Economic Effects of Money

A complex modern economy cannot function efficiently without money. Although the fundamental functions of money are universal, the speed and efficiency with which these functions meet the fundamental requirement of wealth creation and distribution depends on the economic system on which it is used because the system controls the supply of money and lays the rules by which it can be acquired and used. To understand how money influences an economic system. In this article, we examine some key aspects of monetary economics from the Islamic point of view in comparison to Western Capitalistic point of view. We conclude that the economic ills of today's world has been largely caused by ill conceived Capitalist financial system.

In the history of mankind, an amazingly wide range of things have been used as money in various societies. These have included cattle, salt, silk, furs, dried fish, beads, Cowry shells, stones and even feathers. But, in the more advanced economies, gold and silver were most widely used before the advent of paper money. When Islam came, the Prophet(saw) approved the use of gold and silver as money. He permitted the use of the Roman and Persian Gold and Silver coins. Gold and silver then became inextricably linked to Islam as a system of currency although the Prophets approval and through the link with the Commands of Allah(swt) and the Zakat. The Prophet(saw) said that Zakat can be paid on money only if the nisab exceeds 20 Gold Dinars, and that punishment can be implemented on a thief only if what he stole exceeds a quarter of a Dinar.

How Money Affects the Economy

The choice and supply of money

One of the ways by which economies are managed is through the amount of money supply, so called monetary policy. Until the turn of this century, gold and silver were used as real money world-wide. Later, Western governments began resorting to paper money whose supply is not dependent on the hard currency of gold and silver for selfish reasons. Since then, money became easy to create at will. Unlike in Islam, a lot of worthless paper can then be changed into money without a corresponding increase in gold and silver to back it. And when the supply of money far exceeds the supply of goods and services, inflation occurs.

Although many things have been blamed for the cause of inflation the real cause of inflation is the excessive creation of paper money by governments. What are often blamed for inflation are in fact the consequences or side effects of it, not causes. Businessmen are often blamed for the rise in prices which is regarded as a cause of inflation. But, when why is inflation greater at some places and at sometimes than others?

Businessmen are surely not more greedy at some places more than others and at some times more than others. The rise in the prices they charge is a result or a reflection of the other forces. For example, inflation in the 1970's was blamed on the rise of oil prices in 1973 due to OPEC. But in the five years that followed the 1973 shock, both Germany and Japan who depended in 100% oil import had declining rates of inflation, while countries like the USA which depended only on 50% oil import did not. In Japan, inflation fell from over 30% to below 5%. In the US inflation rose from 5% in 1976 to 13% in 1979.

Another favourite explanation for inflation is low productivity. Yet consider a country like Brazil. It has experienced one of the most rapid growth rates in the world, and also one of the highest rates of inflation. This is because changes in growth are dwarfed by changes in the supply of money. The historical facts surrounding great inflationary periods prove this. For example during the German hyper inflation after world war I, money grew at an average rate of 300% per month for more than a year, and so did prices. During the Hungarian hyper inflation after world war II money grew at a rate of 1200% per month for a year, closely followed by inflation at an even higher rate. On the other hand consider the American civil war. The South financed the war largely by printing more money, thereby producing inflation at the rate of 10% per month from 1861 to 1864. But, in May 1864, the Confederacy enacted a monetary reform and dramatically, the general price index dropped, in spite of the reduction in foreign trade and disorganised government.

In the Islamic case, the choice of gold and silver as the form of money means that in an Islamic economy, money is based on real wealth, which cannot be produced at will. Paper money could be used as receipts to increase portability of real money. But in that case, each unit of paper currency must strictly be linked to gold and silver and can be exchanged for either or both of them on demand at all times. As a result:
This eliminates the problem of runaway inflation in two concrete ways. Firstly, the government cannot print or mint more money at will because gold has to be found and extracted. It would be illegal for the government to increase monetary supply by printing more paper money. This is because in such situations, if everybody or many rich people were to go to the treasury and seek to exchange their paper money for gold and silver, the treasury would not be able to honour them. People may then lose confidence in the system and it would then break down,

In Islam, the making of money goes together with the actual creation of wealth as the extraction of gold and silver requires actual input into the form of services and capital investment in the form of goods.

Secondly the making of money goes together with actual creation of wealth as the extraction of gold and silver requires actual input into the economy through human efforts in the form of services and capital investment, in the form of goods. These offset the extra gold and silver to be produced. Moreover it takes time to produce gold and silver from their ores, and their supply cannot be increased at will as they are not common resources. Hence monetary supply would not grow excessively in relation to the supply of goods and services.

Another consequence of using gold and silver is that markets will not be disturbed by sudden influx of worthless paper money. On the contrary, there would be stability and free convertibility in foreign exchange if all countries base their currency on the gold standard, thereby creating a healthy atmosphere for international trade through confidence in it. Suppose for example that both the US fixes $1 to represent 10 ounces of gold internally. Then the UK decides to fix one pound for five ounces of gold internally. Then the sterling dollar exchange rate would automatically be fixed at one dollar for two pounds internationally. And the exchange rate with all other currencies based on the gold standard can similarly be deduced.

Money as a form of wealth

Money is in effect a special form of wealth which is freely exchangeable with all commodities and services and whose uses include the three that have been mentioned before. The most fundamental issue to be addressed by every economic system is that of the creation and distribution of wealth. According to the capitalist economic system, wealth should only be distributed amongst those who took a part in producing it. These are:

Land
That is things that are being used as a means of production which have not previously undergone any processing, such as natural resources.
Capital
Which includes any commodity that has already undergone human processing and is again being used as a means of further production, such as machinery and money which they call liquid capital.
Labour
Which is simply human exertion.
The Entrepreneur
The one who organises these three and bears the risk of profit or loss in production. The owner or provider of land gets their reward in the form of rent or revenue. The provider of labour gets a wage or salary. And, the entrepreneur is rewarded with the profit and the provider of capital gets interest.

In the Islamic economic system, it is understood that the real owner(Creator) of all wealth is Allah(swt). We only 'own' wealth by proxy as guardians. Some of us acquire wealth by engaging in the production process and hence have a direct access to wealth. These include the factors of production as defined by Islam. Others have an indirect access to wealth simply because Allah(swt) as the real owner of wealth has stipulated that those with direct access to wealth through engagement in the production process must pass some of it on to them as He made clear in the Qur'an:
"Give to them from the property of Allah which He has bestowed upon you" [ 24:33]

This usually takes the form of Zakat, kaffarat, sadaqat-ul-fitr etc which are given to the poor and needy. Those who have direct access to wealth i.e the factors of production, include capital, which constitutes those things which can only be used in the production process if they are wholly consumed, such as money. In other words they cannot be let or leased. One cannot derive any benefit from money unless he gives it up in exchange for commodities or services, and hence unlike the capitalist economy, machinery is not but it comes under land together with houses etc. Also, labour includes all sorts of human effort, both physically and mentally. this eliminates the entrepreneur as an independent factor of production. The entrepreneur is not a rewardable factor of production. The entrepreneur is not a rewardable factor of production in his own right but bits of his job is done by the providers of land labour and capital. Instead of rewarding the entrepreneur with profit for the risk of loss that he takes, Islam views that the risk of loss is attributable to capital, that is money itself. Hence there is no place for interest. That is to say, the person who wants to invest their money in a certain business must take the risk of loss and is rewarded with profit. The one who provides 'land' gets rent or revenue, and the provider of 'labour' gets salary or wages. Should the business fail the provider of capital loses their money, the provider of land loses their rent and the provider of labour loses their salary. If a man owns his business, he gets or loses all three rewards. The guarantied reward in the form of interest on capital marks a fundamental difference in the way the Islamic and Western economic systems view and use money. A major consequence of this difference is that, the way people use money will differ depending on the operating economic system. As the provider of capital in a production process has to have a guarantied in the form of the business, If the business would yield a return that is lower than or equal to the going rate in interest, it would not be worthwhile. The effect of this is that the borrower will cease to engage in that production process as he would get no reward in the end. Consequently the economy looses two fold. Firstly, the growth of the economy is hindered as wealth which would have been created. Secondly, the borrower looses a means of income. He would be unemployed through no fault of his.

Further, even if the rate of return would be higher than the prevailing rate of interest and the process goes ahead, interest rates would add to the cost of production which would in turn increase prices unduly. This adversely affects the distribution of wealth to the rich through guarantied interest payments. Hence both production and distribution of wealth are affected adversely, directly as a result of interest.

On the other hand, the fact that Islam prohibits interest payments has a profound beneficial effect on the system of creation and distribution of wealth. Owners of capital can in practice only invest in it in essentially two forms of partnership - Shirka and Mudharaba. In shirka, the two or more people jointly invest and manage the business and jointly share the reward or loss, In mudharaba, some partners provide capital and some manage it with each having a share of the reward or loss. This form of investment to a great extent servers as an effective check on the concentration of wealth which is the greatest of evil of the capitalist economy.

Alternatively, the owner of capital may lend his money with no interest in an Islamic system.

Hence a borrower would be able to go ahead with the business in either way, and the consequence would be opposite to the capitalist state.

Speed of money circulation

Another important way by which use of money in an Islamic economy results to a far better creation and distribution of wealth is through its speed of circulation. By this, is meant how quickly money changes hand. An economy functions by exchange of money for which people create and exchange goods and services. The more money 'changes' hands, the higher the economic activity of wealth creation and distribution. An amount of say £1000 can pay for goods and services several times this value if the system creates a means by which money is passed on quickly. For example, say Mr.A has £10 He invests it by buying goods for Mr.B for use in his business. Mr.B goes into partnership with Mr.C and invests the £10 by buying from Mr.D who uses it to pay for the services of Mr.E. Everybody standard of living is raised as they get real benefit from real wealth. Had each person been 'sitting' on their £10, a total of £40 would have been needed to achieve the same scenario. The Islamic economy achieves this high circulation speed through a wide range of directives among which is the prohibition of interest, the prohibition of hoarding, and the guaranteeing basic needs by the state. These measures together give people the incentive to continually invest while positively reducing the barrier to investment by assuring investors of their basic needs should the business fail. By prohibiting interest and hoarding, owners of money can only increase it by going into partnership with others. Also, those who 'save' money will continuously lose some of it directly to the less well-off in society in the form of Zakat unless they invest it through partnership.


The Answer
 

The answer to the economic problems of the world and particularly the Muslim countries is therefore to resort to nothing but Islam.

From these observations, it can clearly be seen that the Islamic economy, through the choice and management of money, will go a long way towards ridding society of the present day world economic ills and achieving the fundamental objectives of effective wealth creation and distribution. The dynamics of the Islamic economy would be an entirely different ball game from our experiences of the present day world economy which is based on capitalism. There would be a proliferation of small businesses in the form of partnership and individual private ventures. The problem of wealth concentration among few would be removed through business partnerships and also through indirect right to wealth in the form of zakat, kaffarat, sadaqat-ul-fitr, wisarat, nafaqat etc. The motivation for business enterprise coupled with a stable currency would influence strong and real economic growth. Three of the major monetary forces that push and pull and even crash western economies, namely interest rates, exchange rates and runaway inflation would be absent. The economic structures such as financial markets and banks which sustain these and foster the concentration of wealth among a few would be absent.

Overall, through the choice management and use of money, the Islamic system creates a practicable and healthy system of economy with everyone getting what is rightfully due to them. Things would be completely different from the economic systems that we have until now been forced to live under.

Further Reading

A.Adduonline Viewpoints

1.Evils of Paper Currency Standardization

2.Gold Standard

B.Non-Muslim Viewpoints

1.The Mirage of Exports -By Hugo Salinas Price

"All countries of the world, with the exception of the U.S., are very concerned about their exports. This is irrational and denotes a pathological condition in their economies.We might say that the “center of gravity” of each of the national economies of the world is not to be found within each country, in production and consumption for its own use, but rather outside its borders, in exports.."

2.What is a Derivative? - By Hugo Salinas Price

"The Mexican peso, the Argentinian peso, the Brazilian real, the Venezuelan Bolivar, the New Zealand dollar, the Australian dollar, the Canadian dollar, etc., all these currencies are not real currencies that belong to the countries where they are issued and circulate. They are simply derivatives of the U.S. dollar.We absolutely can have no national sovereignty when we use the currency of another country, as our own. It is specially serious that we are in fact using the dollar as our currency, as I am stating, when the dollar itself is not a real currency, but only an artificial unit, lacking any intrinsic worth. The dollar is nothing more than a number. It is not redeemable in anything tangible..."
 

3.What killed Argentina? -By Hugo Salinas Price

"This system of dollar reserves, is a massive system of world-tribute payable to the U.S. It is unjust and implies the impoverishment of the world for the benefit of the U.S. The impoverishment does not produce its results evenly. Some countries go belly-up before others. Argentina is the nation presently going under. .."
 

4.Gold Yesterday,Today and Tomorrow -By Hugo Salinas Price

"This passion for gold will not be eradicated by any New World Order, in my opinion. Rather, if the New World Order which is being established at present tries to eradicate gold, it will find itself up against an intractable feature of mankind.."

5.The main American Export and Argentina's problem -By Hugo Salinas Price

"The main export of the U.S., is paper. It’s very fine stuff, made by a famous papermaker.It appears that this year, exports of paper may amount to $400 billion, perhaps more.This paper is exported in small rectangles. Each one is engraved and says: “One Hundred Dollars”. A cubic yard holds about 765,000 pieces.The whole world loves these pretty papers, so they have been going up in value.The U.S. exchanges these papers for cheap goods all over the world. Every time the papers go up in value, the U.S. gets more stuff in exchange. The U.S. doesn’t have to worry about exporting other stuff; if they want more foreign goods, they just export more paper..."

6.Kitchen Talk -I

"Let me describe our monetary system in simple terms. Pretend we are our own little community. We need something to allow us to do business together. We need a form of money. So, I will be the central bank. I will loan all of you 100 Dave Notes (DN) at 5% per year in exchange for the right to some of your property..."
 

7.Kitchen Talk -II

"Let's go back to the kitchen table. We have 8 people sitting around and I am the central banker. I need to have some "reserves" in which to begin my loan and credit-money creation process. By some inexplicable reason, I have been able to accumulate all the known gold reserves on our island. Let's say I have 700 ounces of gold. This will form our monetary base"