Khilafah.com

Thursday
Oct 23rd
Text size
  • Increase font size
  • Default font size
  • Decrease font size

The Economics of Money

E-mail Print PDF

As the world drifts into a global recession the US which dominated the global economic scene in the post World War II era has begun to lose its post World War II economic hegemony, i.e. the credibility of its chief export - the free market is now being questioned. For many the crisis has brought to the forefront the fact that the US may now be the new ‘sick man'.

America's chief economic weapon in the post war era has been the US dollar. The US emerged from World War II as the world's superpower. The war had exhausted the post World War I powers Britain and France, so the US worked to replace the influence they had established. The US worked to remove both nations from their colonies and the US replaced the British pound with its dollar. It achieved this through the marshal plan which provided Europe with the money necessary for reconstruction and development after the war. This plan also ensured Europe did not drift towards communism.

The aim of this article is to analyse the role money plays within an economy and the problems associated with the different standards used throughout history.

Money: Past and present

Money has existed since the times of Adam عليه السلام, from the earliest times shell beads and pieces of iron were used as money. Bartering was the most common way exchange took place between people, where goods where used to buy other goods. However bartering had a number of problems. Prior to industrialisation society was engaged in subsistence farming and agriculture drove most economies. Because a farmer growing fruit and a wheat farmer needed what the other produces a direct barter swap would be impossible due to seasonal fruit that would spoil before the grain harvest. It was this problem that led to the development of an ‘intermediate commodity' where ones wheat was exchanged for such a commodity, and once the fruit is produced, such an intermediary commodity can then be exchanged for the fruit. Such an intermediary commodity would need to be something that didn't perish and is reliably available throughout the year. Such commodities have been many throughout history such as copper, gold, wine, silver and shells.

From early times, metals, where available, have usually been favored for use as money over such commodities as cattle, shells, or salt, because they are at once durable, portable, and easily divisible. Gold as well as silver have throughout history been accepted as a means of exchange for commodities and services and to make this process easier, the concept of standard coinage was introduced. Coins were pre-weighed and pre-alloyed. Coins were typically minted by governments in a carefully protected process, and then stamped with an emblem that guaranteed the weight and value of the metal. Hence the legitimacy of such coins lay in the fact that they were of a specific weight of Gold or Silver.

Islamic society

The Messenger صلى الله عليه وآله وسلم also made various types of gold and silver as money, regardless of whether these were minted or not. He صلى الله عليه وآله وسلم did not mint money with specific and fixed features, rather the units of gold and silver were Roman and Persian coins. All of these coins were in use widely during his lifetime. Such coins were not considered by their number or whether they were engraved or not; they were only considered according to their weight. The piece of gold could be the size of an egg, and people would still deal with it. The rights of Allah سبحانه وتعالى such as Zakat, the rights of the people such as debts, as well as the prices of goods and services, were related to Dinars and Dirhams i.e. to gold and silver, evaluated by weight.

This State of affairs continued throughout the lifetime of the Messenger صلى الله عليه وآله وسلم, that of the four Khulafaa Al-Rashideen, and the beginning of the era of the Umayyads, until the arrival of Abdul-Malik ibn Marwan. He deemed it necessary to transform all the gold and silver that was in use at the time, minted and non-minted alike, into an Islamic coinage with an inscription, and gave it a standard and invariable weight, thus doing away with the need to make reference to their weight. He collected the largest and the smallest of coins and minted them according to the weight of Mecca. Abdul-Malik minted the Dirhams in silver and the Dinars in gold in the year 75 AH, and ever since that time, Islamic minted Dirhams and Dinars were in circulation i.e. the currency of the Islamic State became distinguished, having the same invariable feature. This is why the basis of the monetary standard in Islam was gold and silver

The wide scale use of commodity money led directly to the development of representative money. This occurred because initially blacksmiths and later banks would issue paper receipts to their depositors, indicating that the receipt was redeemable for whatever precious goods were being stored -usually gold or silver money. It didn't take long before the receipts were traded as money, because everyone knew they were "as good as gold." Representative paper money made possible the practice of fractional reserve banking which then led to the current system in the world - fiat money.

Modern Era

Fiat money refers to money that is not backed by any reserves of another commodity. The money itself is given value by government fiat (Latin for ‘let it be done'). Early bankers would collect the public's deposits and then use such deposits as a basis to lend money. With 100 ounces of gold they would lend 500 ounces of gold. As long as all depositors did not withdraw their deposits on any given day, bankers made a killing. Governments throughout history have often switched to forms of fiat money in times of need such as war, sometimes by suspending the service they provided of exchanging their money for gold, and other times by simply printing the money that they needed. When governments print money more rapidly than economic growth, the money supply overtakes economic value. Therefore, the excess money eventually dilutes the market value of all money issued - this situation is called inflation.

The Gold standard alongside the Silver standard was the prevailing monetary system in the world, and money in circulation throughout history has generally been gold coins and paper money readily exchangeable for their equivalent value in gold. The implementation of this standard led to the establishment of the most productive economic relations. However, when the First World War was declared in 1914, the warring countries undertook certain measures which led to disorder in the gold standard. Some countries cancelled the liability of exchanging their currencies to gold. Other countries imposed harsh restrictions on the export of gold, while others put obstacles in the face of importing it. This continued until 1971 when it was replaced by the floating irredeemable US dollar, with the US using its position as the world's superpower and making its currency the pillar of the international monetary system. The US held the world's largest gold reserves and essentially defaulted on its gold-redeemable obligations to foreigners. Since then, gold has had no relation with currency, but rather has become like any other commodity. The gold standard ceased to be operated throughout the world and this brought in the era of wild fluctuations in exchange rates and inflation.

The role of money

The importance of money in any economy can be seen from the role it plays:

1. Money acts as a medium of exchange. It allows society to make unlimited exchanges and transactions so goods can move around the economy. Money also allowed individuals and firms to generate wealth and increase it. This is achieved when one can readily purchase produced items and sell them for a higher value than they were purchased. The existence of money allows goods and services to get to the people who need them.

2. Money also acts as a store of value, this is where one can sell a commodity, in return for money and be able to be reliably saved, stored, and retrieved.

3. The most important role money plays is it acts as a unit of account. This is a common standard by which all the market value of goods, services, and other transactions can be measured and compared. Without this the value of an economy could not be calculated.

With gold completely divorced from money, initially the British pound sterling was the world's reserve currency after World War II. With Britain's demise on the international scene the US and its dollar become the world's reserve currency. The US receives its legitimacy not from any intrinsic value but due to the global standing in the US and its ability to press the world to view global products using the dollar. This means for any nation wanting to purchase oil or platinum in the international markets they would need to convert their currency into dollars and then take possession of such goods. This means nations around the world face two variables, which since the end of the gold standard fluctuate widely, ones exchange rate with the dollar and the actual price of international goods - which are priced in dollars. It is here that the world is being held to ransom by the US and is the fundamental reason why the world needs to return back to the Gold standard.

Money Debate

Since gold ceased to be money the price of goods and services continues to fluctuate, something that was not the case under the various metallic standards seen in history. In the post war period the debate with regards to money has been reduced to weather ones currency should be restricted to a fixed regime or whether one should have a floating exchange rate. The reason for this is because many consider all metallic standards outdated as there is not enough gold in the world to back the US dollar, let alone all the other currencies in the world, and because with a metallic standard stimulating the economy through increasing the amount of money would not be possible.

The total amount of gold that has ever been mined has been estimated at around 158,000 tons. Assuming a gold price of $1,000 per ounce, the total value of all the gold ever mined would be around $4.5 trillion. This is less than the value of circulating money in the US alone, where around $1.4 trillion is in circulation and another $11 trillion through banking deposits. However the real problem is not that there is too little gold but the fact that there are too many dollars. How much dollars can purchase for you (purchasing power) is the real issue for people around the world, because the US continues to freely print the dollar, and each time it does so the dollar purchases less (devalues). The US who has the dollar as its national currency, can continually print money to meet its economic needs. For the rest of the world because international financial markets and global commodities markets are all priced in dollars they would need to exchange their domestic currency for dollars and hope it retains its purchasing power. If it doesn't then they will need to give up more of their domestic currency to buy dollars.

Money and Inflation

In the post war period the monetarist school of thought gained prominence and became the dominant school with regards to influencing government economic policy. They advocated using money as the primary tool to regulate and stimulate the economy.

When looking at money it needs to be viewed through the lens of prices. This is because any increase or decrease in the amount of money in an economy has a knock on affect on the price of goods and services. This is because every person and company as well as government income originates from another person or company. Taxes levied by the state are regarded as income for the state and an expense to individuals. The monies spent on projects by government and salaries paid would be income for the individuals and an expense to the state. The money spent by employees on goods is an expense to them and income to companies. Anything that gets in the way of such free circulation, such as hoarding, would in fact take wealth out of circulation. This would lead to a fall in spending, which would reduce production and result in the complete halting of the economy.

Hence from this perspective money plays a crucial role in the economy since sufficient amounts of money need to exist in the economy for transactions to take place. The more transactions that take place the more wealth that is created. It is from this perspective that western governments have argued for decades that fiat currency works best as governments are free to print money as and when needed, and the metallic standard would actually result in the absence of such ability. Hence monetary policy today is seen as fundamentally manipulating the amount of money in an economy, which would mean more money is available to make transactions.

However this is where the problem lies. Without any metal representing money governments always print more and more money and you have a situation where increasing amounts of money chase a static set of goods in an economy and this causes price rises (inflation). Hence more money in an economy leads to price rises and how much your money can purchase for you (purchasing power) in a fiat system is always falling. The ability to print money does not stimulate the economy rather it leads to inflation.

As a comparison the purchasing power of gold and silver has remained extremely stable over not just the past century, but over most of history. The price of 100 barrels of oil measured in ounces of gold has remained fairly stable between 5 and 10 ounces of gold for the last 100 years. From just 1973 to 2008, the price of a barrel of oil in US Dollars increased by 3300%. Over the same period the number of ounces of gold required to buy 100 barrels of oil rose by only 18%.

Money and the economy

Ones currency is one aspect of economy. In the order of importance with regards the economy, what monetary standard one uses whether one has the singular gold standard, bimetallic standards or the multi-metallic standard, such a policy comes well down the priority list. This is why nations do not have a currency policy. Ones currency is viewed as a means to exchange; hence it does not fall within the realm of policy making. Industrialisation, wealth circulation, taxation, commerce etc are much more important with regards their effect on the economy compared to what standard one should have for money. However this does not negate the fact that money has a role in the economy.

Islam and money

In Islam when it comes to exchanging a commodity with a specific monetary unit, Islam defined what monetary unit is used for exchange to take place. This specific type of money is gold and silver which the Khilafah state will adopt. The Islamic evidences have designated gold and silver as the primary measuring unit for prices and labour. This is understood from a variety of evidences.

When Islam prohibited the hoarding of wealth, it specifically prohibited the hoarding of gold and silver despite the fact that wealth includes any property that can be owned. However, hoarding is reflected in money, not in the goods and services. Islam has linked gold and silver to a number of rules.

The Messenger صلى الله عليه وآله وسلم was reported by An-Nisai on the authority of Amru Ibn Hazm to have said: "The blood money for one soul would be 100 camels...and for those who deal in gold it would be 1000 dinars."

Bukhari also reported on the authority of Aisha (ra) that the Messenger of Allah صلى الله عليه وآله وسلم also said: "The hand is cut for the theft of one-quarter dinar and upward."

The fixing of certain rules by the dinar, the dirham and the Mithqal, would make the dinar with its weight in gold, and the dirham with its weight in silver, a monetary unit by which the values of goods and services are measured.

When Islam imposed the diyyah i.e. blood money, it specified a fixed amount of gold.

Also, when it decreed the penalty for cutting the hand of the thief, it specified the minimum value of gold that is stolen which would entail the cutting of the hand.

The fact that Islam has linked the Shari'ah rules to gold and silver by text, when these rules are related to money, serves as evidence that gold and silver are emphasised as money. This does not mean other items cannot be money. However Islam requires gold to definitely be part of any legal tender for the Khilafah in a multi-metallic standard.

Conclusion

- Money plays an important role in an economy as it's the means that allow transactions to take place and it acts as a unit of account so goods can be priced and compared.

- The British initially and then the Americans forced their legal tenders on the world ensuring international markets were priced in their currencies. This gave them an advantage over all other nations as their national currency was needed by the world to purchase international commodities, whilst the US can print the dollar and purchase the same goods.

- The metre, gram and second remain constant, however the dollar keeps changing. Whilst the former units are measures of stable physical quantities, the latter is a pseudo-measure, i.e. it is used as a measure that currently no stable physical quantity can be correctly attributed to. For this reason the value of the fiat currencies fluctuates wildly as traders across the world buy and sell based upon what the value of the dollar should be.

- Whilst many consider gold to be an old relic, with no place in modern finance and global financial markets, gold was money for over 5000 years, and hence people have always viewed gold to have intrinsic value.

- By arbitrarily printing money western governments have caused inflation in society. They continue to promote that money expansion is necessary to increase the size of the economy and stimulate economic activity. Without anything to measure against how much money to print, this is why there is always more and more money chasing a static set of goods.

- Having a metallic standard would handcuff governments as they can only print money relative to the amount of metal they can get hold of. This has the effect of containing inflation since money supply increases will be more in line with economic activity.

- It should also be understood that money, although important, does not form part of the overall economic policy of a nation. Polices to do with wealth circulation, taxation, trade etc are much more important and require much more thinking and planning than a nation's currency regime.

 

Bibliography

Joseph T. Salerno, ‘The Gold Standard: An Analysis of Some Recent Proposals,' September 1982, Cato Institute, http://www.cato.org/pubs/pas/pa016.html

Bettina Bien Greaves, How to Return to the Gold Standard, November 1995, Foundation for Economic Education

Paul, Ron; Lewis Lehrman (1982) ‘The case for gold: a minority report of the U. S. Gold Commission,' Washington, DC, Cato Institute

Paul Krugman, ‘The Gold Bug Variations'

DeLong, Brad (1996) ‘Why Not the Gold Standard?' University of California, Berkeley

Nathan Lewis, ‘The Gulf's currency solution,' May 2008, Asia Times Online, http://www.atimes.com/atimes/Middle_East/JE09Ak01.html

Nathan Lewis, Gold: the Once and Future Money, 2007, Addison Wiggin: Books

Barry J. Eichengreen and Marc Flandreau, ‘The Gold Standard in Theory and History,' 1997, Published by Routledge

Bayoumi, Tamim A.; Barry J. Eichengreen and Mark P. Taylor (1996), ‘Modern perspectives on the gold standard,' Cambridge University Press

‘The Economic system in Islam,' Khilafah publications, English translation of the original Arabic,

‘Funds in the Khilafah state,' English translation of the original Arabic,

Khan A, ‘The Global Credit Crunch and the crisis of Capitalism,' April 2008, Khilafah.com

Trackback(0)
Comments (6)add comment

Rismie Ziard said:

Return of the Islamic State is inevitable may all muslims work towards it so it would happen during our life time.
 
report abuse
vote down
vote up
February 26, 2009
Votes: -1

Khalil Khouri said:

The muslime nations must be aware that the currency game that the west are playing can lead them to what it lead U.S economy now to a resision and iflation .. The Malaysian Government had learnted a lesson from its economy crisis although they were following the World bank org and all other western international monetery Organizations rules and regulations that claimed it will lead the malyasian economy to prosperty and wealth ! , but it lead the country to become fragile economically.. The malaysian Gov. has created the islamic dinar and started exchanging with it internally and externally.. I think this what the all islamic nations must do to escape the coming economic crisis of west .
 
report abuse
vote down
vote up
January 04, 2009
Votes: +0

Adnan said:

Jzk for your question

Yes the US does have the world’s largest reserves relative to other nations. However overall with the total amount gold reserves the EU has more gold.

If a nation has a huge amount of gold then it’s possible they can dictate global trade, however this is unlikely due to a few reasons. Firstly if a nation is self sufficient or close to self sufficiency then its imports will be low so its gold will not be going out of the nation. Secondly the Muslims world has the world’s important mineral and raw resources so it doesn’t have the need to import, so its gold will not be used to pay for such items. Lastly Although Islam obliges the state to use Gold as its legal tender, this means it should exist, but this doesn’t not mean we cannot have other metals etc which represent money, this multi-metallic standard will solve the US issue as multiple metals represent the currency.
 
report abuse
vote down
vote up
December 31, 2008
Votes: +0

Adil said:

At present, US is holding the largest amount of gold. So, she has a bargainig power. How khilafah will accumulate gold to strength its economy? What could be the strategies?
 
report abuse
vote down
vote up
December 27, 2008
Votes: +0

suyn said:

The west can be summed up by it's actions as they relate to sister Aafia Siddiqui. May all of the western power structure be destroyed because of what it did to this one woman, her children and all the little boys and girls of the Muslim world who have been butchered by america and her allies.
 
report abuse
vote down
vote up
December 26, 2008
Votes: +1

Salman said:

Very informative piece. It would be useful if the author could have mentioned the role of the use of interest rates as a way of regulating inflation in modern western economic systems
 
report abuse
vote down
vote up
December 26, 2008
Votes: +0

Write comment
quote
bold
italicize
underline
strike
url
image
quote
quote
smaller | bigger

busy