depletion of gold reserves. An immediate solution to this problem could have been to reduce the liquidity rate in an attempt to preserve the gold reserve. Of course this could have led to a crisis in which most of the world wiuld have plunged into economic stagnation and would have suffered from declining trade.

Henry H. Fowler, US secretary of the treasury under Johnson (1965-1968), warned that it was too much of a burden for the United States to supply the world with currency reserve and gold. The dilemma that the United States and world economy faced was one of two options. One was to cut down on the flow of US dollars to Europe and the third world through loans, aid, and spending on cold war expenses. This of course would slow the economy which was prospering at a high rate and force the world economy to stay within the boundaries of the gold reserves. The other option was to continue to pump US dollars in the world economy. When the central banks in Europe seek to convert their dollar reserves into gold, that request should be denied; in essence the United States should terminate the convertibility of dollar into gold. Abort Bretton Woods Agreement.

The choice was in the hands of US financial policy makers between two forms of economy. A real economy backed by gold-based currencies, which grows slowly but surely. Or a virtual economy characterized by pure-paper (and later digital) currencies without any backup from any precious metal, gold or silver. The virtual economy option allows for a virtually large liquidity, allows for an unprecedented wealth growth, allows unparalleled superiority over the Soviet Socialists camp, and allows the preservation of the US gold reserves. As attractive as this option could be, it became the first brick in the grave of the capitalist economy.

The cold war and the fierce struggle with the Soviet socialism provided the suitable environment for this option to flourish and provided the shield which prevented policy makers from carefully evaluating the dangers of such option. The greed of the financial institutions which were responsible for providing the liquidity, in particular the US Federal Reserve Consortium pushed this option forward with great avidity and eagerness. The path was thus paved for the revocation of Bretton Woods Act.

The dollar-gold convertibility crisis was evident by the amount of dollars held in the central banks of Europe. By 1966, Europe held in its central banks more than $14 billion. The United States had only $13.2 billion in gold reserves, of which $10 billion were needed to support US internal market needs. If governments and foreign central banks tried to convert even a quarter of their holdings at one time, the United States would not be able to honor its obligations. The relatively low price of gold at $35 an ounce as determined by Bretton Woods tempted speculators, gold merchants, and rich entities to purchase and hoard gold, thus increasing the rate of gold depletion in the world markets.

In 1971, the central banks in Europe began to redeem gold for their large stockpile of dollars. The US gold supplies were at the risk of vanishing. On August 15, 1971, the United States stunned the world by declaring that it would no longer redeem dollars for gold from its reserves. Essentially, the United States unilaterally aborted Bretton Woods Agreement. The dollar’s link to gold was severed. A quarter century of economic stability had finally collapsed, and a new era of unbounded financial growth began. By 1973, other countries in the world abandoned the gold standard.

For the first time in history, the gold officially became just a commodity, whose price is subject to market rules and regulations. Figure 26 shows the rise of gold prices and their fluctuation based on the London Spot Gold Prices117. The gold prices remained almost stable until 1972 when the United States relinquished the gold standard. After the financial crisis in 2008, the price of gold exceeded $1,200 per ounce.

Since the breakdown of Bretton Woods in 1971 and the end of the gold standard, the dollar has become the default international reserve currency. The twenty years prior to 1970, international dollar reserves increased only about 55%, at a rate of 2.7% a year. Between 1971 and 2001, with the adoption of the dollar instead of gold standard, reserves have increased over 2,000%, at a rate of more than 66% a year118. Figure 27 shows the growth of the world wealth since 1972. Such growth could not have been possible under the gold standard. But when United States turned against Bretton Woods Agreement and broke the link between the dollar and the gold, it freed the dollar from the rein of the gold and unleashed its potential for virtual growth.

After the death of Bretton Woods Agreement, the gold could no longer set boundaries to the growth rate of the dollar based economy; yet there was another string attached to the dollar, which kept it from skyrocketing at exponential rates as noted in figure 27. The string was a set of regulations and restrictions which were placed against financial institutions after the great 1929 Depression. Restrictions were introduced in the 1930s by political leaders to prevent another depression in the future. In essence, the restrictions limited the ability of the financial institutions to grow their wealth by giving more and more loans and generating more and more interest on the loans. Borrowers were required by the regulations to put a significant amount of money down when they borrowed to finance a house purchase. That left the interest-bearing portion of the loan relatively smaller.

In 1982, the Reagan administration decided that the government regulations were impeding the progress of the economy. The government lifted those regulations and removed the restrictions as Regan signed the Garn-St. Germain Depository Institutions Act in 1982 (140, 141). As a result, the US banks embarked on a credit and loan spree with almost no government restrictions, or sound fiscal prudence. Before the Reagan deregulation, the average American household debt was 60%. By 2007, this figure had doubled to 119%119. This was made possible by relaxing the standards placed on borrowing and lending.

The two main constraints placed against the free rise of the dollar wealth were removed by the early 1980s. The gold standard was revoked in 1971 and a decade later the regulations on the financial industry were lifted.

In the final result, the economy in the largest capitalist country has been split into two almost independent branches: a real branch responsible for the production of goods and services and a virtual branch responsible for the production of money. Each branch grows or shrinks at its own pace, and possibly in opposing directions. The real economy might shrink, while the virtual money continues to grow. The growth of virtual money is driven mainly by the stock market value and the interest/usury generated through an extensive credit and loan system. The virtual part of the economy reigned over the rest of the economy.

Virtual economy and the unbounded growth of wealth acted in a way like the Achilles’ heel. It provided a sense of power, a feeling of strength, a tool of prosperity, and enormous wealth. The danger of the virtual economy is that it creates a state of delusion in the economy, which can deceive senior economists and politicians, and drives them to overtake projects larger than their real wealth. There could be a temporary positive effect for this delusion, especially when competing with others for large projects. America has benefited greatly while in a conflict with the Soviet Union during the cold war era, where the Soviet Union used real money to finance its projects and America used virtual economy for its own projects. But when a state is exposed to a financial or political crisis larger than the size of its real economy, the illusion may push the state to a losing gamble. The current wars in Iraq, Afghanistan, Somalia, and the devastating effects of hurricanes in the United States are just examples of external conditions which contribute to the implosion of virtual economy. More seriously is the case when foreign countries intentionally create real crisis for other countries that depend on the virtual economy in an attempt to push them to the limits of their real economy.

It is interesting to note that the delusion created by virtual economy blindfolds policy makers and prevents them from avoiding imminent catastrophes until the virtual economy reaches the point of thrashing. This has occurred in 1929, 1987, 1999-2000, and 2008. And it is not over yet. The consumer credit is just about to explode in yet another devastating cycle of the virtual economy thrashing.

The irony is that the current state of the economy and the enduring crisis is not entirely due to the grave mistakes by the Nixon and Reagan administrations in the 1970s and the 1980s. The policies undertaken by both could have naturally evolved out of the foundations of capitalism. The regulations which Reagan had removed were in violation of the principles of capitalism to start with, as recognized by Reagan and his administration. The gold standard could have been revoked by any capitalist leader for more than one reason. On one side it puts a limit on how much the wealth can grow which conflicts with the principles of private ownership. Also, it prevents the treatment of gold and/or silver as a commodity whose price should be subject to supply and demand. So what really appeared to be a grave mistake of politicians is in fact a grave defect of the ideology itself.

Similarly, the creation of virtual wealth in contrast to the real economy stems from the definition of value under capitalism which treats the value of objects as a relative one. This concept allows the existence of stock markets where the prices (exchange value) of stocks can be traded independently of the production market.

The same concept of “value” under capitalism allows the money itself to be a commodity which can be produced by money rather than by the production of goods and services. In other words, money can be produced by money, in the same manner vegetables can be produced by labor paid for by money. Capitalism does not place any special constraints on the money. When World Wars I and II revealed that uncontrolled production of money can be catastrophic to the political and economic stability of the world, the Capitalist countries had to unanimously agree on placing special constraints on the production of money. They adopted the gold standard not as a means of implementing an ideological principle but in defiance of the ideological principles of free trade, value definition, and price mechanism. When the effects of World War II drove away and the need emerged to produce more wealth and create more liquidity, the US government did not find it totally uncapitalistic to abort the gold standard.

When the financial crisis shocked and swayed the world in 2008, several world leaders including the prime minister of Britain and prominent French leaders called for the reconstruction of Bretton Woods Agreemen. However, none of the economists have argued that a gold standard should be restored on the premise that it belongs to the principles of capitalism.