In mainstream economics, it’s very hard to not discuss interest rate. The idea of interest rate in mainstream economics is so prevalent that if a person successfully pushed the idea of interest rate out of all equations, chances are, modern economic system would undergo a radical transformation, for better or for worse. In Islam, there’s an explicit prohibition of usury (tag). I don’t consider modern-day interest rates as usury but rather, accept usury as unreasonable interest rates, such as those enforced by loan shacks; not rates imposed by proper financial institutions that are based on economic fundamentals. However, if a person really wants to err on the conservative side, it’s really hard for me to reconcile modern economics that I’m acquainted of with Islamic economics. But it occurred to me recently that there might be a way to reduce the presence of interest rates in an economic system. There are probably more than one way but I’ll touch only one.
First, let’s get down to basic.
There are a number of causes why interest rate exists. One of them is inflationary expectation. At the same time, inflation is caused by several reasons. One of them is the increase of money supply. Some people may not agree to that but let’s just assume that the monetarists, the Austrians and the supply-side people have the upper hand over Keynesians.
When inflation is going up, it’s typical to hear a corresponding central bank to increase interest rate; nominal interest rate. A real interest rate is roughly equivalent to nominal interest rate subtracted by inflation. Because inflation necessarily erodes real interest rate, increasing the nominal interest rate prevents the real interest rate from falling too much or at all. For this reason – and other unstated reasons – interest and inflation rate are closely related.
Keeping this in mind and the fact that Islam forbids usury – assuming usury includes those rates that I don’t consider as usury – adopting the gold standard is a logical solution to reduce the differences between Islamic and mainstream economic system (tag).
According to Wikipedia, the “gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold.” In a gold standard, every note issued by a government is backed by gold. This limits or outright eliminates a government’s ability to increase money supply, unlike fiat currency. Again, since one of the causes of inflation is money supply increase, adopting the gold standard eliminates inflation and with it, a cause for interest rate. Of course, this is assuming that the price of gold itself is free from inflation, which it is not. But the price of gold is relatively stable for us to not think too much of it. Gold is a reliable store of value.
Because gold standard eliminates a need – I stress, not all – to have interest rate, I’d expect those that want to build a more Islamic society to support a reversion to the pre-Bretton Woods period; back to the gold standard. Or any standard that takes away the government’s power to increase money supply.
The standard however is not free of fault. It has its own set of problems but I’m not planning to go into that. One question is, do I want to revert back to the gold standard?
Well, I’m pretty happy with the current system. No point fixing something that ain’t broken, yet.
Finally, do you notice something? This practically means there’s a policy overlap between conservative Muslims and objectivists! The causes for support differ but the end result is the same nonetheless. That’s just weird.
p/s – holy shit. Did you guys see how those shares at the local stock market fell today? Words on the streets have it that it has something to do with Iris. The Security Commissions along with Bursa Malaysia’s effort to curb excessive speculations over Iris might have spilled over to many other counters. I haven’t seen so many reds in recent local history!
5 replies on “[789] Of Islamic economics and gold standard”
Well, perhaps. But I’m not ready to put the blame completely on fiscal policies given that it’s hard to find a consensus among economists of what caused or made the Great Depression worse than it should be.
__earth: Heh, Austrians would contend to the Great Depression claim, and I would agree. The Great Depression happened *after* fractional reserve banking. Though the link between the dollar and gold wasn’t dropped, the multiplier effect of fractional reserve banking entails there shouldn’t be any monetary deflation.
I think the better party to blame is the Bank of England and the Fed trying to accommodate them. After the first World War, UK went back to the Gold Standard at old exchange rates, despite the fact that the pound was several times less valuable than the gold it now represents. To reachieve equilibrium, it caused the biggest economic crash the world have seen.
Though it would not be that bad a crash if successive administrations in the United States implemented near-idiotic policies (i.e. the New Deal)
Rajan, you’re especially right about deflation.
And there are papers that fault the gold standard as one of the causes of the Great Depression back in the 1930s. I also agree with the inflation vs unemployment since it’s part of Phillips curve and have somewhat been proven during Volcker’s reign as Fed’s chairman.
Frankly, I myself am no fan of gold standard.
I’m merely highlight the fact that conservative Muslim might prefer gold standard. In fact, heh, Kelantan has just announced something that proves my hypothesis.
I agree. I’ve always found the emphasis some economists place on monetary policy a bit disturbing. Although monetary policy does have a role to play, a fiscally irresponsible government is often a greater harm than incompetent bureaucrats at the central bank.
The problem with the gold standard is that supply only increases by 2% annually, on average – much lower than population growth. Therefore the supply of money per capita actually reduced, causing what even Austrians would call deflation.
Whether or not deflation is bad is a whole other contentious issue. BTW, our inflationary fiat currency system does not work… well. It’s not broken to the point where ringgits are worthless and businessmen are jumping off tall, insolvent buildings. Perhaps a better solution that isn’t as drastic as going back to the gold standard is actually requiring both government and central banks to adopt an expressively anti-inflation outlook.
Unemployment is best fixed not by inflation (inflatory policies increase business cycle fluxtuations; so using that as a solution seems rather stupid); rather by good fiscal policies – low taxes, low restrictions to investment, clear regulation. So if Bank Negara stops trying to balance unemployment and inflation, perhaps our ringgit would be a whole lot less inflationary.
A curious example would be Eurozone – the euro is expressively controlled to prevent inflation – not balanced with the need to lower unemployment. Yet while countries like France, Germany and Italy stuggle with worrying levels of unemployment, others like Ireland and Luxembourg don’t. What differs is fiscal policy. Finland, for example, have taken a path of massive, albeit, gradual fiscal reforms and halved its unemployment of 16-17% a decade ago to around 8% today.