The Myth About Money


The first myth about money is that it is backed by gold. It is not true, money today is not backed by gold or anything of that nature. It is backed by nothing more than the law of fiat. In other words a legal requirement to accept whatever is money as determined by the authorities.

The second myth about money is that 100% of a nation’s currency is its paper currency and coins. It is not true, paper currency and coins forms on average only 3% of a nation’s currency, 97% is money created by banks.

The third myth about money which is about to be debunked is that banks’ creation of money begins with a deposit of cash by a depositor in a bank. Then less a certain percentage paid to the central bank as reserves the balance is lent to a customer of the bank who in turn places the money in his bank which is again relent minus the central bank reserve.

With the deposit of RM1000, and say a 2% statutory reserve the banks can create in total RM24,000 of money out of thin air making a new total of money of RM25,000. Indeed if the initial deposit is RM1 billion, RM24 billion of money can be created by banks out of thin air.

This is referred to as the Multiplier Model of Money which is now being debunked as a money creation process even by Central Bankers such as Mervyn King, Governor of Bank of England in 1994, Adair Turner, Chairman of Financial Services Authority of Britain in 2011 and Vitor Constancio, Vice President of the European Central Bank.

The truth about money creation that is appearing is that banks create deposits when they decide to give a loan. This means the old belief about banks waiting for deposits to come before giving a loan is not true; leave alone the notion that a bank loses the use of the deposit once it gives a loan.

Why can banks do this with impunity?

This is because if the bank needs central bank reserves at the central bank to settle any payments that arise as a result of its lending, it will be able to borrow them from the central bank or from the interbank market.

Even the Financial World Ogre, the Federal Reserve, admits as much via its Senior Vice President, Alan Holmes in 1969 when he said: “In the real world, bank extends credit, creating deposits in the process, and look for the reserves later.”

A Central Bank is obliged always to provide reserves sought by banks to avoid creating a liquidity crisis that will lead to an industry wide solvency crisis for banks.

This is referred to as the Endogenous Money Theory that is continued to be proven by empirical research.

In a particular study by Fynn, Kydland and Prescott a research was done in 1990 to see whether the monetary base increases before banks makes loan as suggested by the Money Multiplier Theory.

They find that “There is no evidence that either the monetary base or M1 leads the (credit) cycle, although some economists still believe in this monetary myth. Both the monetary base and M1 series are generally pro cyclical and if anything, the monetary base lags the (credit) cycle slightly.”

In other words money expands after the loans are made and not before.

Therefore we appeal to the Muamalat scholars to take these facts into consideration before sticking to Majma Fiqh’s 1970’s fatwa which was made before these facts are known to the world.

In summary the following are the parameters and facts about money creation which must be computed in a reconsideration of any ijtihad on money.

1. Money is not based on ‘ain, let alone gold. Money is based on fiat i.e the law of the authorities who determine what is money for the ummah.

2. Paper currency and notes forms on average only 3% of a nation’s money supply, including Malaysia.

3. 97% of a nation’s money supply are created by banks out of thin air through what is called bank money.

4. There is no cap to the total volume of money in a country at any one time in order to maintain stable prices. It zooms up at the mercy and wishes of banks.

5. Level of goods and services can not match the gigantic and constant increases in money supply leading to constant theft of the purchasing power and those that suffer most are the marhaen!

6. Banks ability to create money out of thin air combined with the predominant debt based banking system where loans are made with priority to the rich and the collateralized, means the rich gets richer and the poor gets poorer. And this is in direct contradiction of Surah Al Hasyr, ayat 7, which do not want society’s wealth to circulate only amongst the few.

Finally we wish to state that the earlier fatwa of Majma Fiqh is not wrong BUT IT WAS BASED ON INCOMPLETE AND MISCONCEIVED FACTS.


{For the liberal quotes in the above article we offer special thanks to our friend Ben Dyson, who with Andrew Jackson wrote a courageous book Modernising Money (2012 Positive Money) which earned the respect of even the established Economists and Academicians}

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