The late Shaikh Mahmud Ahmad, though not very well known
to most people outside academic circles, was a meritorious scholar of our
country. In a society as ours, where He who has more money or fame is the one
who is worthy of praise and respect, a scholar as Shaikh Mahmud Ahmad is rarely
afforded the attention he deserves. Yet, it is the society itself which suffers
as a result. Shaikh Sahib made immense contributions to the study of economics
viz-a-viz Islam. It is indeed unfortunate that his monumental book ‘Man and
Money’, in which he attacked the theories of interest, has still not been
published. Fortunately, he summarised some of his criticism in his book Towards
Interest-Free Banking (published by the Institute of Islamic Culture, Lahore,
1989). In this book, he also presented his model for interest-free banking,
Time-Multiple Counter Loan (TMCL) (a criticism on which model has already been
presented in this journal, July & August 1996). Here, Shaikh Sahib’s criticism
on Keynes’ Liquidity Preference theory is presented. This criticism has been
taken from his book Towards Interest-Free Banking with the kind permission of
the publishers. The readers are urged to read the book for many other pertinent
and interesting criticisms on the arguments supporting interest. (Editor)
The General Theory of Keynes is not a cohesive or
integrated book in the matter of guidance as to what we should do in the sphere
of interest. His broad approach is to identify the areas of its exploitative
manifestations. He spells out fifteen reasons why it should be abolished, the
most important of which are that unemployment must persist as long as interest
stays, and that the remedy for inflation is also to lower the rate of
interest. Though this may perhaps be the most revolutionary contribution of
Keynes, it so seriously threatens some of the fundamental postulates of
economics that post-Keynesian economics has preferred to completely neglect this
main thread which runs through the General Theory, and reaches its most
unequivocal expression in his last chapter significantly entitled ‘Concluding
Notes on the Social Philosophy Towards Which the General Theory Might Lead’,
Section II pages 374-377.
A second posture which recurs in the book is one of doubt
whether institutional and psychological factors will allow interest to fall to a
level at which full employment can be attained. He therefore feels forced to
regard a ‘technical minimum’ of around two percent as necessary.
His third concern related to the issue of interest is the
shortage of capital resources. He ponders over the reason as to why the world is
‘so poor as it is in accumulated capital assets’, and reaches the conclusion
that it can be explained ‘neither by the improvident propensities of mankind,
nor even by the destruction of war, but by the high liquidity premium ...
attaching to money’. This is the mental background, the intellectual concern,
which gives birth to the concept of liquidity preference. On account of this
concept, we reach the stage where a low rate of interest, say two percent,
‘leaves more to fear than to hope’.
What was the hope and what is the fear? The hope was that
with every reduction of interest rate, the hazard of enterprise will fall and
its profitability will rise, leading to expansion and deepening of all varieties
of investment, with the consequence of going a long distance towards reducing
unemployment, when interest falls to its ‘technical minimum’ of two percent.
Now what is the fear? The fear is that interest ‘being the
reward for parting with liquidity’, at such a low rate of interest people may
like to keep their saving uninvested. This being precisely the time for
investment why should people like to keep their savings in a liquid form? He
gives three considerations which may persuade them to stay liquid. He names them
transactions motive, precautionary motive and speculative motive. Due to these
considerations, the fear is that long before reducing interest to zero, even at
two percent interest ‘liquidity preference may become virtually absolute in the
sense that almost every one prefers cash to holding a debt which yields so low a
rate of interest’.
If it could be established that at low rate of interest,
people will literally prefer ‘cash to holding a debt which yields so low a rate
of interest’, the theory will stand proved and the purpose of the theory
fulfilled in explaining why the world is so short in capital resources. But that
involves proving that people at two percent interest will start keeping their
savings inside their mattresses or their pillows or create hidden hollows in the
wall or under the floor to stack them. However much Keynes may have erred in the
formulation of this theory, he stopped short of relying on the absurd conclusion
of his logic. He therefore resiles from this preposterous position by first
replacing the word ‘money’ in the place of liquid savings, and including ‘time
deposits with banks and, occasionally even such instruments as (e.g.) treasury
bills’ in his definition of liquid savings.
Now this is no ordinary twist of logic. This amounts to
pulling out the entire foundation of the theory, after which the superstructure
of the theory has no place to go to except falling flat. Once liquid saving goes
to a bank, however much it may remain liquid for the depositor, it becomes a
part of the social money stream, from which the borrowers can borrow, within the
limits prescribed by the statutory reserve. As soon as savings are out of
mattresses and pillows and into time deposits and treasury bills these cease to
be a case in which people prefer ‘cash to holding a debt which yields so low a
rate of interest’. They have already unequivocally indicated their preference
for ‘holding a debt’ to ‘holding cash’ and in so doing repudiated the theory.
How then do we explain the scarcity of capital, which
Keynes wanted to elucidate with the help of this theory? The real point of
contraction of capital resources is not the liquidity of saving but the bank
reserve, which has nothing to do with the three motives spelled out by Keynes.
It is this bank reserve, and this alone, which is a self-contrived arrangement
for scarcity of capital. It is not the logic of Keynes remarkably bearing the
stamp in this case of having been ‘confounded by the touch of the Evil One’
but the bias of economics which forces it to accord acceptance to this theory.
It is the same bias which has compelled economics to give acceptance to every
other theory of interest as well, although every one is as devoid of logic and
of empirical support as liquidity preference theory happens to be.