Money Creation in Islamic Economic System - Term Paper Example

Money creation in Islamic economic system s Submitted by s: Introduction A set of rules economic behavior and outcomes as far as the Islamic economic system is concerned with the main source of these rules being Shari’ah, typically translated as “The Law”. Additionally, organizations and guidelines that result from resolutions taken by appropriate authorities in pursuit of economic strategies that will promote the goals of the Islamic community also exist. Adopting this collection of economic guidelines and institutions is expected to result in a dynamic and growing economy. Otherwise, the higher aims of Islam will not be achieved, as Muslims perceive an economy to be healthy when its regulations, institutions and operations together with the conduct of the people and the entire society conform to Shari’ah. The part played by money as well as monetary management in the Islamic economy must conform to the structure of the entire economic system that is prescribed by Islam. Even though the Qur’an and the Sunnah, which are the key sources of Islam, do not give any direct or comprehensive direction in regard to managing money, they are clear in their disapproval of interest. Therefore, financial and monetary connections in the Islamic system must be conducted and organized in a way that prologues the use of interest in any manner. Ultimately, this limitation makes monetary management in the Islamic system to be different in a fundamental and critical manner when compared to the conventional capitalist system. Money creation The process of money creation by the conventional banking systems is considered as the most dominant undermining aspect in all the contemporary markets (Lippit, 1996, p. 256). Through creating money from nothing and introducing it into circulation, both the central banks and commercial banks have collectively resulted into a succession of speculative bubbles that may be followed back more than three years in the countries of the west. In the case that newly created money is spent on a particular asset like property or shares, the prices of these assets tend to increase naturally. On the other hand, when the banks make a decision to decrease their rates of creating money, buyers will no longer exist in the market and the prices of assets will start reducing. The capability to create money is thus a largely influential political and economic instrument, which is in most cases abused. Two Islamic guidelines function to prevent any form of money creation by the banking system and they include the law of trust and the prohibition of interest. Through the issuance of promises to pay that are more than their cash reserves and lending the same promises at a particular interest, the contemporary banks go against these two regulations so that they can be able to make profits. The contemporary financial economy differs from the Islamic economy in a number of ways one of them being the nature of money (Hunt-Ahmed, 2013, p. 31). While the two systems allow money to function as a store of value as well as a medium of exchange, the economic system that is based on the financial markets allows money to be treated in a similar manner to any other commodity that can be traded for profit or interest. On the other hand, the Islamic system requires that money be completely backed by assets while considering it unacceptable to permit money to be subject to trade unless it is at par. From an Islamic point of view, a crucial significance of allowing credit money to be created and interest based lending is to enable the banks and other financial institutions to create huge amounts of wealth without considering the rest of the society, particularly the poor. This results in the preordained perception that this form of economic system provides special treatment to the rich at the expense of the less fortunate. The Islamic faith does not approve the capitalist or the communist financial systems even though both systems have a number of similar elements with Islam. Some of the similar elements include providing encouragement to people to work and increase their productivity so that they earn as much as they can. Nonetheless, Islamic principles promote awareness in the hearts and mind of its adherents while instructing them to avoid being overwhelmed by greed or being overly attached to material things especially money. Real Islamic principles forbid imbursement or acceptance interests along with any form of non-natural creation of money through processes of fractional reserves (Omar, Abduh and Sukmana, 2013, p. 147). These fractional reserves pose huge problems in the economy as a limited amount of equity can be used as collateral when borrowing large amounts of money as this would result in the creation of a financial bubble. As these forms of unprecedented crises progress, Islamic banking as well as finance has been experiencing exponential growth with the worldwide value of Islamic finance growing to almost one trillion dollars resulting in research and interest. As far as the Islamic economy is concerned, Islamic banks function in the same manner as venture capital firms, which collect people’s wealth and invest it in the economy, and afterwards distribute the profits among the depositors. The Islamic economy dictates that only the wealth that the banks have in their possession can be lent to the customers therefore eliminating the ability of banks to create money in any way. The requirement of the Islamic economy is that money should be completely asset backed and it does not allow any form of money trading except at par. Supporters of the Islamic banking system and finance industry have forecasted that the rapidly growing industry may have a solution and has the potential to solve the financial crisis. Even though the comparatively small proportion of the Islamic finance industry may mean that this view is impractical presently, an unparalleled chance exists that will allow the presentation of the Islamic economic system together with the solutions this finance had to some of the prevailing issues. Misperceptions have existed for a long time concerning the discounts being permissible in the Islamic economy and interests being impermissible. There are unequivocal mentions in verses of the Quran and Hadiths that Riba is related to increase, and this can be considered as a fact since only increases can lead to artificial scarcity of the products in the society. On the other hand, discounting does not define any form of artificial behaviors instead; it is an essential sharing behavior. The misconceptions that are associated with the notion of interest that link it with time as indicated by numerous economists and researchers has led to impractical misperception between interests associated with banks and discounting and most people think they are similar, but in actual sense, they are not. This misperception is informed by the application of time-based rates in the two cases. Riba does not depend on time as it can be associated with hand-to-hand exchanges with no specific periods especially in the case of loans, but it is mainly concerns increases and not decreases. It is a comprehensively thought out and carefully researched conclusion that discounting in terms of official bills and instruments is not covered under the restrictions of Riba. Discounting structures adopt the strong attributes of maintain the circulation of money in its natural framework and can be considered as a substitute driver for economic activities for the banking industry and by extension capital. Role of central banks The main role of monetary policies as well as central banking in an Islamic system is to guide the growing financial institutions and tools, which allow for efficient mobilizing of savings and effective allocating of resources in adherence with the economic development goals of the Islamic economy. In particular, the central bank is tasked with initiating and fostering the development of primary, secondary and money markets, and simply adopting Islamic guidelines of finance will not develop the drive for financial and economic developments where the superficiality associated with the financial markets and the absence of attractive financial tools have created hurdles to the connection between saving investment. As a far as an Islamic economy is concerned, the central bank is obligated to preserve the value of money, and therefore, the central bank should only permit an increase in the supply of money only to the extents that are justified by possibilities of contribution to the creation of actual balances (Krichene, 2013, p. 488). High priority should be accorded to the stability of the value of money due to the clear stress of Islam on honesty and fairness in all the dealing carried out by human beings, and as a consequence of the negative effects of inflation on socio-economic justice and overall wellbeing. However, instead of absolute, this goal means there is a comparative stability in the overall level of the price. This is because an absolute stability in prices is not practical or appropriate since it may create conflicts with the optimum growth and complete utilization of the aims of the monetary policy. Whilst inflation may be discordant with the objectives if the Islamic economy, persistent recession and unemployment that results in human suffering are also impermissible. For that reason, monetary policies must purpose for an enhanced rate of economic development with total implementation and application of industrious resources. Nevertheless, maximizing economic growth at all costs is not the main goal of monetary policies in an Islamic economy meaning that the material wealth and affluence must be achieved within the structures of values associated with the Islamic faith. Wealth is not supposed to be amassed through producing fundamental and ethically dubious goods and services. Further, it should not result in an excessive and excessively rapid use of resources that are given by Allah at the expense of generations to come while maintaining that it should not harm the present and future generations through the degeneration of ethics and the environment. The degeneration of the environment, which entails degrading and depleting land, water bodies and forests as well as severe air and water pollution, is an aspect of great concern all over the globe. Therefore, the notion of sustainable growth, involves providing for the requirements of the current generation without interfering with the requirements of the generations to come. Both economic growth and sound environmental management are factors that complement each other based on the same goals. Therefore, in the absence of enough protection, development will be weakened, and with lack of growth, initiatives aimed at protecting the environment will not be successful. The monetary policies that are created by the central bank should be employed actively in the promotion of distributive justice while preventing wealth and economic power from concentrating in one area as far as an Islamic economy is concerned. Nonetheless, excessive concerns with distributive justice in the formulation and implementation of monetary policies may have an adverse effect on its efficacy and usefulness in the attainment if other objectives of the monetary policies such as development, employment as well as progress. A decrease in the income inequalities as well as obligatory redistribution should be a vital policy goal of Islamic states and therefore the purview of its fiscal policies since monetary policies can underwrite to these goals. Challenges to Islamic banking Islamic banking as well as Islamic financial industry is still in its infancy stage and experiences many challenges since the Islamic banks conduct their operations in economies that are inspired and influenced by interest, and in the case of a financial economy, the banking sector is sustained and controlled by the central bank (Khan, 2013, p. 264). The guidelines and policies of the central bank are intended for conventional commercial banks and it functions as a lender of last resort but majority of the Islamic banks do not get these form of privileges. Working under operational procedures is another problem that is faced by Islamic banks as these procedures differ from those associated with the conventional banks with the resultant non-compatibility preventing the central banks from controlling or supporting the Islamic banks in the event that a liquidity gap develops. As the Islamic finance industry operates under a secular system, similar systematic issues that the modern conventional financial institutions face may affect the Islamic system. For instance, because of improper regulation, the Islamic banks do not take part in risk sharing; therefore, any clients who default in the Islamic banking system will face the same consequences as the clients associated with the interest-based banks. Ultimately, if Islamic banks take part in the creation of money, they will eventually suffer similar inflation as well as boom-bust cycle that are commonplace in the economies of the west. Conclusion Looking at the Islamic financial systems as merely being interest free does not paint a real picture of the entire system. Even though it restricts people from receiving and paying interest, which is the core of the system, it is backed by other ideologies of Islamic doctrines that advocate for the rights and duties of people, rights to property, equal wealth distribution as well as the sanctity of agreements. The Islamic financial system is not restricted to the banking industry as it covers insurance, process of forming capital and all other forms of financial intermediation while suggesting that proper and virtuous factors in the regulatory structure are also required to complement the prudent and sound guidelines. The philosophical basis of an Islamic economy extends past the overlap of aspects of productivity and economic behavior as it can be wholly appreciated in the context of Islamic values on business ethics, the distribution of wealth, as well as socio-economic justice and the part that is played by the government. While the conventional systems concentrate predominantly on economic and financial characteristics of transactions, the Islamic system accords similar emphasis on ethical, virtuous and religious elements in order to increase equality and fairness, which are doctrines of the Islamic law. The people who work in the Islamic systems as well as the clients do have to be Muslims, but they must be willing to accept the moral guidelines that are highlighted by the Islamic principles. Bibliography Hunt-Ahmed, K. 2013, Contemporary Islamic finance, John Wiley & Sons, Hoboken, N.J. Khan, M. 2013, What is Wrong with Islamic Economics?, Edward Elgar Publishing, Cheltenham. Krichene, N. 2013, Islamic financial markets, Wiley, Singapore. Lippit, V. 1996, Radical political economy, M.E. Sharpe, Armonk, N.Y. Omar, M., Abduh, M. and Sukmana, R. 2013, Fundamentals of Islamic money and capital markets, Wiley, Singapore. Read More