Why did the Prophet (saw) demand that transactions involving Gold and Silver and other key commodities be traded on the spot market, ie. Immediately – hand to hand?
It is reported that al-Baraa bin ‘Aazib and Zaid bin Arqam used to be partners, and so they bought silver for money and a deferred payment, and when the Messenger of Allah (saw) heard about this he ordered them with the words “Whatever was paid by money is permitted, and whatever was for a deferred payment must be returned”
Islam set out 1400 years ago trading rules, including key financial instructions which protect the market and its participants. The natural question arises as to how can markets be hurt by non spot trading and immediate delivery of such commodities?
A good example was raised this week by the accusations against large bullion banks using the Comex futures exchange to depress the price of silver – an accusation that has also been raised about the gold market in recent years. The “futures” market allows trades in key commodities to be effected for future delivery ie buy or sell now for delivery in 3, 6 or 9 months time. As the trader does not need to have the commodity “to hand” they can simply keep rolling over their trades, and defer settlement indefinitely. In this way concerted and heavy sell orders (without the need to deliver immediately) will naturally force the price down. This is the tactic of short sellers, who sell securities they don’t own (by borrowing or forward dating delivery) with the objective of forcing the price down and then later buying the security at a lower price (and profiting from the difference). Perhaps the worst example of market manipulation via short selling was seen in the Asian financial crisis of 1997 when hedge funds sold short Malaysian, Indonesian and other markets in volumes many multiples the size of the actual market. The result being entirely predictable – a massive dive in the value of those markets to the profit of the hedge funds and cost of the local populations.
Another tactic of market manipulators is to place spoof trading orders which can be readily withdrawn before execution of the order, yet the fact and volume of placement will have an immediate impact on the market as it appears that there is a high volume of (usually) sell orders. Again this will depress the overall market price. Some sharp operators have even developed sophisticated electronic trading systems which will instantaneously and advantageously place and withdraw such trades. All possible when the dealer does not need to stump up the actual commodity when placing trade orders.
There is a political aspect to this trade. When these commodities (gold/silver) are in a sustained bull (up) market it seems strange that large banks are persistently working on the down side of the market. The reality is that it is expedient for the US government to have the price of gold and silver suppressed as it helps to show the instable fiat (paper) based currencies in a far more favourable light than they deserve. And seeks to delay the inevitable devaluation they mask.
It is interesting to note that the Shariah rules requiring “hand to hand” on the spot settlement for such important commodities removes completely this type of manipulation and provides a fair and functioning market which is transparent and open. Traders can take confidence in the prices which are agreed between participants as the commodities must be available and settle immediately, leaving no room for attempts to push down prices artificially. It is also interesting to note that despite the protestations raised in the article linked below, nothing will be done to outlaw futures trading and short selling as currently widely practiced.
http://www.mineweb.com/mineweb/view/mineweb/en/page32?oid=114217&sn=Detail&pid=102055
After an investigation that has taken the best part of two years, on Tuesday, Oct 26, Bart Chilton, a commissioner at the U.S. CFTC said there had been repeated attempts to influence prices in silver markets. The Commodity Futures Trading Commission began probing allegations of price manipulation in the silver futures market in September 2008. At a hearing in Washington on Oct. 27, CFTC Commissioner Bart Chilton said there have been "fraudulent efforts to persuade and deviously control" silver prices and that violators should be prosecuted.
According to an article published on Bloomberg on Oct. 28, both JP Morgan and HSBC Holdings have been accused in an investor's lawsuit of placing "spoof" trading orders to manipulate silver futures and options prices in violation of U.S. antitrust law. The investor alleges that starting in March 2008, the banks colluded to suppress silver futures so that call would decline, and put options would increase, according to the complaint filed in a federal court in Manhattan. The collusion was also intended to maintain prices at levels at which some options would expire as worthless. The banks placed so-called spoof trading orders, or the "submission of a large order which is not executed but influences prices and is then withdrawn before it reasonably can be executed," according to the complaint.
Sunday, 21 November 2010
Monday, 8 November 2010
QE – Is the end nigh?
As expected the US Federal Reserve this week signaled that they will shortly embark on the next phase of Quantitative Easing (QE). With $600 billion announced in addition to the $1.7 trillion of last year and $300 billion in train, markets are worried over where this will end and what the full ramifications will be not only in the US but also globally.
Essentially the purchase of additional government securities is the equivalent of “printing money” or effectively devaluing every dollar currently in circulation and committed to. The mechanism is relatively straight-forward for developed economies like the US. With a sluggish economy, which is struggling to get moving again, and no room to reduce interest rates below their near zero level, the Federal Reserve sees little option other than to increase the money supply through QE. The Fed will credit its own account with new money (from nothing), use this “new money” to buy financial assets, usually government bonds (Treasury Bills) in a process vaguely called “open market operations”. So the Federal Reserve makes more dollars and effectively deposits them with large financial institutions (Banks) and hopes thereby that the Banks will help kick start the economy via increased lending – in multiples of what was given to them (fractional reserve banking). If this all sounds confusing it can be summed up as the Central bank prints more money out of nothing (it is only paper after all), lends it to Banks at tiny interest rates, and hopes that the Banks will use the deposits to create more money via loan (credit) creation thereby creating yet more money.
There are several dangers with this approach:
1. Where does it end. The QE creation of $1.7 trillion last year was supposed to provide the solution. It didn’t. Now inflation is beginning to appear in food and other commodity prices (real assets appreciate against ever increasing fiat papers). Some commentators believe that QE will not end here, the economy shows signs of dropping back into recession and the US deficit grows ever greater. There is a perfect storm brewing of no recovery, unemployment growing, federal and state deficits growing, and little real wealth growth to bail it out. In this scenario the QE will merely devalue dramatically the value of the dollar, which is inflationary, and potentially hyperinflationary. One might reasonably ask when the policy gurus have gotten it right over their economic decisions, and can they control the inflation genie when it is out of its bottle?
2. The worlds largest debtor (the US) is running short of countries that will lend to it. China has for many years, but is now getting cold feet over the more than $2 trillion dollars of US Treasury Bills it holds. In inflationary/QE times these T Bill assets will devalue rapidly. The US may feel this is a clever way of paying back its debts with hopelessly devalued dollars. But in an ever smaller world, this will create severe problems in future re global trust and cooperation whether in trade or elsewhere. If the world cannot trust the custodians of the defacto world currency (US$) to manage it responsibly where else will trust be lost.
3. The US dollar is declining relative to other country currencies, which on the face of it should be positive for US exports (now costing less in foreign countries). However, the rest of the developed world is facing a similar problem and many too are also doing their own form of QE, and therefore devaluing their currencies in a desperated effort to kick start their economies. In a race to the bottom of the currency devaluation war, real asset inflation is the only winner. Jobs, the economy, trade and business confidence will all take a severe beating. The stakes are very high and if this doesn’t work confidence in the whole system will be hit hard.
4. Banks have not and are not lending in anything like the required levels. Furthermore there is not the appetite for relatively free credit as there was in the pre-recession boom period. The economies are not back on track and Banks are using the money given to them by QE to strengthen their weakened balance sheets. This is also counterproductive in a fiat money system which relies on steadily growing credit to keep business afloat, confidence high and recessions few and far between. The consumer is worried about keeping his job, his home, and is now saving what little he has after basic expenses. Hardly a recipe for rapid consumer led spending growth.
In essence the lessons learnt from the financial crisis have not been heeded. Governments, not being content to witness the largest uncontrolled growth in credit in history, and the creation of the largest house and asset bubble, are now hoping they can spend their way out of the problem. Yet the money is not there and needs to be conjured. It is hard to see anything other than a continuation of recession, and inflation if not hyperinflation.
Until the Islamic Khilafah is again established we are unlikely to see the stability of the gold/silver standard which precludes government action to debase the currency. With no interest, a clear and unchanging rule of law and a far more positive and open trading environment I think the Islamic state’s trading partners will also look forward to the real change Islam provides.
Essentially the purchase of additional government securities is the equivalent of “printing money” or effectively devaluing every dollar currently in circulation and committed to. The mechanism is relatively straight-forward for developed economies like the US. With a sluggish economy, which is struggling to get moving again, and no room to reduce interest rates below their near zero level, the Federal Reserve sees little option other than to increase the money supply through QE. The Fed will credit its own account with new money (from nothing), use this “new money” to buy financial assets, usually government bonds (Treasury Bills) in a process vaguely called “open market operations”. So the Federal Reserve makes more dollars and effectively deposits them with large financial institutions (Banks) and hopes thereby that the Banks will help kick start the economy via increased lending – in multiples of what was given to them (fractional reserve banking). If this all sounds confusing it can be summed up as the Central bank prints more money out of nothing (it is only paper after all), lends it to Banks at tiny interest rates, and hopes that the Banks will use the deposits to create more money via loan (credit) creation thereby creating yet more money.
There are several dangers with this approach:
1. Where does it end. The QE creation of $1.7 trillion last year was supposed to provide the solution. It didn’t. Now inflation is beginning to appear in food and other commodity prices (real assets appreciate against ever increasing fiat papers). Some commentators believe that QE will not end here, the economy shows signs of dropping back into recession and the US deficit grows ever greater. There is a perfect storm brewing of no recovery, unemployment growing, federal and state deficits growing, and little real wealth growth to bail it out. In this scenario the QE will merely devalue dramatically the value of the dollar, which is inflationary, and potentially hyperinflationary. One might reasonably ask when the policy gurus have gotten it right over their economic decisions, and can they control the inflation genie when it is out of its bottle?
2. The worlds largest debtor (the US) is running short of countries that will lend to it. China has for many years, but is now getting cold feet over the more than $2 trillion dollars of US Treasury Bills it holds. In inflationary/QE times these T Bill assets will devalue rapidly. The US may feel this is a clever way of paying back its debts with hopelessly devalued dollars. But in an ever smaller world, this will create severe problems in future re global trust and cooperation whether in trade or elsewhere. If the world cannot trust the custodians of the defacto world currency (US$) to manage it responsibly where else will trust be lost.
3. The US dollar is declining relative to other country currencies, which on the face of it should be positive for US exports (now costing less in foreign countries). However, the rest of the developed world is facing a similar problem and many too are also doing their own form of QE, and therefore devaluing their currencies in a desperated effort to kick start their economies. In a race to the bottom of the currency devaluation war, real asset inflation is the only winner. Jobs, the economy, trade and business confidence will all take a severe beating. The stakes are very high and if this doesn’t work confidence in the whole system will be hit hard.
4. Banks have not and are not lending in anything like the required levels. Furthermore there is not the appetite for relatively free credit as there was in the pre-recession boom period. The economies are not back on track and Banks are using the money given to them by QE to strengthen their weakened balance sheets. This is also counterproductive in a fiat money system which relies on steadily growing credit to keep business afloat, confidence high and recessions few and far between. The consumer is worried about keeping his job, his home, and is now saving what little he has after basic expenses. Hardly a recipe for rapid consumer led spending growth.
In essence the lessons learnt from the financial crisis have not been heeded. Governments, not being content to witness the largest uncontrolled growth in credit in history, and the creation of the largest house and asset bubble, are now hoping they can spend their way out of the problem. Yet the money is not there and needs to be conjured. It is hard to see anything other than a continuation of recession, and inflation if not hyperinflation.
Until the Islamic Khilafah is again established we are unlikely to see the stability of the gold/silver standard which precludes government action to debase the currency. With no interest, a clear and unchanging rule of law and a far more positive and open trading environment I think the Islamic state’s trading partners will also look forward to the real change Islam provides.
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