Menu
Home
Log in / Register
 
Home arrow Business & Finance arrow The art of RF (riba-free) Islamic banking and finance
< Prev   CONTENTS   Next >

Application of the RF Law Using the RF Commodity Indexation Discipline

As discussed earlier, the RF law requires that commodities be priced in terms of another reference commodity before being traded for a higher quantity, volume, or weight of the same type of commodity. For example, one cannot trade 100 bushels of good-quality wheat for 500 bushels of lower-quality wheat because it constitutes ribit/riba. However, one can sell the 100 bushels for another commodity (e.g., gold or silver) and use the proceeds to buy the lower-quality wheat. This way, the markets would be used to define the real value of the item traded and that would keep the market in a stable condition and in equilibrium. A transparent RF market system is free from both ribit/riba and gharar (deception, speculation, and misrepresentation).

Please note that when it is suggested that one uses gold or silver as a reference pricing commodity along with other food staples, it is not intended to enter into a discussion and get involved in arguments on the subject of going back to the system of the gold standard, advocated by some and vehemently opposed by others. In fact, if we apply the rules of the RF law as detailed in Exhibit 6.1, which was first displayed in Chapter 3,[1] one can make a compelling case that the fiat currencies are not considered as food staples or pricing commodities. Based on that, paper money can be handled as category C, which allows for increase and deferred exchange. That is where the real RF spirit comes in. It is not just about the interest and a percentage sign attached to that charged interest. The RF discipline is indeed about the intent and spirit of the transaction — how prudent and fair it is and whether it is looked upon as an investment or as a mere renting of money and capital. What is strongly recommended here to preserve the Judeo-Christian-Islamic Shari'aa law is to use the RF Commodity Indexation Discipline, which requires that we test the price of things in the economy (e.g., oil, houses, food items) by the use of one of the two types of reference commodities (e.g., precious metals — gold or silver — or food staples — such as wheat, barley, and rice) to detect if they are valued at a fair price. In Exhibit 6.1, the item classified as A would be a referencecalibrating commodity that must be exchanged in equal amounts and on the spot. Items classified as B would be items of different commodities, but the purpose of their use is the same, like a metal or food. For example, gold and silver can be exchanged for more than equal amounts but must be traded on the spot in a hand-to-hand transaction. The same would apply for wheat and rice. Items classified as C can be traded freely. Please read Exhibit 6.1 carefully and attempt to make your own conclusions about paper (fiat) money in contrast to real money.

It is interesting to note that in 1987, the then-secretary of the United States Treasury, James A. Baker III, told world financial leaders during the 1987 fall meeting of the International Monetary Fund (IMF)[2] that the Reagan administration “is prepared to consider” using the price of gold in trying to steer its own and the world's economies. Gold, Mr. Baker explained, could be used in a specially designed index, along with other commodities, to help governments discern inflation and then adjust their policies — by using interest rates or taxes, for example. Professor Robert A. Mundell, a Columbia University economist and proponent of the concept, stated that “this is far from a gold standard.” On May 20, 1999, soon after the United Kingdom announced its decision to sell part of its gold reserves, Alan Greenspan, then chairman of the U.S. Federal Reserve, said: “Gold still represents the ultimate form of payment in the world.” Dr. Mahathir Mohamad, the former prime minister of Malaysia, also made some very interesting comments in one of his speeches[3] in response to the 1997-1998 Asian currency crises, which resulted from massive hedge fund speculations in Asian currencies. The speculation caused massive devaluation of local currencies in Thailand, South Korea, Malaysia, Hong Kong, Indonesia, and many other countries in the region. Dr. Mohamad discovered that even many of his senior central bankers[4] were not aware of the mechanics of international currency speculation by heavily capitalized hedge funds and other investment banking institutions — or the way to stop such speculation. The “textbook” solution offered by many senior finance officers and ministers of finance of these countries was to support the local currencies by selling hard currencies reserved by the central bank of the country involved like the U.S. dollar, the Japanese yen, and the euro, and buying the local currencies to create new demand for the local currencies to attempt to keep the exchange rate intact. The problem was the huge volume of currencies needed. Many of the countries lost a major portion of their reserves without causing a dent in the exchange rate. The following is a snapshot of what

EXHIBIT 6.1 RF Rules Governing Sale or Exchange of Items in the Marketplace

RF Rules Governing Sale or Exchange of Items in the Marketplace

Note: The above rules are based on two Hadeeth of the Prophet (pp) and the explanation provided in “Fiqh al-Sunnah” by Sheikh Sayed Sabiq. The Hadeeth explicitly mentioned six items categorized as food or currency. Scholars' opinion is that it also applies to any food or currency.

happened to some currencies in a very short span of time. The decline of exchange rates relative to the U.S. dollar on February 16,1998, compared to June 30, 1998, is shown in Exhibit 6.2.

EXHIBIT 6.2 Decline of Exchange Rates in Asian Currencies Relative to the U.S. Dollar

Country

Decline

Indonesia

75%

Malaysia

36%

Thailand

48%

Philippines

36%

South Korea

47%

One interesting but sad and painful case was that of Turkey. The Turkish lira's exchange rate was 108,340 lira for each U.S. dollar in January 1997; it declined by 93 percent to exchange at 1,474,525 lira per U.S. dollar in January 2002. Such massive declines obviously resulted in a reduction in the values of salaries, peoples' savings, pensions, and the meteoric rise in the price of goods and services. Imagine what a poor farmer in the Philippines would do when the cost of rice in his local currency — the only currency he knows about and is using — increases significantly. Such a sudden reduction in the value of local currencies raised the value of shortterm debt of the country involved, usually denominated in U.S. dollars or in euros, and increased debt service. As if this were not enough, the sudden currency devaluation reduced the credit rating of the country involved, which resulted in an increase in the cost of borrowing on the international markets; that is the interest rate charged by the international banks on sovereign debt solicited by these countries. All these unfortunate results reduced the country's economic activity, resulting in massive increases in unemployment and poverty.

In an effort to apply the RF Commodity Indexation Discipline by testing the valuation of different commodities in terms of one another in order to conduct sales and trading at a higher price, as stipulated by the Judeo- Christian-Islamic Shari'aa law, we attempted to price different commodities in terms of gold, silver, wheat, oil, and other reference commodities. What was intended in this research was to detect the historic trend of pricing a commodity, say, oil, in terms of gold or another staple commodity, using the RF Commodity Indexation Discipline, for example by asking the question: How many barrels of oil can one buy for every ounce of gold, or how many ounces of gold or bags of rice are necessary to buy a home using average home prices in the United States? We have done the same for commodities such as natural gas, coal, wheat, corn, rice, and soybeans as well as stock market indicators.

In this approach, we conceptually disengaged and tried to neutralize the effects of the use of fiat money, and instead used a reference commodity as stipulated in the RF Judeo-Christian-Islamic Commodity Indexation Discipline detailed earlier. It will be made clear that if we refer the value of each of the commodities to another reference commodity or index commodity, we shall find, in general, that the price or market value would be more stable, less volatile, moving within a narrow band reflecting the normal supply and demand equilibrium patterns, and more fair. Exceptions to this general finding are cases that involve changes in production processes, technological developments, political factors, or significant change in taste and/or lifestyle. The charts also show that regardless of how the price of a commodity changes in terms of fiat (paper) currencies, like the U.S. dollar, the value in terms of a reference commodity are more representative, and that an economic pricing bubble can be detected whenever the band of price fluctuations that reflects normal market forces of supply and demand, for example, seasonal changes, is penetrated to the higher or lower side of the pricing envelope defined by normal forces of supply and demand. In doing so, the reader is encouraged to consider using this RF discipline as a macroeconomic tool to indexing their own products and services to a reference commodity, in order to avoid participating in an economic bubble like those we have witnessed throughout history — from the tulips in the seventeenth- century Holland “tulip bubble” to the year 2000 stock market “dot-com technology bubble” in the twentieth-century United States, to the “housing bubble” at the beginning of the twenty-first century, which resulted in the 2008 global financial and monetary meltdown.

  • [1] “Islamic Finance and Capitalism: An Introduction,” a presentation prepared by Muhammad Yusuf Dadani, Ahmed Naji, Mohamed Osman and M. Hashem Sherif. Presented at the Islamic Society of Central Jersey, 4145 Route 1 South and Promenade Blvd., Monmouth Junction, NJ, May 23, 2010.
  • [2] Peter Kilborn, “Baker Hints at Gold as Guide on Policy,” New York Times, October 1, 1987.
  • [3] Mahathir bin Mohamad, “The Gold Dinar as an Alternative International Currency,” Kuala Lumpur, Malaysia, July 1, 2003.
  • [4] Mahathir bin Mohamad, The Malaysian Currency Crisis — How and Why It Happened (Kuala Lumpur: Pelanduk Publications, 2000).
 
Found a mistake? Please highlight the word and press Shift + Enter  
< Prev   CONTENTS   Next >
 
Subjects
Accounting
Business & Finance
Communication
Computer Science
Economics
Education
Engineering
Environment
Geography
Health
History
Language & Literature
Law
Management
Marketing
Philosophy
Political science
Psychology
Religion
Sociology
Travel