This document summarizes a lecture on the basics of monetary economics and common misconceptions about money. It discusses how money is created through trust and legal frameworks rather than emerging spontaneously through barter. It debunks the myth that commodity money like gold was historically dominant, and explains how token and fiat currencies have been used effectively throughout history. It also discusses how insufficient money can harm economic production and how stabilizing a currency's value is challenging without tying it to commodities like gold.

1. Basics of Monetary Economy:
Seeing Through Deceptions
Dr. Asad Zaman
Lecture 13 of A New Approach to Islamic Economics
Complete Course: http://bit.ly/IslamicEcon2023

2. Preliminary Note
• Substantial Confusion on Shari’a status of token money.
• My recommendation: LEARN the economics FIRST. Only then is it
possible to discuss the question of Shari’ee status.
• One cannot give a ruling on a matter without knowing precise details.
• Understanding the economics of money leads to substantial clarity on
the Shari’a rulings regarding money.
• Very few have this clarity. They base their Shari’a opinions on myths
about money (such as widespread dominance of stable gold standard
historically).

3. Old Fatawa on Validity of Token Money
َ‫ل‬‫ا‬َ‫ق‬ ‫الخطاب‬ ‫ْن‬‫ب‬ ‫ر‬َ‫م‬ُ‫ع‬ ‫كان‬ ‫ولقد‬
:
‫من‬ ‫الدراهم‬ ‫أجعل‬ ‫أن‬ ‫هممت‬
‫فأمسك۔‬ ‫بعير‬ ‫ال‬ ‫إذا‬ ‫له‬ ‫فقيل‬ ‫اإلبل‬ ‫جلود‬
(
‫البلدان‬ ‫فتوح‬
,
‫بالذری‬
)
‫کہ‬ ‫ہيں‬ ‫لکھتے‬ ‫بالذری‬ ‫يحيی‬ ‫بن‬ ‫احمد‬ ‫مورخ‬ ‫مشہور‬
‫فرمايا‬ ‫نے‬ ‫عنہ‬ ‫ہللا‬ ‫رضی‬ ‫فاروق‬ ‫عمر‬ ‫حضرت‬
:
‫نے‬ ‫ميں‬
‫کہا‬ ‫سے‬ ‫ان‬ ‫کيا۔‬ ‫ارادہ‬ ‫کا‬ ‫بنانے‬ ‫درهم‬ ‫سے‬ ‫چمڑے‬ ‫کے‬ ‫اونٹوں‬
‫گيا‬
:
‫اپنا‬ ‫نے‬ ‫انھوں‬ ‫پر‬ ‫اس‬ ‫تو‬ ‫گے‬ ‫جائيں‬ ‫ہو‬ ‫ختم‬ ‫اونٹ‬ ‫تو‬ ‫تب‬
‫ديا۔‬ ‫کر‬ ‫ترک‬ ‫ارادہ‬
Umar RA planned to use camel skin to make
Dirhams, but was told that this would lead to
scarcity of camels. Then, he abandoned the idea
Imam Malk says that if leather was being use
as token currency, then I would place upon it
the same restrictions that apply to gold and
silver.

4. Basics of Usool-ul-Fiqh
Ibaratun Nass: Clear and Explicit Command from Quran and Hadeeth.
Isharatun Nass: Hint or Indication of something
Dalalatun Nass: Some which can be derived as a logical consequence of
commands within authentic source materials of Islam.
That Gold and Silver are money is isharatun Nass. This can be a
recommendation, OR just a description of the ‘urf – without any
particular indication of favor or disfavor.

5. Differences: A Mercy for the Ummah
Example: Prohibition of Smoking Cigarettes – Dalalatun Nass . Those
who disagree cannot be considered as rejecting Islam.
But, if someone disagrees with Ibaratun Nass, then he cannot be
considered Muslim.
Principle: Be FIRM on usool (fundamentals) these are worth dying for.
But be RELAXED on the furoo’ (branches) – diversity is a mercy for the
Ummah.
CRITICAL: Before issuing Shari’ah ruling, we must understand clearly
and in detail, the matter at hand. That is, the economics.

6. First Myth: Adam Smith’s Story of Origins
Barter requires double coincidence of wants. Money circumvents
difficulties of barter.
Historically, this has nothing to do with how money emerged. WHY was
this false story created? To hide the essential role of governments in
creation of money, and to present money as a creation of the free
market.
David Graeber: Debt: The First 5000 years, presents an alternative,
historical account of emergence of money. Money emerged as a way to
quantify debt – social debt is not quantifiable. This however is just one
aspect of a very complex and tangled history.

7. Money Between State and Market:
Giannini: The Age of Central Banks
Two Theories of Money – both from Aristotle:
1. Money emerges to facilitate market exchange
2. Money is a created by a legal framework given by the state.
Both are true – money would not emerge if it did not facilitate market
exchange. BUT, it also requires state support to varying degrees.
Chartalism: G. F. Knapp The State Theory of Money (1905) provides the
key ideas.
Value of money is created by law, social conventions, and taxation.
Money does not necessarily require any backing.

8. Functions of Money – Red Herring
• Medium of Exchange
• Store of Value
• Unit of Account
• Standard of Deferred Payment
These are among the most important functions, though there are many
others. BUT, these are deceptive, in terms of teaching us what money
is.
It is only after money is created that it can have these functions.
Different kinds of money have different functions. HOW does money
come into being is the critical question, NOT answered by these.

9. Anybody can create money:
Problem is getting people to trust it.
Critical Question: How do we create TRUST in money? This trust
enables all the functions. Without trust, money cannot function.
Doomsday Scenario: World Ends Tomorrow. What is the value of
money? This idea leads to the Overlapping Generations Model (OLG)
Simplest and Crudest Method: Use of commodity money. Trust is built
into the money itself. It is intrinsically valuable.

10. For those who understand money:
Mystery: How did commodity money persist?
This is the reverse question from that asked by those who do not
understand money: How can token or fiat money persist?
WHY? What is wrong with commodity money?
Use of Commodity puts that commodity out of circulation for its own
use. (Scarcity of Camels will result from use of camel skin)
More Serious: Commodity money cannot adapt to the needs of the
economy. THIS we explain further, in greater detail

11. Scarcity of Money
According to QTM, this cannot happen. Prices adjust to make money
sufficient. If there is too little money, prices will decline.
QTM is false.
Insufficient money leads to recessions, depressions, and economic
contractions.
I will provide one theoretical example, and several historical examples.

12. Simple Theoretical Example
Economy has 1000 farmers. Each one needs to spend 1 dirham on
seeds, fertilizer, water, energy (inputs), and 1 dirham on labor to
produce 1 metric ton of wheat, which can be sold for 5 dirhams.
If each farmer has 2 dirhams, 5000 metric tons of wheat will be
produced. (Required money supply = 2000 dirhams, perfectly
distributed).
If there are 2000+ dirhams available, farmers who need them can
borrow, and repay upon harvest. Full production, but with
redistribution of wealth to financiers.
If dirhams are in short supply, then wheat will not be grown.

13. Graziani: Monetary Theory of Production
Critical Insight: Money is essential to production process.
Farmers borrow money from financiers. They pay private firms for
inputs. They pay laborers wages. Then they produce, and sell their
produce to consumers.
Theory of the monetary circuit: Private Sector Firms,
Laborers/Consumers, Financiers, Producers.
For the moment, the critical insight is the Q=F(K,L,M) money is an
essential input into the production function.
Insufficient money will lead to less output: Actual output/Potential < 1

14. Consequences of Monetary Production
Money must be present to allow production to take place.
Insufficient money will lead to unemployment of resources which could
have been employed. In particular, it will lead to unemployed labor.
More than enough money MAY lead to inflation – this depends on
factors which we will discuss later.
Excess money will not lead to inflation, if it does not create excess
demand for goods. Sitting idle in bank accounts it will not have any
effects. Or, it could cause rise in stock prices, land prices, speculation,
etc.

15. Small Change Example
Needs of Business lead to creation of money. Gold and Silver are too
expensive for everyday transactions. So we find token money in use for
day-to-day transactions throughout history.
US, UK, Japan, all had gold silver standards but used token monies in
periods where small change was in short supply.
In Islamic Civilization, this was called Fuloos – token money for small
denominations. It was issued by local authorities and trust was
generated by various methods. All religious authorities have approved
used of Fuloos as money.

16. More Myths About Money: HP & Multiplier
See: The Battle for Control of Money: http://bit.ly/AZRiba1
Critical Question (Econ texts give wrong answers): Who creates money?
Standard Answer: Government creates High-Powered (HP) Money.
There is a money multiplier such that M = m x HP Total Stock of money
is in control of government.
In modern advanced economies, governments create less than 5% of
total money. Financial Institutions (banks, shadow banks) create 95% or
more of the money. HOW do they do this? Not explained in textbooks.

17. Origins of Modern Money:
The Bank of England
There are many, many ways of creating money, documented in history.
However, once a successful method emerges, it tends to be widely
imitated. Alternatives get buried in the graveyard of history.
This is called the bandwagon effect – for example, in computers.
Study of history of England is necessary, because that is where the first
Central Bank – Bank of England emerged.
Its success led to widespread imitation, and the model continues to be
in use globally.

18. The Sovereign Problem
Kings needed money – lots of it – for wars. They could get only a small
amount by taxation, and this was slow, painful, and dangerous.
TECHNICALLY, they could borrow. But, Kings were all powerful, so no
one could force them to repay their loans.
History of England is a battle between the King and the Aristocracy. The
King could seize properties of the Aristocracy as a way of getting
wealth.
The Parliament was created to prevent this, and forced upon the King.
Critically, Kings had to ask for parliamentary approval for taxation.

19. 1690: Battle of Beachy Head: Crushing Defeat
of British by French Navy
King William needed to build a navy, to protect England from France.
He wanted to borrow 1.2M pounds at 8% interest, but financiers were
not willing to give him this loan.
Bank of England was created to give him this loan. But how this was
done is of great interest.
Financiers provided him with credit of this amount. They printed paper
notes carrying official authority of the King, and promising payment in
gold. This paper was provided to the King.
The King promised to pay 96,000 (= 8%) pounds of gold to the BoE, via
taxation. BoE also acquired power to collect these taxes for King.

20. Monetization of Debt
The King issued BoE an IOU – I will pay you 1.2M pounds of Gold in 5
years.
Paper currency issued by BoE was backed by this promise of the King.
This is called monetization of debt.
But BoE also had substantial amounts of gold. Anyone who wanted to
convert his paper into gold could do so at the Bank. This easy
convertibility of paper into gold created the TRUST that this paper is
equivalent to gold.
Paper is much easier to carry and has many advantages over gold. BoE
notes began to circulate widely.

21. Money Creation: Very Strange & Paradoxical
King issues IOU to BoE. BoE issues notes on authority of the State of
England, backed by the promise of the King to pay. These notes are lent
to the King at 8% interest!!!
But there is secondary backing: notes are convertible to gold. Gold
reserves required to create confidence in convertibility are far less than
100%.
How to understand this? This is a mechanism for creating public TRUST,
central to creation of money.
For more details, see: http://bit.ly/WEAocb

22. Consequences of Money Creation:
BoE was tremendously beneficial for England
The King was able to build up his navy to counter the French.
The massive (deficit) spending required for this purpose led to
substantial progress in industrialization.
The huge industrial effort needed, including establishing ironworks to
make more nails and advances in agriculture feeding the quadrupled
strength of the navy, started to transform the economy.
This helped the new Kingdom of Great Britain – England and Scotland
were formally united in 1707 – to become powerful. The power of the
navy made Britain the dominant world power in the late 18th and early
19th centuries

23. Creation of Fiat Money closely linked to WAR
American Greenbacks were issued to cover Union expenses in the Civil
War. (North versus South USA)
Confederates (South) also issued currency as promise to pay after
Victory. Both greenbacks and greybacks circulated at par value while
outcome of war was uncertain. However, greybacks lost value as
Confederate position became worse.
Currency can be created based on trust only. This creation is essential
in emergencies like war, because sufficient gold cannot be found to
finance expenditures. Same is true in normal times, but less obvious.

24. Stabilizing the Value of Currency: Inflation
Crypto shows that we can create unbacked currencies, based on trust
only. However, value of crypto has fluctuated enormously.
Today, Pakistan is experiencing economic distress because of huge and
rapid rise in USD/PKR rate.
If we create currency, how can we keep its value stable? This amounts
to keeping inflation at 0%.
Here again, the suggestion becomes to tie it to something which is
stable in value – like gold.

25. Some arguments against gold backing
The price of gold has been stable for long periods of time, due to stable
demand and stable supplies.
However, sudden jumps in demand (like those created by war) and
sudden increases in supply, such as those created by discovery of new
gold mines, have caused huge fluctuations in the price of gold.
Much more important is the fact that gold backed currencies cannot
flexibly adjust to the demands of the economies.
Just as trust based currency becomes essential in war, so trust based
currency is also essential in peace for good economic performance.

26. Stabilizing Value: Achieving 0% Inflation
First Step: Reject the QTM Myth: Money is always and everywhere the
sole cause of inflation. This is completely false, but widely believed.
Under QTM, the sole method to control inflation is to control the
money supply. This failed in practice, so Central Banks switched to
interest rates as the prime instrument of monetary policy.
But Central Banks have been unable to control inflation using monetary
policy around the globe. This is because economic theory does not
provide us with a correct theory of prices and hence inflation.
Class Conflict Theory of Inflation: http://bit.ly/weaCCT
Modern Money and Inflation: https://www.dawn.com/news/1720438

27. Inflation: Caused by Rising Prices
Imported Inflation: If prices of essential imports rise, there will be
inflation in domestic economy. This has little connection with monetary
policy.
Conflicting Goals of Monetary Policy: Keep exchange rate stable,
provide sufficient money for domestic economy. If we create a lot of
money, sufficient for needs of domestic economy, value of PKR in
foreign market may go down, and cause increase in USD/PKR rate.
Historically, the gold standard kept exchange rates stable, but did not
meet needs of domestic economy. This suited the aristocrats, but was
against the interest of the working classes – the laborers.

28. Critical History: Rise and Fall of Gold Standard
Too long and complex to provide here. See:
On the Vital Importance of Understanding International Financial
Architecture: http://bit.ly/AZifa1
Understanding International Financial Architecture: Part 2
http://bit.ly/AZifa2
Nutshell: Gold Standard existed for only about 50 years prior to WW1.
It served the interests of the powerful elites, and subjected masses to
misery. The two WWs depleted gold stocks in Europe and forced it off
the gold standard. Bretton-Woods created the USD standard, and
Vietnam War delinked dollar to gold to create floating currencies 1971

29. To prevent inflation: Avoid Imported Inflation
How to do this?
Achieve self-sufficiency in essentials. If prices of non-essentials rise,
that is not important, it only hurts the rich.
BUT, this is a long term goal. What to do in short-run?
DO NOT use free market trade (WTO). This is against interests of
development.
BARTER for essentials. That is, calculate essential import needs, and
create sufficient export earnings to buy them. This must be done via
planning, at state-level, not via private exporters and importers.

30. Sovereign Currency:
• Must avoid loans in foreign currency.
• If there is a gap between imports required and export earnings?
Do not take dollar loans. A dollar loan is a promise to repay from future
dollar earnings, via exports. Short-cut the process, and promise exports
of goods for repayment.
All liabilities of government must be in domestic currency. In this case,
the government has complete control of monetary policy.

31. Other Steps Towards Zero Inflation
Mosler and Forstater: Natural Rate of Interest is Zero.
MMT meets Islam: 0 interest, 0 inflation, 0 unemployment
We need to make institutional arrangements which lead to zero
interest rate on money.

32. What controls the value of money?
Price of essentials determines minimal wage in the economy (roughly).
So if costs of essentials is kept in control, minimal wages will remain
stable.
All wages are set in some stable proportion to minimal wage – or
should be. Costs of production are determined (partially) by wages.
Prices are determined by markup over costs.
If costs remain stable, prices will remain stable, and inflation will not
occur.

33. Some complications
If there are essential imports, then imported inflation can occur.
If there are non-essential imports, the costs of comforts and
beautification can rise. This is not a problem.
A correct measure of inflation would be inflation in prices of essentials.
That measure life standards among the poor, and that is the relevant
measure.
Happiness Studies shows that happiness is a state of mind, once basic
needs are fulfilled. It depends on character, social networks, and
psycho-spiritual configurations. Consumerism is highly damaging to it.

34. Correcting Measures of GNP and Growth
Capitalism works by producing massive surplus – far in excess of needs.
These cannot be sold without manufacturing desires for this excess.
Example. Hire laborers to produce shirts and pay them wages. Wages
are useful to enable purchase of sugar, produced and imported from
the Americas using slave labor.
No wages, No sugar, and No labor – happier people with more time for
social connections and spiritual progress.
GNP should only measure necessary goods. Welfare should start by
measuring basic needs fulfillment, and move to social networks.

35. Critical Aspect of MMT: The Job Guarantee
Creating money which leads to increased output is not inflationary.
Everyone who want to make a productive contribution to society
should be given a chance to do so. Printing money to support this job
will not be inflationary.
Productive value of output is greater than wage costs means that job is
net benefit to society.
There can be macroeconomic imbalances – If we give everyone money
for a job, then economy will be awash in money.

36. Consequences of Money Creation
Optimum Quantity of Money: Money is free to produce, so we should
produce in large amounts – to create as much social welfare as
possible.
Historical Experience: The privilege of creating money has been
captured by a very small financial elite, and has been used to create
concentration of power and wealth in a very small number of hands.
This elite has recognized the central importance of power/knowledge
connection. They have created textbooks and controlled discourse,
preventing truths about money from being learned by the public

37. How to Create Money for Public Welfare
Current Debate in West: Private Banks create money for private
interest, and against social interest. Privatizing gains, and socializing
losses.
Remedy: Shift power of money creation to government alone.
Problem: Governments are also corrupt. Also, governments lack the
information required to serve public interest.
Solution: Three Partners: Communities, Islamic Banks, and
Governments – See: A New Vision for Islamic Banks: http://bit.ly/AZibf

38. Much More is Possible Using Money Creation
An Islamic Monetary Policy: http://bit.ly/AZRiba1
Community Based Money Creation, for projects of social value.
The eternal inflation question, and its answer: Money and Inflation
have no direct connection. Inflation occurs via rising costs. Costs of
essentials can be controlled by various natural economic mechanisms.
Two Transformative Ideas: Skills Loans and Life Loans.