Tuesday, 6 April 2010

Gold and silver as Islamic money?

How would you respond to the claim that Islamic money is gold and silver and that Muslims should support an international return to the gold standard?

Money that is being dealt today has given us a lot of benefits and also giving us problems that are affecting most parts of the world with the financial crisis bubble burst. Comparison between gold or silver and fiat money or paper money will be done so that the pros and cons will easily be evaluated in the perspective of economics and Sharia’.

3) Islamic perspective on money
In the period of the rising of Islam, gold and silver was used as a common medium in trading. Most of the Arabs were businessman and traders, they were not known of craftsmanship so the Arabs dealings were always conducted in gold and silver as they have nothing else of significance in high demand to be used as money.
Early Muslim scholars considered gold and silver as the natural money or money by creation. Given that fiat money has replaced gold and silver, Muslim scholars have equated the modern fiat money with the jurist rules of gold and silver. Consequently, all kinds of prohibited interest or riba on gold and silver, as well as all conditions or requirements of zakah on gold and silver have been passed to fiat money.
There is not much being said in the Islamic perspective on gold and silver as generally Islam does not really endorse on the usage of gold and silver or even opposes on the usage of fiat money. There is a hadith by the Prophet salallah alaihu wassalam that interprets most miserable is the servant of Dirham and Dinar which emphasises on the usage of gold and silver which warns us on not to be obsessed in using gold and silver . It is undoubtedly that gold and silver may lead us astray due to its inherent value but it is a reminder for us so that we will not hesitate when spending gold and silver or money and always be a servant of Allah (god) rather than the servant of gold and silver.
If paper money was a debt of real wealth of gold and silver, it would not be allowed because of the prohibition from one of the Prophet’s Hadith about any transactions in gold, silver, wheat, barley, rice and dates is to be done on the spot and hand to hand. If the paper money represents gold, therefore this transaction goes against the hadith as the gold is not being transferred from one person to another.
4) Fiat money
Generally, the value of money is determined by the law of supply and demand which has been said by Ricardo “the value of money is not determined by the labour time its substance embodies, but by the law of supply and demand only.” If money is being over produced but it is low on demand, the value of the money will depreciate tremendously. The United States of America dollars is being over produced but it is being supported by most parts of the world which makes it high on demand even though it is over produced for the capacity of its nation.
Generally fiat money will always be spent due to its specific purpose as a medium of exchange and because of its depreciating value. Time value for money will have an effect here, so people will tend to get rid of the fiat money in a shorter period compared to gold and silver. The disadvantage here is that when fiat money is over spent it will then lead to debt. Too much debt will create crisis which will affect the communities which has been experienced frequently with the likes of United States of America in recent times. Hence, it will create a bigger gap between the rich and poor which leads to a bigger disastrous effect.
Fiat money also has an advantage if it is conducted in Islamic law which eliminates riba or interest, which is proven in recent history that it is achievable. It is also possible to do it with gold and silver if it is being conducted in Islamic law as well. Both are prone to interest but it is illogical to implement it with gold and silver due to its limited resources.
Fiat money is widely known due to its liquidity. It is easily measured and managed because of its size and weight compared to the gold and silver which is a hassle to manage because it is bulky and heavy to be transferred around. This is certainly a big advantage to the fiat money and one of the reasons that the fiat money was created.

5) Gold and silver
Gold and silver are resources from the earth in contrast to the fiat money which is produced by human. Humans cannot over produce the gold and silver as it is a limited resources from the earth. This will be beneficial as it cannot be over produced but it can also be a disadvantage as it is limited and demand will only rise as the population of the world is ever growing. Although so, the higher demand for gold will only make it more valuable which makes it more stable than fiat money as history has shown it has been depreciated.
Comparing gold and silver with fiat money, the stability value of gold has always been superior in comparison to the depreciating fiat money. As mentioned by Luthfi Hamidi, one troy ounce of gold was equivalent of US dollar 1,939 in the year 1800. In 2004, one troy ounce of gold is equivalent to US dollar 455,757.This is because the US money production of the US dollar is ever growing but gold is not being over produced for the last 204 years. Gold resources are limited but the demand is growing through the population of the world and therefore makes it value appreciated and not be depreciated. It is better to leave it in the hands of god rather than in the hands of another human being or government which can or able to manipulate the value of money.
Using gold and silver as a medium of circulation could make people feel reluctant to spend or use it in circulation. People would rather keep the gold and silver due to its inherent value. This will be a disadvantage because it might not satisfy the equation of quantity theory of money which is V=Y/M. V represents the average velocity of circulation, might not be adequate due to hoarding gold. Where else fiat money has the advantage here, as it has a specific function which is to be spent in exchange of goods and services. If one decides to keep the fiat money, it is because to save up until it reaches certain amount and only to be spent in a larger amount.
People have the tendency to feel reluctant to spend unnecessarily with gold and silver, debts will be kept at a minimal and therefore may avoid being in a financial crisis. With gold and silver, it will make people more aware and only spend on necessities. Financial growth will take on a slower pace but will be considerably more stable compared to the usage of fiat money.
Due to the facts that of the usage of gold and silver people are more reluctant to spend it, it will lead on to a higher interest rate. People will be afraid to let their valuables go, therefore demanding a higher interest rate when loaning it out. Contrast to the fiat money, even though people would willingly loan it out, it will be on a lower interest rate. Interests are commonly known to be prohibited in Islam as being mentioned in the holy Quran. (2:275)
Gold and silver are limited resources therefore it will be illogical for one to demand more than what is available. In a way it can somehow stop people on dealing with interest or riba. In contrast to the fiat money which is always being produced, one can always demand on interest because the supply will usually meet its demands. Even though these interest are at a smaller percentage, too much of these small percentage of interest will add up to a big amount that can be unsustainable.

Gold cannot be implemented as gold reserve standard because of the prohibition from the Prophet that gold has to be exchange from one to another on the spot. Therefore if one were to endorse the usage of gold as money, it cannot be gold reserve standard but has to be the physical gold itself.
Gold resources might be sufficient to be used commercially but the issue is that if the average velocity of gold circulation is adequate to fit in the quantity theory of money equation which is V = Y / M, as people naturally will hoard gold rather than spending it generously.
Gold would give a trade-creating effect which is positive rather than fiat money which gives a debt-creating effect that will lead to financial crisis. The important thing for the Islamic Economic System is to get back to the trading side and not to the debt-creation side. Islam generally encourages us to do trading and avoid debts.
The important goals of monetary policy in an Islamic economy:-
Ø “Economic well-being with the full employment and optimum rate of economic growth;
Ø Socio-economic justice and equitable distribution of income and wealth; and
Ø Stability in the value of money to enable the medium of exchange to be a reliable unit of account, a just standard of deferred payments and a stable store of value” .
Gold would fit in this monetary policy as a stable in the value of money.
Gold and silver are not necessarily money from the Islamic perspective and Muslims should not support an international return to the gold standard. However gold and silver may be implemented as money if gold minting is being used. Fiat money can also be used from the Islamic perspective but it would be better if fiat money were to be more stable and perhaps new solutions for the fiat money through evolution could be ideal money.

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