In the Name of Allah, the Most Gracious, the Most Merciful
Grande Strategy

Chapter Seven New Medina Economic Model

Economic Model

Glossary of terms used is provided at the end of the book.

I owe a debt of gratitude to Sheikh Imran Hosein for a proper understanding of riba and money from an Islamic perspective. Prior to this understanding, I had, indeed in earlier editions of 21st Century Islamic State dismissed the idea of fiat currency being haram. However, I have now made a 180 degree turn and accept with full conviction that this is the case.

The fundamental viability of any state is its economic system. The inability of the Muslim world in creating viable economic models that are not cheap replicas of Western economies is perhaps the biggest challenge that we face. Riba (interest) is central to the western economy and for Muslims this is unacceptable. Any models we develop on the lines of their system are therefore fundamentally un-Islamic. We have to be brave in breaking new ground, in finding a viable alternative framework rather than conniving the latest trick in the book to put another name for riba, and somehow guise it as “rent”, “fee”, “resale” or the many other terms we play with. Riba is wrong; there is no going around this.

Let us then start this discussion with a look at what is considered riba. The discussions in the next section of this chapter are a summary of what I have learned from, and have been convinced by, from Sheikh Imran Hosein.

Riba and Money

In the first verse on riba, the Quran discusses riba in the following manner (30:39):

The above is given in the clearest possible word-for-word translation of the first ayat revealed regarding riba. Muhammad Asad in The Message of the Quran defines riba in the following manner:

“Roughly speaking, the opprobrium of riba (in the sense in which this term is used in the Qur’an and in many sayings of the Prophet) attaches to profits obtained through interest-bearing loans involving an exploitation of the economically weak by the strong and resourceful: an exploitation characterized by the fact that the lender, while retaining full ownership of the capital loaned, and having no legal concern with the purpose for which it is to be used or with the manner of its use, remains contractually assured of gain irrespective of any losses which the borrower may suffer in consequence of this transaction.

“With this definition in mind, we realize that the question as to what kinds of financial transactions fall within the category of riba is, in the last resort, a moral one, closely connected with the socioeconomic motivation underlying the mutual relationship of borrower and lender; and, stated in purely economic terms, it is a question as to how profits and risks may be equitably shared by both partners to a loan transaction. It is, of course, impossible to answer this double question in a rigid, once-for-all manner; our answers must necessarily vary in accordance with the changes to which man’s social and technological development – and, thus, his economic environment – is subject. Hence, while the Quranic condemnation of the concept and practice of riba is unequivocal and final, every successive Muslim generation is faced with the challenge of giving new dimensions and a fresh economic meaning to this term which, for want of a better word, may be rendered as “usury”.

I leave the reader here with the belief he or she knows the different types of riba, or can find a better book about them. I would recommend Sheikh Imran Hosein’s book The Prohibition of Riba in the Quran and Sunnah for further reading. Let us now turn to the question of riba and money, riba al-fadl, which relates to riba in money transactions. We start with two principles:

1.      What constitutes money should have intrinsic value either in the form of precious metals or commodities of staple food consumption that have a shelf-life.

2.      These precious metals and commodities as given in Point 1 are prohibited from like for like transactions unless they are exchanged equal for equal and the transaction is a spot transaction (and not on credit).

The proof of these two points is given at the end of the book under the section titled Proof for Riba and Money in Islam.  Sheikh Imran Hosein, in The Prohibition of Riba in the Quran and Sunnah explains the issue with great clarity:

“If one person gives a loan of one gold dinar to another, then the contractual obligation for repayment of the loan should not exceed one gold dinar. Secondly, just as we need to buy French Francs when we visit France, so too, in a market which uses real money, people need to buy money. Just as we may seek to buy the French Franks with US dollars, so too, in a market which uses real money, we may seek to buy gold dinars with silver dirhams. Or we may wish to purchase a dozen larger size gold coins with a weight of one dozen ounces, with smaller size gold coins (and this is like changing five US $20 currency notes for a US $100 currency note, - with the exception that paper money is itself riba). Such money transactions, i.e. in which money is exchanged for money, are required to meet the condition of equal for equal and hand to hand  in order to avoid riba.

“It is of crucial importance for us to carefully note that while like for like required an equal for equal transaction which was also a spot transaction, when gold, silver, dates etc., were being bought and sold, this was not so for camels:
‘Hassan bin Muhammad bin Ali bin Abi Talib reported that Ali bin Abi Talib sold his camel, named ‘Usaifir, in return for twenty camels (on credit).’ (Muwatta, Imam Malik).

‘Nafi’ reported that Abdullah bin Umar bought a she-camel in exchange for four camels and arranged that those four camels should be delivered to the owner at Rabdhah.’ (Muwatta, Imam Malik).

“The reason for this was that camels were not used as money, while dates were sometimes used as money. And so four young camels could be exchanged for one adult camel, but two baskets of inferior quality dates could not be exchanged for one basked of superior quality dates.”

Now that we understand riba and riba al-fadl, or riba in money transactions, we end with the emphasis that fiat currency is therefore haram, that interest-based lending under any and all pretended Islamic garbs is haram, that fractional reserve banking is haram, that limited liability is haram. With this premise, let us now look at the economy today and the quest for an alternative system to the present interest-based system.


The fundamental question for an Islamic economy, or perhaps any economy for that matter, is in defining how savings-investment will work in an alternative framework. That is, how savings in an economy may effectively be transformed into investments. If we take out both interest-based banking and limited liability (thus corporations as we know them, stock flotation and leverage), because of their inherently un-Islamic nature, we appear to be taking out this important link between savings and investment that economies today thrive on. In taking out this important feature, we need to find an adequate replacement. This replacement insh’Allah can be an alternative venture capital centered investment economy. Another alternative may be to redesigning the corporation as we know it to incorporate liability. This would create a very different economic system.

Let us look at why Venture Capital (VC) is not able to compete today with banking. One reason is that western economies subsidize loans over investment in equity because interest payments are not taxable while dividends are. This puts VC at a disadvantage and gives banking an unfair advantage. There does not seem to be any real rationalization for this without going into a “conspiracy theory”, but suffice it to say for intended or unintended reasons, this is the case. VCs are also restricted to only receive funding from accredited investors, effectively barring the public. Another disadvantage is the VCs cannot create money out of nothing through fractional reserve banking, which again allows banks an unfair advantage.

As a result of these unfair practices, venture capital and other forms of equity investing suffer a double jeopardy. We see that venture capital is greatly marginalized in western economies both in quantity and in quality, focusing narrowly on the highest yield opportunities which also involve the highest risk.

Let us now turn to the issue of limited liability. Within investments in equity, corporations created in limited liability (and the concept of the corporation as a legal entity) and by extension the stock market, dominate because of their access advantage to funding and limitation of liability. The public is also practically barred from investing in non-publicly traded companies, i.e. companies that are not large enough, not limited corporations and are not willing to pay the typical 30% of their stock value to investment middlemen (say, from Wall Street), to gain access to public flotation of company stock.

This monopoly is maintained by law, meaning it is illegal to bypass this greasy and shady process to directly sell shares to the public. While theoretically it may be possible to start your own exchange, the bureaucratic and regulatory burden is enough to ensure that any such enterprise by an outsider to the vested financial institutions is practically doomed to fail. This essentially is the other handicap that small companies have to face in addition to the well-known preference of banks to finance large firms. These disadvantaged categories of firms are then left to raise money informally from friends and family, mortgaging their personal assets and/or to seek venture capital.

If we want to imagine an alternative, the best alternative is to set the market free – disable the handicaps to private equity and enable handicaps on unfair money creation through the interest-based banking system. Let us imagine an alternative savings-investment framework. Our savings-investment vehicles could include:

1.    Venture capital firms;
2.    Investment banks;
3.    Restructured corporations; and
4.    Restructured stock market.

Corporations may be restructured to include liability. In that case however, it may be reasonable to pass responsibility that information is provided accurately to the top management. If the company fails because the management was hiding information in any way then the shareholders should not be held liable for the losses beyond the value of the stocks. Any stocks that are showing poor balance sheets, income statements and cash flow statements could be de-listed from the stock exchange mechanism and moved to pink sheets. Investors investing in these pink sheet companies will be fully cognizant that they are dealing with companies that could default and fail, resulting in them being held liable for losses. This is but one possible solution to restructuring corporations as we know them.

Derivatives need to be severely restricted and regulated by the markets to ensure that speculation does not reign. This is important to ensure that the financial system is subservient to the "real economy". The rules earlier discussed under Riba & Money would play the role of judging if a certain derivative is acceptable or not. This decision of classification has to be made by people who understand both the revelation and the subject matter at hand.

Venture capital firms would need to play a key role in the economy, a role that will be far less restricted by regulation and would also not be restricted by the opportunity costs created by interest (riba) in Western countries. They will therefore need to be structured differently from the VC firms in western markets. They will be larger, more “bank-like” in their investment decisions and willing to take on lower yield investments.

We must note that banks cannot play the role of a venture capital firm because they lack the skills, training, organization structure and basic mindset. It is therefore not surprising that our attempts to turn banks into investment firms have met with limited success if not abject failure.

For VC firms becoming larger and taking more of the lower risk spectrum of the market should be a natural adaptation and evolution for them given that there will be no competing interest-based system to take the lower yield and lower risk side of the market. The financial system will not subsidize interest based lending (as in the west and discussed earlier) and there will be no "risk-less interest" to artificially raise yield requirements for risk-sharing investing.

Land and Property

By and large, the vast majority of humanity lives today as tenants to property owners. The rents they pay (or their mortgage payments) are a substantial portion of their income. It is small wonder that buying a house is such a major facet of people’s lives. It is also an important salient that property booms and busts are of such critical importance to economies today. When the house of cards comes down, newspapers speak of this salient as defining their downturn: homelessness.

Yet, Islam does not allow man to claim property for himself perpetually. All land belongs to Allah, and according to Islamic shariah, man cannot claim land that he has not been using productively. The land does not belong to some remotely located land owner; neither does it belong to a “nation state” or “government”.

An application of this Islamic law alone would liberate the common people. It would allow citizens of our Islamic state to live outside the oppression of either earning a wage or to live “homeless”. It would drastically bring down property prices. Simultaneously, it would introduce new workers into the work force who are the unproductive landowners and government stewards. For an economy where a portion of the populace originally makes no effort to earn a wage, the productivity of the economy would increase.

Those owning the land would also more likely be users of the land; this could further increase productivity as long as regulation is in place to ensure that agricultural land-holding size is adequate for economies of scale.

While Maududi has spelled out that any land not in use for 3 years is open for people to make use of or in fact a duty upon government to allocate efficiently, very few if any Muslim economists consider how critically different our economy will be when people are freed from the oppression of the landed and propertied classes, how much less financing would be required for acquiring housing and how this would impact the stability and dynamics of the economy as a whole.

Economics is the study of supply and demand, imagine an Islamic economy where a man owns a piece of land and is not productively utilizing it:

1)      He is afraid that it may be taken and is thus more pressured to sell.
2)      In the market, people do not have banks and mortgages to fall back on, thus the bidding prices are significantly lower.

Bottom line: Property and housing will be significantly more affordable. The barriers to entry are low; one can simply find a piece of unused land, build a simple hut and own his own residence.

Ignoring the economic revolution behind reformulating today's property rights is perhaps the biggest crime Muslim economists are doing today.

In Transition
In the event of the establishment of an Islamic state, abolishing banking outright would be catastrophic. Money supply would shrink rapidly. Demand and investment would collapse and spiral the economy into recession. The knee-jerk reaction from the populace would be to increase savings, further reducing consumption and compounding the problem.

The correct solution perhaps would be to gradually impair banking. Gradual change is a divine method utilized during the advent of Islam. We see numerous examples of this, one of which is the gradual process of the prohibition of drinking. Just as the Communists created a socialist state to achieve Communism, so too must the Islamic state act in staging itself through a transition. Staggered increase in the reserve ratio of banks and gradually changing the regulatory framework can go hand-in-hand in transforming today's banks from caterpillars to butterflies. 

The aim, eventually, is to move banking towards a theoretical 100 percent reserve ratio; depositors would have to give the bank consent to invest their money. One option would be that such banks would offer liquidity options with time horizons such as three days, one week, one month, etc. Investments would not have a fixed guaranteed return but rather a risk sharing return. Because of the nature of the investments, greater liquidity options would still generally yield lower returns and thus still maintain those natural patterns of investment that economists have come to consider almost equal to the law of gravity.

For those depositors seeking 100 percent reserve and complete liquidity, the banks should be allowed to charge a service fee for holding the money in safety. After all, such a service would represent a clear service to the bank's customers with clearly identifiable costs to the bank. 

Monetary and Fiscal Impact of Transition

We have already touched upon how liquidity would dry up in transition. Even with the most gradual transition it would result in recession, and the more gradual it would be the longer the recession would last. Let us consider three possible policy options: increasing the reserve ratio, curtailing interest-based banking through regulation and restricting and regulating the stock market. All would result in a rapid reduction in the money supply, and a rapid downward projection of the economy towards an inevitable crash; ceteris paribus, deflationary pressures would reduce investment and consumption expenditures and reduce national income

Is this a necessary pain to create an Islamic state? One, impoverished and destitute already, would he or she be willing to dip even deeper into unimaginable poverty and hopelessness? No. Insh’Allah there is a solution. It may in fact be an ideal opportunity. Let us consider the possibilities.

Keynesian economics dictates that a (read non-Islamic) economy can be revived by public spending to boost consumption and thus inject the system with new demand and new money.

C and I is counteracted by G
Y is National Income
C is Consumption
I is Investment
G is Government Expenditure
X is Exports
M is Imports

Because an interest-based Western economy is inherently cyclical and dependent on an ever increasing GDP & Money Supply, the Keynesian solution is often the last resort when all monetary and information options have failed. That is, for instance, when simply expanding credit and the money supply either becomes ineffective or becomes untenable.

The great downside of Keynesian fiscal expansion is inflation. Yet, this may not be a downside in deflationary times. Here is the opportunity within our framework of a transitioning Islamic state: if we attempted fiscal expansion during our earlier described banking and stock market transition, we would be ideally placed to carry out our expansionary fiscal policies without paying the price of inflation!

However, as with anything in life, timing and proportion is crucial. A cricketer (or a baseball player) perhaps understands this better than an economist. Yet for the economist, that mistimed ball would result in far more damage than the cricketer can fathom. It is perhaps for a reason that Alan Greenspan played the violin; dreamers must be good and timely executioners, if their dreams are to succeed.

Sunnah Money in Transition

The present Muslim world is in a heated debate concerning the Gold Dinar. While I have reversed my position and noted that I now agree that fiat currency is utterly haram, with no room for any mistake in this opinion, I also want to note that Sunnah money is not only precious metals but can also be commodities used as food that have a shelf life, as we earlier discussed.

In transition, we will have to see both existing side-by-side. As the government issues more dinars and dirhams, the problem then becomes one of Gresham’s Law, that bad money will drive out good money. The solution is to ensure that the price of gold/silver/precious metal currency is exchanged at market rate with fiat currency. The problem encountered with Gresham’s Law was with the government determining the value of the precious metal coins, which is circumvented by allowing the market to determine its true value.

Sheikh Imran Hossein is also of the view that a free market should exist between various standards of dinars and dirhams available in the Muslim world at present, rather than attempting to force everyone to agree on one set standard. In transition, it would be hoped that we, over time, increasingly move away from fiat currency and towards currencies that have intrinsic value. This will not only be superior from a theological perspective, but will also act as a check and balance against the central bank and foot-loose monetary policy.

Money Supply in Transition

While we are transitioning to a precious metal and commodity based monetary system, we would have a period of time where we need to manage the fiat currency based monetary system. This transition period, as earlier noted, may be best dealt with in a gradual elimination process rather than a sudden break. While the fiat currency system still operates, we would need to manage the system. The value of the fiat currency in this transition period may be maintained on the basis of:

1)      A basket of goods and services that is reflective of the economy as well as;
2)      The value of a basket of currencies that would be represented by their level of trade with the Islamic state.

Of these two factors, the former (a basket of goods and services reflective of the economy) should be weighted more than the latter (basket of currencies being traded with), given the importance of the Islamic state's own real assets and value to its citizens. This ratio of decision-weighting would need to be determined and could perhaps be in the region of a 80:20 ratio, heavily in favor of maintaining the value of the currency for the local consumers.

Alternatively, the ratio could perhaps be equal to the proportion of foreign trade to domestic consumption, a more classical way to address the issue and something discussed in conventional Western economic thought.

For this to work in practice, a completely independent monetary authority would be needed. If the US constitution has three branches that are independent of each other, the Islamic State need many more than three. The independent monetary authority may be one such independent authority that maintains the value of the currency, and post transition to a dinar, dirham and commodity economy would function as the independent authority that ensure people’s money is not tampered or exploited by the government.

Another independent institution will deal with statistical data and this may also need to be completely independent of the other arms of the state. This is important and is mentioned here because it would be less useful to have an independent central bank if it depended on data that was manipulated by governments as a means to sway the central bank.

We have seen how Western governments have played with key statistics such as inflation and unemployment. The Islamic State may not repeat that mistake. An independent statistical arm of the state will provide statistics for all independent arms of the government to base their decisions on, including data needed by the independent monetary authority of the state.

Post Transition

This period of fiscal expansion should not however go beyond the period of transition. Governments cannot be allowed foot-loose monetary and fiscal policies. Balanced budgets may be hardwired into the constitution. Division of powers would ensure that monetary policy is conducted by an independent arm of the government that is autonomous of the political and administrative authority. This will ensure that the money supply is not abused and inflation is kept at or near zero percent. Combined with a hardwired balanced budget, this will ensure the stability of macroeconomic conditions in the country.

On the surface, such a setup appears grossly flawed. When a Western economy faces recession, not only does consumption decrease but so does government revenue. As a result, balanced budgets would do great harm in actually advocating reduced government spending during a recession. However, in our economic model we believe that the economy will be far less cyclic given the elimination of interest and fractional-reserve banking and the expected higher level of civic duty within the community. The latter is an anti-cyclic element that, if strong enough, would by itself provide a non-governmental solution to any cyclic economic imbalance. Secondly, we can add a provision that the monetary authority will have the final say as to the amount and extent of any fiscal intervention in the case of a recession. Since in our form of government the monetary authority is a completely independent arm of government, the conflict of interest issue is perhaps resolved.

Yet another possible supplemental solution is a delayed effect and weighted budget that looks to match revenue earned X years ago and is an average of a few years thence.

Insh’Allah these solutions effectively eliminate one the greater quandaries of Western economies - the conflict of interest between political government and vested interests on the one hand, and the higher intellectual goals of managing booms and busts.

As a synopsis, our model makes a trade-off that enables us to have a more stable and less cyclic economic model at the expense of being (and not being) able to inject massive liquidity relatively quickly. This implies that such an economy, while more stable, will be unable to grow at spectacular rates as was observed with such countries as Japan, South Korea, China, etc. This is the downside of the model, but within a Solow Growth model context, would become less important as we reach nearer saturation levels of income in the long-run. Slow and steady wins the race.

Meritocracy as the Central Theme of our Model

Let us consider the central principles of our Economic Model. Centrally, we seek free enterprise within the constraints of Islam making it philosophically an effort towards a meritocracy and simultaneously a welfare state within that which has been prescribed in Islam given the Muslim obligations of zakat and alms giving.

We observe the salient of removing riba, fractional reserve banking, fiat currency, absolutist land ownership and inflation as a tax imposed by government. We find a defanged savings-investment system built around equity investing and freed from the injustices of regulation, double taxation and unfair competition that equity investments face today in the West, and an independent state bank to have complete control over the money supply with the central purpose of maintaining a stable value of money.

A central theme of meritocracy inevitably plays out, given Muslim requirements for almsgiving and zakat (which incidentally is a wealth tax), Islamic redistribution laws on death, and if we are to pursue an endowment policy for the young, as outlined earlier. Linked with free education and a meritocratic political model, we see that the theme for meritocracy would become intrinsic to the Islamic state, politically, economically and spiritually; the Day of Judgment too will be meritocratic, each soul being rewarded by what it earned. That will be a Day of Perfect Justice.

Our meritocracy on the other hand, is a human meritocracy and flawed by our human limits, a point we must make great effort not to forget. For inevitably such ideas, if ever implemented, would become dogmatic altruisms on their own, and then become yet another ideological oppression upon the people.

Economic Modeling & a New Science of Muslim Economics

Economic modeling will need to be rethought as many of the key models have interest (riba) as a key element in the models. Perhaps Tobin's Q
could be a replacement for riba when the profit rate is insufficient or problematic. “Islamic Economics” needs to look beyond Microeconomic discussions of interest-free banking. We need to fundamentally rethink utilitarianism as an ideology and perhaps replace it with the conceptual foundations of Imam Shatibi’s Maslahah. We need to see if GDP measurements make sense to the world, let alone to a non-materialistic Muslim state. We need to find alternative measures that make more sense. This author is presently investigating suicide rates as a better guide to measuring welfare.

What started off as a pioneer spirit has, over the last 30 years fizzled into mimesis and small minded intellectualism; mindless reworking of Western economic models into “Islamic” frameworks. The central problem is structural – our universities as they stand today are not meant to create Islamic scholars, their structure inherits a legacy that is fundamentally un-Islamic. Consider for instance that students essentially come to universities to get certificates and find a better job. This materialist paradigm cannot create the quality of scholarship we need.

An education system designed to create obedient employees is not suitable for creating idea people and free thinkers. Without a critical mass of such people we will not be able to make any headway.

Academic scholars at universities work to meet research specifications which often mean they have to publish their work in Western journals, having to measure up to their expectations and thinking patterns. Again, they are living within a materialist paradigm of professional progression rather than altruistic intellectual jihad.

Endless conferences where the scholars of our time present yet another notch on their resumes; another conference: to condemn riba yet again or to claim again that there is no other option and that 'this is the best we can do'. Mindless chatter from men of speech-without-actions, men of no consequence: Such men are only to be pitied or reviled for their hypocrisy. Curious still – many such 'academics', long on speech on how to reform the Muslim Ummah are not to be seen in masjids at the times of prayer. A point observed by the author while studying at the International Islamic University Malaysia.

Let us ask ourselves how many conferences the Prophet (peace be upon him) attended and from what university did he gain his PhD? When the very venue, the people, the method and the motives are non-Islamic, do we still wonder that 30+ years hence, we have still failed at the 'Islamization of Knowledge'?

Another issue is of the life-cycle of the science of economic theory. Adam Smith’s landmark work would not have earned him a PhD in Economics today, for it lacked the manner of writing, the methodology and the emphasis on mathematics and statistics. A research supervisor would potentially laugh at his work and say “it’s too broad, focus on something specific” or “it needs quantitative rigor”. This is because the Western intellect is at a different stage of their journey, we cannot hope to find help in their present model of education to answer our quandaries; we would end up stuck in the minute, which is only relevant when the broader picture has been clearly established. Scientific fields develop from the broad to the specific, but with the present paradigms of mimeses, we are stuck on the minute, myopically copying the West.

We complain that we do not have the means to do jihad. Yet, no nation is stopping us from doing the intellectual jihad. Why then are we this way? Perhaps someday we will stop producing mindless trash and move to the actual work of developing a real alternative model.

"Because Allah will never change the Grace which He hath bestowed on a people until they change what is in their (own) souls: and verily Allah is He Who heareth and knoweth (all things)."
(Al-Quran, 8:53. Translation: Yusuf Ali)
Vision Without Glasses


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