ISLAMIC ECONOMICS

Economics

The State collected the necessary funds for its expenditures

• Collecting revenue is concerned, the State collects the zakat due on money, land and livestock as an obligatory worship and is exclusively distributed amongst the eight categories mentioned in the Qur’an.
• The State never used the zakat fund for managing its expenditures.  Thus, it collected kharaj over the land, jizyah from non-Muslims, and customs duties in its capacity as the supervisor over internal and external trade.
• The State did not collect funds except according to the Shari’ah.
• As for funds distribution, the state had a nafaqah system (financial support) for the disabled, placed the safeeh (incompetent) and mubaddir (the one who spends his wealth on haram) under guardianship and established lodgings in every city and along the roads to the pilgrimage to assist the poor, destitute and the travellers.

The Battle for the Control of Money: Huge misconceptions surround the concept of money and monetary policy. There is a reason for all of the complexity and confusion regarding monetary policy. The current international financial system is extremely unjust – it allows the extremely wealthy to create money at will, expanding their power to control the world. An essential part of the system is deception: wrong theories about money and finance are propagated and widely believed. A correct understanding of the nature of money would deprive the financiers of the control they currently exercise over world affairs. For more details, see my paper on “The Battle for the Control of Money”( https://ssrn.com/abstract=2766855). One simple example will illustrate how false theories are propagated for the benefit of the financiers. As detailed by Atif Mian and Amir Sufi, there were two possible explanations for the Global Financial Crisis. One was that it was due to a liquidity crunch, in which case it was necessary to rescue the financial system by providing a trillion dollar bailout to the corrupt financial institutions which had caused the crisis. The second was that it was due to excessive debt, in which case the solution involved providing relief to the indebted households with mortgages that they could not pay. The first theory was adopted and used to provide trillions of dollars to the financial industry. This policy did not prevent the Great Recession which followed and continues to adversely affect global economy to this day. The second solution was the correct one, was far less costly to implement, and would have prevented the Great Recession. However, this second solution and the associated theory was not accepted then, and continues to be rejected, because it goes against the interests of the financial sector.

Modern International Financial System: A detailed explanation of how the modern financial system works, and how it provides enormous benefits to the USA, which is responsible for designing this system, is given in a pair of lectures: On the Vital Importance of Understanding International Financial Architecture and International Financial Architecture: Part II . Here we provide a very brief summary.  After the two world wars depleted gold reserves at Central Banks in Europe, the Bretton-Woods agreement created an asymmetric system based on the use of the dollar as a replacement for gold. The USA agreed to keep the dollar backed by gold. This led to Central Banks all over the world using dollars instead of gold as reserves to backup their currencies in the international market. This asymmetric system, which creates enormous financial power for the USA, was chosen over a more balanced and just system proposed by Keynes, because of the political power of the USA at the Bretton-Woods conference. Later, when the Vietnam War depleted the gold reserves of the USA, Nixon de-linked dollars with gold in 1971. In effect, this move made the US Dollar the equivalent of gold in the modern era. The USA prints dollars and uses them to buy real resources from across the globe in exchange for paper. This system is extremely harmful for the rest of the world, but it is held in place by the power of the USA in the global trading system. See A Lopsided Monetary System for more details.

Sovereign Money: In modern time, money comes into existence as a creation of the state. The status of money is created by law, and the use of money is governed by laws created by the state. In particular, the certification that “this note is legal tender for all debts, public or private” within any given nation, is what makes that piece of paper money. Since money is created ex nihilo (from nothing) states can never run out of money – they can always print any amount of money they want. This does not mean that they should print arbitrary amounts of money. Printing money has many consequences, and all such consequences must be carefully considered in deciding how much money to print.  However, some very important consequences follow from the ability of the state to create money. One of the most important is that the state does not need to raise money to finance expenditures. Conventional economists are concerned about how the government will raise money in order to finance development projects, or to pay salaries of government servants. According to conventional theory, like a household, the government must raise money by taxation, or by borrowing from domestic or international sources, or by creation of money. But, since the government can print as much money as it wants, it never needs to borrow money from any source, domestic or foreign. This point is not understood by policy makers, and large portions of government budgets are payments of interest on past debt. Similarly, taxation is never needed for revenue. Rather, taxation policies can be used to control inflationary pressures, and to create equity in income distribution. If the government collects taxes and then burns the money collected, there is no loss to the government, nor does it make any difference to the macroeconomic scenario being faced by the government.

Why the Confusion? The central assertions of the previous paragraph, based on the analysis of MMT (Modern Monetary Theory) are startling to conventional economists and policymakers. It has always been thought that one of the central problems faced by governments is raising revenue to finance development expenditure. Huge amounts of efforts are spent on collecting taxes, as well as borrowing money from domestic and international sources, public and private. The idea that the government can print as much money as it needs seems repulsive to our intuitions, trained by the household budget constraints. Households must balance budgets, and must earn revenue in order to be able to spend; but then, they do not have printing presses which allow them to print legal tender. It is essential to emphasize that MMT is an analysis of how money is created and how it functions in modern economies. MMT is not a recommendation for the government to print arbitrarily large quantities of money. Printing large amounts of money can have potentially disastrous effects on the economy; all MMT says is that the government has the capability of printing as much money as it wants. It does not say that the government should exercise this capability. One very important reason for confusion about this point is that the financial sector, both domestic and international, benefits enormously from the widespread misconception that governments must borrow in order to finance spending.

How is Value of Money Created? If government prints money by fiat, with nothing backing it, what makes such paper valuable? Why would anyone accept it in payment for anything? What determines the value of such government created money? This is a complex topic, which we will oversimplify here. Value is created by trust, consensus, and certain markers of value. MMT holds that taxation is central to creating value for money. Government taxes creates a necessary use for money, which ensures that money has value. But there are many other devices which can also be used, instead of taxes or in addition to taxes, to create value. One possibility is government ration stores, which accept government money in return for essential goods at prescribed prices. In explaining value of money, it is also essential to rebut two major widespread myths. One is the myth of commodity money: money is valuable because it is gold or silver, or other valuable commodity. Money acquires value because the government PROMISES to redeem it in gold; this sets the value of money at the market price of gold. In the USA, laws were passed which prohibited US persons from exchanging dollars for gold or vice versa, but this had no effect of the value of the dollar. The second myth is the idea of money as debt. On many currencies – such as the 100 Rupee Pakistan Note – it is written that the “Governor of the State Bank will pay the bearer of this note 100 Pak Rupees”. This is a meaningless promise – the bearer will get what he already has. For a more detailed discussion, see “Differentiating Social, Market, and Government Debts” (http://bit.ly/AZdebt). When the government prints money and uses this money to purchase services or goods, the money it gives is not a debt of the government except in a formal accounting sense. This does not create a liability for the government which  will come due and have to be paid using real resources.

Key Questions of Monetary Policy:  We have argued that governments have the capability of creating arbitrarily large amounts of money. However, they should not necessarily do so. Two central questions of monetary policy are:

1. How much money should be created?
2. How should this money be created? Conventional economists consider three options: by printing, or taxation, or borrowing.
3. What should be done with the money that is created?

Even though the government can, in principle, create sufficient revenue to finance all projects by printing money, there are other goals of monetary management for which taxation and borrowing can be very useful. Thus, governments will typically use taxation and borrowing in addition to creation of money. However, it is essential to note that the government does not need to tax or borrow to finance expenditures. Both taxation and borrowing serve other purposes.

General Methodology for Social Goals: Having clarity on the goals for which government needs money makes it easier to decide on the answers to the first two questions. The primary policy objective (in the monetary/economic area) for the government is to ensure that the basic needs of the entire population are met. Meeting food, education, health, housing, and other essential needs of the population must be a primary goal of money creation. However, there are two ways in which the methodology for achieving this goal is different from that of Western societies:

1. First responsibility for social welfare is on communities and neighborhoods, organized into units by masajid. Every neighborhood must take care of needs of its members, using resources at their own disposal. A higher level community is created by the Friday prayers, at which multiple neighborhoods gather. This is the occasion for neighborhoods to exchange resources with each other to collectively solve problems. This methodology comes from the concept of Farz-e-Kifayah, where social responsibility is handled by the ones closest to the need, organized in increasingly wider circles.
2. Political organization is also along these lines. Every neighborhood has a shoora, which sends representatives to higher level shoora, ultimately reaching the highest level of the  national shoora.
3. The government should help the communities indirectly, providing financial, technological, or other assistance, with the goal of strengthening social organization of communities. If the government intervenes too directly, this will weaken the communities’ capacity for local action, and create dependence on government action.
4. Help should be organized along lines of self-help, then family, then kinfolk, and then neighborhoods. Furthermore, help should undertake to ensure that everyone is a productive member of the society.

Key Policy Recommendations for Monetary Policy: There are several important policy recommendation that emerge from Modern Monetary Theory:

1. The Job Guarantee Program: everyone in society should be given the opportunity to make productive contributions, in the form of a job or a service. Communities are best able to recognize talents and needs, and ensure that their members are all engaged in productive activities which have social value. The government should facilitate this by providing money as needed. Loans can be provides as Qarz-e-Hasana to communities as a collective responsibility; the idea of placing responsibility for repayment on communities, not individuals, was successfully pioneered by Grameen Bank. Zero Interest Loans can be preferably be provided by community-based Islamic banks, on the pattern of the first Islamic Bank set up in Egypt: Mit-Ghamr. Apparently, a local community bank working with zero interest was also established in Pakistan in the early 1950’s. All of these provide good patterns and precedents to follow. Several functional Islamic microfinance schemes working at zero interest are currently in operation in Pakistan. The point is to provide money to enable and facilitate all people to be productive members of the community.
2. Obviously, in an Islamic society, interest rate will be set at zero, and charging any non-zero interest rate would be prohibited. This means that nature of banks and the financial sector would be radically different from those in the West. Some details of the kinds of institutions that would be expected to emerge is provided in “Building Genuine Islamic Financial Institutions”. A zero interest rate is essential in keeping the value of money stable across time; otherwise, Rupees 100 today is equal to 110 tomorrow when interest rate is 10%. Similarly, a goal of Islamic monetary policy would be to keep inflation rate at 0% as well, since inflation lowers the value of money, just like interest. Keeping the value of money stable is a critical goal of monetary policy. Mechanisms to achieve this goal are complex, and required detailed discussion.
3. Encourage socially productive investments. Created money should flow into education, health, social welfare, and project of collective value to society. This goal can be achieved using models of community driven development, where finances are initially provided by local community banks,. For larger projects, government can provide Qarz-e-Hasana to communities based on suitable criteria and process.
4. Discourage privately profitable investments. In a capitalist economy, money flows into investments which generate maximum short run profits. These are often real estate and stock markets. These activities have little to no social benefits and should be discouraged. Capital raised for social productive ventures can be organized without the need for a stock market. This requires a three way partnership between government (for financing and auditing), domain experts (for specialized guidance), and communities (for responsible investments).

Shift of Focus: From Finance to Real Sector: The wealth of a nation consists of its resources, both natural and human. Humans, both in terms of their actual and potential capabilities, are the most important resource. The amount of money in hands of the government does not matter is all, since arbitrary amounts can be printed at will. If real resources are present, there is never any financial constraint on production. If the society has the cohesiveness to create a collective agreement on the value of fiat money, that will be sufficient to create all money required. If the love in the hearts is not present, not all the money in the world can buy it. Creating social consciousness, and the will to live by collective agreements must be the first goal of governments. The government must strive to enable all human beings to achieve their full potentials. To this end, the government should ensure production of basic needs and self-sufficiency of the economy. Enough resources must be devoted to agricultural to provide food for all the people. In addition, critical sectors which provide housing, education, and health services must be given sufficient funding. Again, the government should avoid directly providing these services; rather, it must facilitate communities to create these services for their own members, and collectively act for larger goals. Energization of communities, and creation of social solidarity is among the primary goals of the government. The key lesson is the resource constraints occur ONLY in the real sector – required finance can always be created in the amount desired. Instead of looking at money requirements, we should look through the veil of money to the real resources required to carry out projects: if the real resources are available, the projects can be carried out by creating money required. If the real resources are not available, then no matter how much money is available, the project cannot be carried out. This holds true for the domestic economy. When we look beyond the domestic economy to the international arena, resources will always be available, but will require a price denominated in foreign currencies. This issue is complex, and we leave it for later discussion.

Critical Elements of a Job Guarantee: The government provides a backup guarantee that every productive member can be enabled to provide service to society and receive a minimum wage for this service. This serves as the minimum wage in the entire economy. Since private sector firms must provide this much or higher wages, setting the minimum wage too high can stifle or damage productivity of the private sector. At the same time, the minimum wage must be enough to provide basic needs to the employed. Some of the critical elements in a job guarantee program are as follows:

1. Setting of the minimum wage for the job guarantee at a level high enough to provide for basic needs and low enough to allow private sector firms to thrive.
2. Promotion of the Islamic work ethic: Earnings are HALAL only if the worker does honest work and provide services to community which match or exceed wages received. This is essential because wage guarantee will ensure substantial amounts of money in hands of the population, and this will multiply the demand for products. This demand must be offset by production of goods and services created by the jobs provided, in order to prevent inflation.
3. People employed at minimum wage on the Job Guarantee must be engaged in sectors which correspond to, and offset, the additional demand which will be created by wages being provided to all workers. In particular, it is essential to ensure that domestic food supplies are enough to meet local demand. Increased agricultural productivity is of central importance, especially in light of climate change. In general building communities and cities with zero ecological footprint, is also of central importance in modern times.
4. Engaging every member of society in productive jobs requires a massive amount of localized information which is not available to governments. This must be left to communities which can differentiate between those who are capable of production and those who are not. Also communities can find niche jobs for particular talents within their members, and also motivate ones who are inclined to shirking and laziness by using social approval or disapproval.
5. There are many different ways to ensure that communities have sufficient money available to engage all members in productive jobs, as well as provide for basic needs of all those who are unable to do so for themselves. Community banks are one possibility. Another method is to allow issuance of local currencies backed by labor – since there is a job guarantee, everyone who offers an hour of labor can receive credit for that amount of money. If these prove insufficient, the government can step in as a lender of the last resort and provide zero-interest Qarz-e-Hasana to communities based on well defined criteria.

The inflation of the dollar is a hidden tax, caused by an increasing dollar creation in the global financial system.  We must work for a single stable global currency tied to the price of a basket of gold, maize, rice, wheat, barley and sorghum.