There is much criticism of the current Islamic financial paradigm. One criticism is that an authentic Islamic finance industry is not possible with the proliferation of fiat currency. Since the Prophet’s time, the currency utilised was the dinar or dirham, the gold or silver coin. This bimetallism ensured that the opportunity to keep producing money was limited and therefore the possibility of inflation was reduced, as excessive inflation is when there is too much money chasing too few goods. Moreover, by limiting the amount of money in the economy, inefficient use of money on profligate investment can be reduced.

There are active supporters of a return to bimetallism with mints in Malaysia and Dubai, and activists such as the Murabitun even arguing that zakat cannot be paid in fiat currency. Indeed, for them fiat money is inextricably linked to the charging of interest and thus by the principles of Islamic law is inherently forbidden to use. As fiat money is ubiquitous, one is forced to use it but the drive should be to change the monetary system, not encourage it.

Other intellectual currents also challenge the presence of fiat money. Bitcoin, and other forms of crypto currency, have been touted as a suitable replacement and have witnessed popular uptake. Today there is even an exchange rate for bitcoin. Bitcoin subverts the current monetary system, removing bank’s power of supplying money – the institutions that brought the world’s financial system to its knees – and giving it to the individual.  At least this is the principle, and one that attracts adherents.

All this brings us to the question as to what is money? For economists, money is seen as a store of value, a medium of exchange and a unit of account. But beyond defining money’s functions, what can be considered money is far less clear. Traditional accounts have assumed that money was invented to overcome the inefficiency of barter, but increasingly historians are expressing doubts about this account. Indeed, excavations have revealed inscriptions on clay tables from Mesopotamia several thousand years ago which show the payment of taxes in crops or debt relationships indicating the movement of some form of currency from the borrower to the debt and visa versa.

On the island of Yap in the Western Pacific Ocean, inhabitants had previously used stone money as a totem by which inhabitants would exchange goods and services. This stone money was fixed and rarely moved between economic actors due to their size. Yet with their presence the island inhabitants were able to transact and keep account as to who owned the money even if the money itself did not move.

In this situation, an important characteristic of money can be defined. Money, as the economic historian Niall Ferguson states, is “trust inscribed.” By this he means that people have to trust in the value of the object used as money. Without having this trust, the cash one carries in his wallet is nothing but a piece of paper. Similarly, when one talks about gold and silver, people have trust in the value of that commodity. Remove trust, and throwing gold into the sea as one would throw pebbles, would be the same endeavour and the gut feeling of loss would not occur.

Consequently, it is not the medium used as money that defines something as money, but how people view it and whether they trust in its value. This value is given to it either by the government (as is the case of commodity money), the market (as is the case of fiat currency) or by a group within the market (as is the case of bitcoin). With regards to commodity money, pre-modern governments often stated a fixed value onto the commodity money and backed it up by inscribing the face of the ruler. Money then had value, but as gold or silver were used by many countries, the metal itself had value beyond the value inscribed onto it. Consequently, if the value of gold not as money was higher than gold as money, capricious individuals would mint gold coins into gold and sell it on the market to receive the profit. Mints had to ensure that the difference in values was not so great as to encourage this sale otherwise they would be a reduction of currency in the economy. Another problem was the wear and tear experienced by the commodity money. As the gold or silver wore down, devalued currency would be used in the market enabling counterfeiting.

But perhaps the greatest challenge of using commodity money was its fixed nature. This became a particular problem during World War 1. European governments wished to increase the size of their army but were limited by the amount of commodity money in their coffers. By linking paper currency to the value of gold, it gave governments’ free reign to print money. Paper currency was like promises to recipients giving them claim on goods and services as well as a means to save. Inflation was perhaps less a problem due to rationing and saving during the war. Also the currency was being used in particular sectors of the economy, limiting the possibility of inflation as the money did not have a wider outreach.

Not being constrained by the amount of commodity money, gives governments the opportunity to invest and spend more. If anything, the mantra of the current economic system is growth, and growth entails greater productivity and innovation.  This is especially true during war situations and thus the delinking to gold was so important during both WW1 and WW2.  Linking back to gold limited how extensively a country could use monetary policy tools as a means of regulating their currency. Countries with little gold reserves were especially constrained, and trade would be difficult resulting in the inefficacy of monetary policy to encourage trade.

The need for continuous growth though productivity and innovation requires a steady supply of money. Hence banks through credit creation via loans or through other debt finance tools act as an important linkage. Debt finance assumes that the repayment will be made possible by the revenue of the borrower company. It incentivises the borrower company to ensure that they are generating enough revenue though ensuring demand meets supply. This creates an endless cycle of debt, which is can only be serviced by productivity.

Commodity money limits growth. Pre-modern states could only increase the amount of goods through their economy through conquest and ownership of new lands. Colonialism was a key way that Europe developed extensively at the expense of colonial services as resources flowed into colonialist countries. Today growth is achieved by being able to invest and enabling the flow of currency, and the need for conquest is a less common desire. If the dominant economic thinking is that mankind can only achieve happiness through economic growth, then to call for a return to some sort of gold standard is wishful thinking. The arguments for this return are therefore not persuasive if we accept this mantra. Unfortunately, for those calling for an authentic Islamic finance, postulating a return to gold without offering a palatable alternative to the mantra of growth is idealism without substance.

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