Monday, July 23, 2012

Money as a store of value in Islamic economics

Islamic economics has developed much under the radar of Islamic finance (despite having preceded the development of the modern Islamic financial industry), but occasionally a few items from Islamic economics enter into the discussion of Islamic finance, and one of the most common is the idea of reintroducing the Gold Standard (i.e. bringing back the Islamic Dinar as a backing for currency), whose prime advocate is former Malaysian prime minister Mahathir.  I view the adherents of this idea no differently than I do any other calls for the return of the gold standard: I am dismissive of the idea as a solution in search of a problem. 

However, I saw an argument that ties into the idea of a return to the gold standard, brought about through Islamic finance, that approaches the problem from another angle where the return of the gold standard would be the natural outcome.  An excerpt from Iraj Toutounchian's book Islamic Money & Banking: Integrating Money in Capital Theory (note: I am basing the post just on the excerpt) includes the proposition that:
"The money market, which plays such a major role in the capitalist system, is the result of speculation with money.  It is only logical, then, that the abolition of interest would lead to the total disappearance of this market.  Therefore, any changes in the level of investment in an Islamic economy should be directly attributed to the marginal efficiency of capital (or, equivalently, the rate of profit).
To summarize then:
Money has just two functions to perform: as a medium of exchange and a unit of account.  It can no longer be a store of value."
There is probably little doubt that from a definitional perspective there would be no Islamic money market, since the very idea is based on exchange of money for money with profit, something which no doubt falls into the prohibited areas.  However, the idea that money cannot serve as a store of value is peculiar.  If you are talking about paper money, and asserting that it cannot be a store of value, than it is reduced to being an accounting mechanism only, and really doesn't serve as a very good as a medium of exchange. 

The economic situation would then be reduced to finding another store of value, which would likely mean precious metals like gold and silver.  However, if the whole point of Islamic finance (and presumably Islamic economics as well) is to encourage a risk-sharing alternative where money has value only because it can be invested in economic activity to make a profit, or used to avoid the costly need for the 'double coincidence of wants' that plagues a barter economy, then money has to serve as a store of value.  Whether that is in the form of gold, or in the form of paper currency, there cannot be a system in which money ceases to exist as a store of value or its use as anything more than an accounting mechanism (as the ruble was in Soviet Russia when it was not freely convertible into any other currencies).  It would not be money as money is currently defined.  This applies both to paper currency and precious metals.  Precious metals fall under the same rules in Islamic finance as does paper currency with respects to riba.

There can be arguments about how money can function in the economic system in order to generate profits, and Islamic finance doesn't allow what would be thought of as a "money market", but that is an entirely different thing than saying it cannot be a store of value. 

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