Honest Money

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Islamic finance and boom & bust

Posted by Ivo Cerckel on August 17th, 2009

In order for Islamic finance to help break the vicious cycle of boom and bust, Islamic finance must return intrinsic value to money.

Islamic finance can help break the vicious cycle of boom and bust, argues Mushtak Parker today in Arab News newspaper. (1)

First we need to explore what causes booms and busts.
Then we need to explore how the Holy Koran teaches to prevent booms and busts.

THE CAUSES OF BOOMS AND BUSTS

The cause of business cycles with boom and bust is central bank stimulation of bank credit expansion by expanding central bank liabilities and therefore the cash reserves of all the nation’s commercial banks. The banks then proceed to expand credit and hence the nation’s money supply in the form of check deposits.

Business cycles are therefore not rooted deep within the free-market economy and booms and then busts do not just simply happen. But one phase of the cycle flows logically from the other.

The initial phase from which everything follows central bank stimulation of bank credit expansion. (2) 

It is inflation, especially in the form of credit expansion, that sets the stage for financial contractions and deflations – i.e., for depressions. (3)

By inflation, entrepreneurs misallocate capital resources into areas that would not attract investment if the money supply remained stable. (4)

This misallocation is called “malinvestment”. (5)

THE HOLY KORAN & PREVENTION OF INFLATION

We have established that the business cycle with its booms and busts is caused by central bank stimulation of bank credit expansion.
The question how the Holy Koran teaches that booms and busts must be prevented becomes then the question how the prevent inflation, especially in the form of credit expansion.

As Milton Friedman, a Nobel Prize winning economist, once said, “inflation is always and everywhere a monetary phenomenon”.

The Holy Koran says in Verse 161 of Surah An Nisaa’:
That they took usury, though they were forbidden; and that they devoured men’s substance wrongfully;- we have prepared for those among them who reject faith a grievous punishment.\

This blogger asks:
When one party gives something of value
and the other party pays him with something,
in this case paper, of no value,
and when one party’s wealth is created out of thin air,
while the other party has to slave and earn to pay off the ill-gotten credit or loan,
is this not devouring of other people’s wealth?

This means that money in Islam must have intrinsic value.
If not, the buyer is devouring the seller’s wealth.

There is moreover a Hadith of Prophet Muhammed (Peace and Prayers be upon Him) in the Sahih Muslim which teaches:
“Abu Said Al Khudri reported Allah’s messenger as saying:
“gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt. (When a transaction is) like for like, payment being made on the spot, then, if anyone gives more or asks more, he has dealt in riba, the receiver and the giver being equally guilty.”

This Hadith of Prophet Muhammed establishes two things:

ONE ‘money’ in Islam is either precious metals such as gold and silver, or commodities such as wheat, barley, dates and salt.

TWO when gold, silver, wheat, barley, dates and salt were used as money, their value was ‘inside’ and not outside’ the money.

Hence, it is established that ‘money’ in Islam must possess intrinsic value.  (6)

In order for Islamic finance to help break the vicious cycle of boom and bust, Islamic finance must return intrinsic value to money.

Ivo Cerckel
honestmoney@maktoob.com
http://twitter.com/ivocerckel/

NOTES

(1)
‘Islamic finance can help break the vicious cycle of boom and bust’
Mushtak Parker | Arab News
Monday 17 August 2009 (26 Sha`ban 1430)
http://www.arabnews.com/?page=6§ion=0&article=125545&d=17&m=8&y=2009

‘(2)
Murray N. Rothbard, Economic Depressions: Their Cause and Cure
http://www.lewrockwell.com/rothbard/rothbard183.html

(3)
George Reisman, “Capitalism – A Treatise on Economics”, Ottawa, Illinois: Jameson Books, 1998, 3rd ed., p. 938

(4)
http://en.wikipedia.org/wiki/Austrian_business_cycle_theory

(5)
Murray N. Rothbard, “Man, Economy, and State – A Treatise on Economics”, Auburn, Alabama: Ludwig von Mises Institute 2001, (originally published 1962), p. 861

(6)
Imran N. Hosein, “Explaining the Disappearance of Money with Intrinsic Value”, paper delivered at the International Conference on the Gold Dinar Economy, held in Kuala Lumpur on 24 and 25 July 2007, p. 1

One Response to “Islamic finance and boom & bust”

  1. Jeroen Says:

    Awesome post, Islamic banking for dummies!

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