Survival of the Interest Rate Based Debt Financing System

Abbas Mirakhor and Mughees Shaukat
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Abbas Mirakhor : INCEIF
Mughees Shaukat : INCEIF

Journal of Money and Economy, 2012, vol. 6, issue 4, 1-26

Abstract: Evidence has been mounting (over the centuries) that the interest based debt financing regime is under ever increasing distress. All of the earlier crises whatever label they carried -exchange rate crisis or banking crisis- have been debt crises in essence. At the present, empirical research suggests that the debt-to-GDP ratio of the richest members of the G-20 threatens to touch 120% mark by 2014 while by 2020 the U.S and the other major European centers would amass a ratio of at least 150%, with Japan and U.K going to 300% and 200% respectively. Even more disconcerting is the projected interest rate paths on their debts which would increase from now almost 5% to 10% in all cases, and as high as 27% in U.K. Moreover there is also evidence that out of securities worth $200 trillion in the global economy, no less than three-fourth represent interest based debt. It is difficult to see how this massive debt volume can be validated by the underlying productive capacity of the global economy. This picture becomes more alarming when it is realized that the growth of the global economy is anaemic at best while the interest rate on debt is sure to exceed the rate of growth of global GDP for the foreseeable future. Hence, a more serious financial crisis may be in the offing and a general collapse of asset prices may occur. This paper argues that the survival of the interest based debt regime is becoming less tenable, as is the process of financialization that has accompanied the growth of global finance over the last four decades. It further argues that Islamic finance, with its core characteristic of risk sharing, may well be a viable alternative to the present interest based debt financing regime.

Keywords: Regime Uncertainty; Ambiguity; Complexity; Black Swans; Debt Stress; Islamic finance; Risk-Sharing (search for similar items in EconPapers)
JEL-codes: E42 E49 G21 G24 G32 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (1)

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