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The Money Market in Islamic Finance

Posted on 18th July 2012 by Camille Paldi,

 

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

“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.

Money can be viewed as a public good.

Money is potential capital and as soon as it is legally combined with one factor of production its legal character changes to capital and hence is eligible for a reward in the form of profit, whose magnitude is neither fixed nor predetermined.

The volume of money is dependent upon the economic capacity of the economy.  Therefore, its supply can, in theory, increase indefinitely provided that the capacity allows.

Banks act as shareholders and are therefore not capable or allowed to create either money or credit.  They can only supply capital.  Hence, the conventional required reserve ratio is irrelevant and its rate can go down to zero.  Naturally, there would be no markets for money or loans in the system.  If these conclusions are correct, then what is the use of talking about the money market (as do Khan and Mirakhor 1987:177 and Khan 1985:12) or demand for money in an Islamic economy (see Chapra 1985: 209, for example?)  Therefore, the appropriate policy followed by banks can no longer be called ‘monetary’ policy, but rather ‘financial’ policy.

Based upon the assumption that all capital expenditures are financed through banks, the opportunity costs of capital is zero.

The ultimate result is that there can only be three markets in an Islamic system: labor, capital and commodity, in which their respective unit values are wage rate, profit rate, and price level.” (308-309)

“It has been made clear throughout this book that Western financial markets are essentially money markets built on speculation.  They produce instability via artificial risk and, by creating virtual, rather than real, wealth, distort the allocation of resources.  It is a zero-sum game that leads to an inequitable distribution of income and wealth and prevents the economy from moving towards equilibrium…

Past experience has shown that the constant manipulation of interest rates in the money market by the central banks of industrialized countries has both greatly damaged their credibility and produced uncertainty in the real sector.  As long as the central banks adhere to such damaging policies, the situation will only get worse.” (325) – Iraj Toutounchian


Posted on 18th July 2012 by Camille Paldi


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