Economic arguments are marshaled to support the gold standard which
was the practice of the Prophet (saws), all of Islamic society during
it first four hundred years, and most of civilized society throughout
history. Several years ago I made a presentation before Muslim economists
meeting at the World Bank at which I presented arguments for what I
considered to be the correct Islamic position on a number of fundamental
economic issues. Referring to my call for a return to the gold standard,
one of the economists asked me why I was for ijtihâd on every issue
except that one. He didn't understand that ijtihâd means to struggle
for a correct opinion on an issue. It does not necessarily mean rejecting
an ancient tradition. In this particular case the ancient tradition
happens to be correct.
Far from being a "barbaric relic" (as John Maynard Keynes characterized
it, gold is the natural monetary commodity which Allah has provided
us for an equitable monetary policy free from the arbitrary or self-serving
manipulations of central banks and politicians. In this paper I shall
outline the economic arguments as to why the dinar is indispensable
for an Islamic monetary regime. My goal is only to emphasize the importance
of the issue, not to make an exhaustive treatment. Thus, I shall not
address important related issues like financial intermediation, forward
transactions or interest. (See, however, Ahmad 1996.) Finally I shall
make a suggestion on how a transition may be possible and timely. Indonesia
and Malaysia had thriving economies, but suffered from external deficits
and a fragile financial sector. Analysts trace the origins to the crisis
in Asia to the Chinese and Japanese currency de-valuations. The Mexican
currency crisis was the final trigger in confidence problems.
The disagreement between Prime Minister Mahathir Mohamad and former
Deputy Prime Minister Anwar Ibrahim over whether to deal with the crisis
in Malaysia with currency controls or free markets has since taken an
extremely ugly turn (see Johnson 1998). It is not the currency speculators
who are responsible for the Malaysian crisis. They merely sought to
cash in on the unsound, and, as I shall argue, harâm monetary policy
that made the ringgit an unreliable currency. A government which blames
speculators for the consequences of its unsound monetray policy is like
a rancher who, having slaughtered his cows on the open plains, blames
the vultures for descending on their carcasses.
The monetary problems in both Malaysia and Indonesia have led to political
problems. Various solutions proposed are partial solutions. One must
attack the fundamental issue. If we go back to fundamentals we can see
that the only complete solution is an Islamic monetary system, that
is, hard money. The otherwise strong economies of Malaysia and Indonesia,
combined with the low price of gold at this time, put them in an unusually
good position to make a transition if they can muster the political
will, or failing that the religious enthusiasm, to do what our religion
mandates anyway. Let us begin by reminding ourselves of the origin of
money. Primitive societies engage in barter.
Depending on the particular society, certain commodities eventually
become accepted in trade by people who have no immediate need for them
because they become aware that others who need them will accept them
in trade. The fact that such commodities possess certain "monetary"
qualities: a high store of value, divisibility, recognizability, etc.,
increases their market value because their monetary utility augments
the value arising from their other social uses. They never suffer from
a crisis of confidence because people know that even if they lost their
utility as a kind of promissory note, they would still have some value
in themselves. In the time of the Prophet, gold, silver, hard wheat,
and a few other commodities served a monetary function. Gold and silver
were the best of these and in the early centuries of Islam they were
the bimetallic standard of the Islamic world. Because the exchange rate
between them was stable there was no problem abiding by this standard
for 400 years. Then, the exchange rate between them departed from parity
providing an opportunity for the mint to issue debased currencies.
Ashtor (1976, p.257) describes how the vizier of the Ilkhan Gaikhatu's
experiment to fund deficit spending in 1294 by issuing "paper money,
modeled on the Chinese paper currency ... was a complete failure, as
the people refused to accept the bank notes. Economic activities came
to a standstill, and the Persian historian Rashid ud-din speaks even
of 'the ruin of Basra' which ensued upon the emission of the new money."
The door to debasement opened in the next century when the silver to
gold exchange rate suffered its first serious change since the rise
of Islam. In the early centuries of Islam the rate had always been around
20:1. In the thirteenth century changes in the market led scholars to
speculate that the rate had changed to 10:1, but the official rate remained
fixed at 20:1. "The stocks of silver in the mints decreased progressively
from about 1380.... Whereas the exchange rate of the dirham had for
130 years been 1/20 dinar, that of the debased dirham was 1/25 and later
1/30 dinar" (Ashtor 1976, p. 305). The "main reason was the increased
demand in Italy, where the value of silver had risen considerably at
the end of the fourteenth century.... At the beginning of the fifteenth
century the striking of silver dirhams was discontinued altogether"
(Ibid.) Al-Mikrizi blames a high court dignitary who tried to "enrich
himself by the striking of copper coins" (Ibid.). The monetary crisis
was accompanied by famine and a lengthy civil war. High taxes were levied
to equip the armies against repeated revolts. Interest rates rose from
4-8% during the crusades to 18-25% in the fifteenth century (Ibid.,
p. 324).
Although "the supply of gold from the Western Sudan was never interrupted,"
Sultan Barsbay in 1425 devalued the dinar "for the first time in the
history of the Muslim Near East" (Ibid.). Until then the dinar had always
been a gold coin of approximately 4.25 grams. With the devaluation a
3.45 gram dinar called al-Ashrafi "remained the gold coin of Egypt until
the end of Mamluk rule" (Ibid.). This was the weight of the European
ducat, evidence for the swing in monetary standards away from the Muslim
world to the rising Christian West. (Ahmad 1996.) The stability of hard
currency is not appreciated by the general populace. People look at
the inflation which has hit even the dollar to varying degrees thorughout
this century and forget that a high quality suit of clothes which cost
ten dinars a century ago still costs ten dinars today. People have come
to think of "currency" as "money" though they are extremely different.
Historically, currency may be actual money (coins) or tokens redeemable
in coin. Very recently, currencies have been issued not redeemable in
anything. For example, the Federal Reserve Notes most of us have in
our wallets have for some decades been payable not in gold or silver
coin, but in Federal Reserve Notes of other denominations. Under Allen
Greenspan the Federal Reserve Board has pursued a tight money policy
that has succeeded in easing down America's serious inflation problem,
but not without cost. Greenspan's usually prudent judgement has been
coupled with fortuitous good luck that will last only as long as God
wills. All-too-human manipulation is evident, for example in the Long
Term Capital Management debacle bailout. An artificial "sound money
policy" is no substitute for natural, I would say divine, monetary regime
manifested in a hard money subject to market forces. Money supply sometimes
needs to expand or contract according to the exigencies of the times.
The supply of gold money can expanded naturally through additional mining
or the meltdown of jewelry. It can contract through the diversion of
coins into jewelry or other products. The difficulty involved in money
supply adjustment is natural and controlled by God. Soft currencies
(tokens, paper) are all too subject to the manipulations of governments
seeking to engage in deficit spending or bankers seeking to increase
their interest revenues through fractional reserve banking.
Some Muslim economists, for example M.A. Choudhury (1997) have noted
the superiority of hard currency but only as an element in their campaign
against interest. The absence of hard currency is a detriment to the
long-term stability of an economy apart from its complicity in the manipulation
of interest rates. (Note that soft money permits manipulation of interest
rates down as well as up.) Historically interest rates have tended to
be much lower when and where the gold standard was adopted than otherwise.
The sixty percent interest rate in Malaysia is not unusual given the
weakness of the currency. The six percent mortgage rates which American
perceive to be "low" today (compared with the double-digit rates in
the 1980's) is actually very high compared to the previous century when
the gold standard ruled. Some economists have accepted the demonetization
of gold despite their opposition to interest.
Chapra (1985) writes: "Although inflation has been a continuing phenomenon,
gold prices have fluctuated in a volatile manner after its demonetization
due to international speculative forces and gyrations in the rates of
interest. Silver prices have suffered the same fate. Both these precious
metals cannot hence serve as units of account." Chapra has accepted
the circular reasoning that because gold is not used as a unit of account
it cannot be used as a unit of account. In fact the opposite is the
case. If the one billion Muslims of the world would use gold as their
unit of account the volatility (after an initial surge due to the shock
of so many people readopting the monetary commodity) would stabilize.
Muslims cannot escape the fact that gold is our money. Even if we pretend
that it is not, we continue to use it in calculating the nisâb. Instead
of fighting the will of Allah, I propose that we embrace it. The fact
that gold prices are currently so low is not a reason to avoid it, but
rather an unprecedented opportunity to adopt it since we can buy it
while the price is low. Unless one uses a hard currency as a unit of
account, it is only a matter of time until a disaster strikes the economy.
Usually the villain is inflation as the money supply exceeds the demand.
The expansion of the money supply by the government or the banks constitutes
a form of fraud. It is akin to counterfeiting for it uses an increase
in the overall price levels to subsidize the purchases of the creators
of the excess currency. The distortions introduced into the system hit
hard at the recipients of fixed incomes. They also tend to subsidize
holders of the higher orders of production (e.g., land) the values of
which rise faster than the mean of other price levels. Occasionally
the money supply may contract too quickly leading to depression. Apart
from the political obstacles to adopting a gold standard (the unwillingness
of banks and politicians to give up their ability to manipulate the
supply of currency), there are several economic obstacles. One is the
fear of volatility expressed by Chapra. This fear is ill founded for
the reasons given above.
Another is the argument that the Muslim countries do not possess much
gold. This is certainly NOT the case for Lebanon and Saudi Arabia. But
in any case, it is irrelevant. A country like Malaysia which doesn't
possess a large store of gold but which has goods and services to offer
can acquire gold through trade.
Money is STANDARD.
Ibn Khaldun pointed out a long time ago the fallacy in the notion
that a society is wealthy because it possesses a large quantity of monetary
commodities. He noted that the Sudan has more gold than the more prosperous
countries of the east. Further, he argued that the prosperous eastern
nations export much merchandise. "If they possessed ready property in
abundance, they would not export their merchandise in search of money...."
(Ibn Khaldun 1967). Ibn Khaldun understood that a surplus of money would
result in a cash outflow, and correctly argued that a high level of
(net) exports argues against this being the situation. Again the essential
point is that money is a standard. Currently, the American dollar is
the standard. Although really an unbacked fiat currency, it is treated
as hard currency because people have confidence. This confidence is
not completely unjustified since although the United States makes no
promise of redemption it has assets, both liquid and fixed behind it.
The United States owns enough gold to buy back 21% of M2 (a measure
of the total money supply). A 100% reserve in a monetary commodity is
not necessary if one has ample total collateral to maintain confidence.
Thus the islamisation of the money supply of a Muslim country can take
place in stages. The first is simply to adopt the dinar as the MEASURE
even before one has the backing in gold provided one does not distribute
more promissory notes than one has in all types of backing. Further,
one can use the current advantageous low price of gold to institute
an initial spread in the buy and sell price of the dinar. For example,
the official price of the ringgit is 26 cents, but the black market
price is lower. Let us assume a true market value of the ringgit of
20 cents. One could replace it with a dinar, which could be minted for
approximately $30. Ringgits would be retired over a period of six months
to two years. During that period they would be bought at a rate of 150
per dinar or at the official price of gold at the official ringgit exchange
rate, which ever is LESS. Over the retirement period, the value of the
ringgit would presumably drop against the dollar as holders seek to
get rid of them while the price of gold may go up against the dollar
as the adoption of a gold currency might fuel speculation of a return
of the gold standard.
This means that the new Malaysian currency (the dinar) would RISE in
value against the retiring currency AND against the world standard of
the dollar. Further, sales of the new coin could be marketed to numismatists
and to Muslims around the world to generate dollar and other foreign
currency income to aid the financial crisis. After the transition period
the country would be forced into monetary and fiscal discipline not
by the IMF, but by the God-given discipline of the dinar. A more detailed
and lengthy treatment of the transition mechanism beyond the suggestion
offered here is needed, but is beyond the scope of this paper. Such
a treatment would include a discussion of the monetization of other
commodities (e.g., land, oil, rubber) and how one might effect such
monetization while retaining the dinar as the unit of account.
Such approaches would be of interest to those policymakers who understand
the reasons why commodity currencies are an indispensable element for
preventing fraud in banking and public policy, but fear that mandating
convertibility into gold would somehow benefit gold-mining countries.
Although Ibn Khaldun has shown that this fear is unjustified (it would,
on the contrary, open up new trade between gold-mining countries and
the countries adopting the gold standard), the existence of such concerns
is a political fact of life that must be addressed. Nonetheless, the
point of this paper stands that it is no accident that commodity currencies
are successful in yielding "sustained macro-stability." I have never
been keen on following tradition simply because it is tradition.
The case for following our Islamic heritage on these matters is moral
as well as utilitarian. The difficulties of finding an effective and
sound monetary policy are obviated in Islam by the monetary regime of
the Dinar.
REFERENCES
Ahmad, Imad A. 1996, "Comprehensive Development of Muslim Countries:
An Interdisciplinary Approach from an Islamic Perspective," Minaret
of Freedom Institute preprint series #96-4.
Ashtor, E. 1976, A Social and Economic History of the Middle East (Berkeley:
Univ. of California). Chapra, M. Umer 1985, Towards a Just Monetary
System (Riyadh: The Islamic Foundation).
Choudhury, M.A. 1997, Money in Islam: A Study in Islamic Political
Economy (London: Routledge).
Ibn Khaldun, Wali ad-Din 1967, The Muqaddimah: An Introduction to History,
Franz Rosenthal, trans. (Princeton: Princeton Univ. Press), p. 282.
Johnson, Ian 1998, "How Malaysia's Rulers Devoured Each Other and Much
They Built," Wall Street Journal, v. 232 #87. 30 Oct. 1998: A1.