UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Properties of Money in Islamic and Conventional Settings and the Effect on Society

Early Morning Firenze

Thoughts from Iraj Toutounchian’s Islamic Money & Banking, Integrating Money in Capital Theory

…if benevolence were to lead each person to regard her fellow’s concerns as her own, there would be no free riders or parasites to be restrained by the visible hand of cooperation.  All would seek naturally to coordinate their actions for the common good, without putting forward opposed claims to the fruits of their endeavours, which justice must resolve.  (Brosio and Hochman 1999, Volume 1: 114).

‘In my view, the most important properties of money in an Islamic Setting are the following:

(1) Centrally produced and managed (by central bank);

(2) Indivisibility (further elaboration needed);

(3) Velocity of circulation (greater than one);

(4) Externality (of becoming actual capital);

(5) Non-excludability.’

In the case of fiat paper money in capitalism, its being considered durable, with no depreciation, but interest bearing seems to have raised its rights well above those of commodities it represents.

If money itself were a commodity, like gold, the picture would look different, as we saw above.  The commodity value of gold contained in money would appears as  one of the asset items on the Central Bank’s balance sheet, with the other part, which comprises the exchange value of the money, as a liability.  Therefore, there are two extreme cases.  First, total money consists of say gold in which its exchange value equals its value; that is, its metallic value.  Second, total money consists of fiat paper money, in which its commodity value is nil.  In the first case, the metallic value of money appears as an asset item in the Central Bank’s balance sheet and nothing, in this regard, on the liability side.  In the second case, all exchange values of the money appear on the liability side of the balance sheet and nothing, in this regard, on the asset side.

In capitalism, the functions of money are traditionally discussed and analyzed with the underlying implicit assumption of interest.

‘Only in the event of money being used solely for transaction and never as a store- of- value, would a different theory become appropriate.’  J.M. Keynes

‘The transition from the conception of money as a medium of exchange to money as a store- of -value has raised new problems.’  (H. Johnson)

Mill was not unaware of the function of money as a store- of- value:

…the effect of the employment of money, and even the utility of it, is that it enables this one act of interchange to be divided into two separate acts or operations; one of which may be performed now, and the other a year hence, or whenever it shall be most convenient.  Although he who sells, really sells only to buy, he need not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another. (Mill 1848:70)

This statement clearly demonstrated that Mill had quite well understood the analogy between store- of- value and speculation.

Many economists, myself included, believe that the capitalist economic system is incapable of settling such annoying issues in a satisfactory manner.  Its inability to do so probably stems from its denial that speculative motives could be behind the motive demand for money; which is obvious and clearly undeniable.  Any attempt to save capitalism from its malfunctions is futile unless the robust destructive role of the store-of-value function of money as a means of speculation is admitted and the system amended accordingly.

It was long believed that money had just one important function to play; that is, as a medium of exchange.  To this was added the unit- of- account function.  This belief, beginning with the pre-classical monetary theory and extending to the classical and neoclassical monetary theories, was maintained during the period from 1650 through to 1936.

In the economics of John Maynard Keynes, as Professor Dillard so aptly put it,

…’money holds the key to explaining unemployment but not to its remedy.’  In the economics of Jacob Vanderlint … money holds not only the key to explaining unemployment, but also the effective remedy for unemployment.  The explanation of this phenomenon lies in the fact that none of these writers paid any attention to the role of expectations in the economic decision-making process.  Hence, the theory of liquidity preference is conspicuously absent in their writings.  Without the speculative (asset)-demand-for-money function, the elasticity of aggregate demand with respect to an increase in the quantity of money will be equal to unity.  (Ascheim and Hsieh 1969: 141: my italics).

1. Social Justice is the ultimate goal of Islamic economics, the importance of which cannot be exaggerated.  Any deviation from such teachings brings about Zulm (injustice).  Embedding justice into the heart of an economic system is not as hard as most mainstream economic theories imagine.

2. There must be cooperation among all individuals and legal entities, from which positive synergy emerges.  This will naturally bring about externality, both in consumption and production.  Externality  in consumption takes the form of interdependent utility functions; in production it gives rise to ‘the share economy’ or a ‘grand cooperative system,’ which make it possible for individuals to enjoy part of the profits of the firms for which they work.

3. In any conflict between social and personal interests, the social interest must prevail.  To most Western economists, the concept of efficiency is based on Paretian value judgments, which assume that: a) there is no society above and beyond individuals.  Thus, we should be interested only in the welfare of individuals and nothing else; (b) individuals are the best judges of their own welfare and choose what is best for themselves; (c) social welfare can be said to have increased if at least one person’s welfare has increased and no one else’s has fallen.  Pareto optimality has little to say about the ‘correct’ allocation of resources and says nothing about equity (justice).

When it comes to the debate over the level of redistributive taxation of public expenditure, such comparison cannot usually be made using the Pareto criteria.  Similarly, saying which of two options is the better when both are Pareto improvements is impossible.  (Connolly and Munro 1999: 32-3)  In brief, the capitalist system exhibits all the hallmarks of a zero-sum game.   Muslim scholars have different interpretation of ‘individual’ and ‘society,’ however.  Briefly, in Islam we believe that (a) society exists independent of real entities (individuals); (b) society has the prerogative in policy issues; (c) only with cooperation among individuals will social welfare increase; (d) with cooperation and the resulting externality, both individual and society benefit without incurring any loss to either side; and (e) the Islamic economic system can be visualized as an increasing-sum game.  Keeping all of this in mind, we are really talking about a very different economic system.

4. There must be no money market.  This is a simple outcome of the abolition of Riba in Islam, which in turn prevents the development of speculation in any market.  Money then becomes an endogenous variable and integrated in capital theory. 


Capitalism is mainly characterized and analyzed in an environment with no cooperation and externality – the two fundamental characteristics of human societies, whose neglect has a profound and adverse impact on the welfare of a state.  Specifically, Pareto optimality, which has been proved not to be necessarily superior to any non-optimum, ignores these two elements (see Nath 1976: 21-2).  Underlying the concept of Pareto efficiency (known as the first and second fundamental theorems of welfare economics) are the Paretian value judgments outlined above.

Pareto optimality has been extensively criticized as being overly utilitarian, with Professor Sen leading the attack:

The traditional propositions of welfare economics depend on combining self-seeking behaviour, on the one hand, and judging social achievement by some utlity-based criterion, on the other.  In fact, the traditional welfare economic criterion used to be (and still seems to be) the simple utilitarian one, judging success by size of the sum total of utility created  – nothing else being taken to be of intrinsic value.  A social state can be said [said to be] Pareto Optimal if and only if no one’s utility can be raised without reducing the utility of someone else.  This is a very little kind of success and in itself may or may not guarantee much.  A state can be Pareto Optimal with some people in extreme misery and others rolling in luxury but can be made better off without cutting into the luxury of the rich.  (Sen 1987:30-1)

Sen believes that the basic issue is whether there is a plurality of motivations or whether self-interest alone drives human beings.

Quite contrary to the Paretian Value judgments outlined above, I like Murtada Mutahhari believe that:

Society is a real compound like the natural compound.  But the synthesis here is of minds and thoughts and of wills and wishes; the synthesis is cultural and not physical … Individuals … who enter into social life with their gifts acquired from nature and their inborn abilities, spiritually merge into one another to attain a new spiritual identity which is termed ‘social spirit.’  In this case, the whole or the compound does not exist as a single entity.  It is different from other compounds … In the synthesis of society and individual, though an actual synthesis takes place .. the plurality of individuals is not converted into a unity … Society conceived as a single physical unity is only a hypothesized abstraction.  (Mutahhari 1985: 12)

Viewed in this way, the welfare of society takes place over one or a group of individuals.  This overrules the Paretian values and means that society is the best judge when conflict arises between the welfare of the society and that of an individual.  (Iraj Toutounchian)

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