The following is the text of an email dialogue between Professor Nejatullah Siddiqi and the editor on the subject of Islamic banking and commodity money, reproduced with Professor Siddiqi's kind permission.

Editor:
Assalamu `Alaikum Professor Siddiqi.
It is a long time since we last spoke. I hope you are well, insha'Allah.
I read your recent Harvard paper, discussing tawarruq, among other things.
Contract combinations have been practiced by "Islamic" bankers to create quasi interest-based loans for at least thirty years. At first they were doing it with murabahah, now they take the more direct route of using tawarruq. When people like myself risked our careers to state in public that these practices were a ruse, deployed to misdirect Islamic financial rejuvenation, we were mocked for so doing and few grandees came to our defence. In recent months I have noticed that two of the Shari`ah scholars who once opened the door to this Trojan Horse are now calling for a re-evaluation. But what is required is something more fundamental than that. Modern commercial banking grew from the foundation of usurious money creation, it could not grow in a truly Islamic soil, and that is why the Islamic commercial banking experiment has largely failed. Your suggestion, many years ago, for a two tier mudarabah based on genuine profit and loss sharing was a vision that could easily be made to work. But it would need a different monetary and institutional framework to do so and, most importantly, an elite that had the vision and courage to implement it. Alas, some of our elite are signing one page fatwas for tens of thousands of dollars (and sometimes not even looking at the contract). Others make grand-eloquent speeches on the conference floor, but afterwards are found seducing the secretary in a quiet corner of the hotel restaurant. These are some of my experiences from the shop floor. You have your experiences too, no doubt.
Over breakfast in Pasadena, you advised me "not to become involved in what is happening" and to "get on with producing an alternative instead". But look what has happened because of our detachment. A monster has been created, very purposefully, and it will now require a huge effort to overcome. As for the idea that we only need to devise a workable alternative to the present paradigm, this I am afraid ignores the present political realities. The most powerful patrons of Islamic banking are not interested in such a thing. Their whole purpose is to suppress workable interest-free alternatives, and thus protect their golden goose.
Looking forward to hearing your thoughts insha'Allah.
Wassalam
London

Muhammad Nejatullah Siddiqi:
I am so glad you read that paper.
When I was in Jeddah I had discussions with, among others, the late Sami Homoud, the supposed introducer of murabaha in Islamic finance. From his practical experience in Amman he told me there are things that cannot be done through 2 tier mudarabah. One example: financing the laying down of a sewage system in part of Amman. The benefits for which charges can be collected from users are spread over, say, 75 years but the cost has to be met NOW. Think how problematic it is to mobilize capital on a profit-sharing basis. So they opted for a murabaha model.
Modern financing needs can not all be met by a simple 2 tier model. Secondly debt or credit has always played a role in financing. The real question is of discovering a proper mix, a balanced model.
Many of the ills of modern monetary and financial system can be cured by reforming the monetary system by making new money creation FIRMLY linked to real wealth generation, to production of goods and services. I tried to make this point in my Riba, Bank Interest and Rationale of its Prohibition (available at www.irti.org).
Who are the 2 scholars willing to look back?
M.N.Siddiqi
California

Editor:
[Like you] I have also made the point regarding "theory following practice". This has been a typical feature of the interest-based sector for some time. Here, the theories that are promoted most are the ones that provide the establishment with the justifications it needs to carry on with business-as-usual. They are excuses more than theories, of course. Last time I was at the IDB, I witnessed a gathering of scholars responding to a request from upon high that they find a way of justifying a murabahah price that could be fixed after contract signing. The words "according to a benchmark" stuck in my mind especially. You can guess what the benchmark was, and indeed the purpose of the whole exercise.
We both know that monetary reform is a cornerstone of our escape from usury, and it is therefore unsurprising that the major banking organisations are pouring substantial resources into educational propaganda that favours the current monetary system. Hence it is a great disappointment to find that many of the academics and institutions of the Muslim world, far from providing an effective alternative to that propaganda, have incorporated it into their own framework. We therefore face the rather ironic situation in which the most practical opposition against usury comes not from the Muslim world, where the ideology is still formally against usury, but from the West where the prohibition of usury was defeated long ago. So, while the Gulf countries have appointed the ECB to advise upon their currency union, several Members of Parliament in Britain have signed a motion requesting a debate on the use of interest-free money. Isn't it strange that I should be invited to speak in favour of money reform in both the House of Commons and the House of Lords, whilst barely finding an opportunity to do so in gatherings of the Ummah?
What are we to do about this? Write more papers? I do hope that your gentle encouragement towards a re-evaluation will work, but then again people have been writing cogent criticisms of commercial banking for a long time and where did it get them? William Cobbett went to prison for it in London, two centuries ago. The way I see it, you are an academic and so the Islamic banking bandwagon will ignore you. And if a scholar on the inside attempted to implement a genuine paradigm, the Islamic banks would dump him, eventually. What we have is partly a problem of education, but more one of ensuring that the right people are defining the vision for the industry. If we had the latter, practice would begin to follow the theory, and a wholesome institutional framework would in due course build itself.
However, the present Islamic banking establishment will not address these problems for us. They have shown themselves to be institutionally incapable of doing what is necessary. That is why we have tawarruq. It is the end result of applying principles that were established in the formulation of murabahah many years ago, despite opportunities to chart a different course in the meantime. The moral hazard in the selection of Shari`ah has operated frequently here, such that even if ninety-eight out of one hundred scholars judge that a product is haram, the Islamic bank will employ the two who say that it is halal. The banks are in effect able to pick and choose the rules for themselves, while telling everybody that they are only following the rules laid down by the Shari`ah scholars. This is no way to carry on. We cannot leave commercial forces to determine the law. There needs to be a higher imperative.
With regard to your question, I have been told by people close to him that **** has recently been in contact with some of the larger Islamic banks in the Gulf and elsewhere warning them that the direction in which things are moving is not a wholesome one. His remarks are directed particularly at tawarruq, this I know, and perhaps also at the nascent Islamic hedge fund industry. **** has recently commented on the volatility of the Saudi stock market and the fact that such volatility took place despite the widespread Islamisation of the banking sector. He too questioned the direction of Islamic banking, but his substantial participation in its promotion within KSA over recent years does not leave him in a strong position to criticise.
Finally, two specific points arising from your paper and e-mail comments:
1) I occasionally hear the argument that the Islamic banking system is more stable because money is only created against real assets, and that therefore the connection between the real and financial sectors is largely maintained. This is the argument that was deployed by the Bank of England in its defence of money creation during the British government's Bullion Committee hearings of 1810. The Bank's argument was largely rejected by Committee members who found that money creation was not limited by lending against productive assets because entrepreneurs could concoct an unlimited supply of new real-world investment projects for the banks to lend into. The committee found against the Bank of England and recommended curbs on paper money creation for private profit (recommendations that were sidestepped when they were in due course implemented). The Bank's arguments are being resurrected now by Islamic bankers in Muslim countries to justify (or in some cases deny the fact of) money creation.
2) I am in favour of separating payment transmission services from investment management, placing the latter off-balance sheet perhaps and structuring it so that asymmetrical risks are avoided. I don't see any difference between us here. Investors could share profits and losses with the investment manager (tier-one), and the investment manager could invest into various projects (tier-two). Many Islamic banks use a tier-two structure that contains two elements, one in which they fund an SPV using a mudarabah contract, the second in which the SPV in turn funds assets using Islamic contracts (that need not be confined to mudarabah). In the example you cited of funding a 75 year infrastructure project, there need be no problem in using mudarabah if tradability is introduced via securitisation of the tier-two assets. Buyers in the secondary market would bid for the SPV's securities at a price that reflected the increase in present value as the duration of the securities decreased, and this would eventually be sufficient to provide a capital gain for those who bought at issue stage, even if no coupons/dividends were paid in the meantime. Liquidity is already being provided by the arrangers of some Islamic funds, and sukuk are being quoted with bid-offer spreads by the larger banks. If Islamic bankers and policy makers devoted as much effort to improving tradability for Islamic securities as they have done to "perfecting" murabahah, there need be no major problems in funding 75 year infrastructure projects.

MNS:
I confine myself to a single point:
The virtue of tying new money creation to real assets.
I presume you agree to the need for an increasing money supply in a world characterised by increasing population, increasing production of goods and services and expanding market. Ideal would be to match each new unit of money with its equivalent in new wealth, but new wealth comes tomorrow while money for mobilising resources for its production is needed today. We need a proxy for wealth yet to come, that proxy is an existing asset. Whatever the problems involved we have to overcome them.
In the model of narrow banking you are suggesting, the problem does not go away.It is not an accounting problem, it is a real one.

Editor:
For the record, I believe that pre-Classical theories are largely appropriate in describing the money supply process under a truly interest-free system. I have summarised this elsewhere as follows:
"In the monetary system I envisage, anyone can produce money. All they need do is go out and dig for it. Then, if the amount of gold obtained by digging is more than the amount of gold that it costs to do the digging, the people will produce money. Otherwise they won't produce money. This is a simple, market-driven mechanism for the supply and demand for money, one that features an in-built tendency towards price stability. It has nothing to do with interest, nor with the arbitrary creation of money for no effort. And if people want to dig for platinum, let them. If one man feels that another will accept copper as payment, let him dig for copper. When the people have true freedom in money, what will they tend towards? Gold and silver, of course. This is because Allah has created us with a love for 'heaps of gold and silver' (Qur'an 3:14). He has created everything for a purpose and the purpose of gold and silver is to act as money (Ibn Khaldun, Muqaddimah)."
The concerns we have as economists in an interest-based monetary system may become far less relevant under a truly interest-free alternative. For example, it is entirely possible that the price level will tend to fall over time, relieving much of the current pressure towards money supply expansion. There would then exist a commercial force that encouraged people to delay their purchases. A nice counter-balance to consumerism, and the death knell for at least one modern argument in favour of interest.

MNS:
I think you got it all wrong.
Digging gold and silver is not possible for everyone everywhere all the time ---- as your ideal would require. Gold mines are very unevenly spread, they tend to exhaust as time goes on and so is silver or XYZ. What a colossal waste commodity money would involve, more so a thousand years from now!
What is more intriguing is that even if all this is ignored, money, any kind of money, cannot manage itself. It has to be managed by us, human beings with all their failings. So we are back to square one.
What pains me most is your quoting Qur'an. That verse does not describe human nature. It describes a kind of person, oblivious of life after death and the Creator, indulging in worldly wealth. Read it in context.
Ibn Khaldun was an empiricist. He wrote what he observed, in the language of his times, stating observed facts as eternal truths. The reality has changed. We are moving towards a money with no corporeal existence. Ibn Khaldun today would have said, Lo! God created computers to usher in electronic money!

Editor:
When I presented a paper at the Gold Dinar conference in Malaysia in 2002, I highlighted as part of my presentation various views that oppose commodity money. I was accused then of putting up "straw man arguments" in order to win easy victories in front of the audience. But now you come repeating some of those arguments as intellectual criticisms. Strange world, heh?
For example:
>> Digging gold and silver is not possible for everyone everywhere all the time----as your ideal would require. Gold mines are very unevenly spread, they tend to exhaust as time goes on and so is silver or XYZ.
Surely you recognise the slight element of metaphor in my argument? A person need not physically dig gold himself. He can find someone else to do it for him, for example by buying shares in a gold mining company, or by buying bullion through a dealer. Oil fields are also unevenly spread in this world, but that doesn't stop people using oil for its intended purposes.
>> What a colossal waste commodity money would involve, more so a thousand years from now!
Which is the greater waste. To keep 30,000 tons of gold beneath the earth in the vaults of central banks, or to release it so that people can use it as money? I have not seen the latest figures for global gold production, but let us say it is very approximately 2,000 tons per year. At today's prices this amount of gold is worth less than USD20 billion. We can say that this is the approximate worldwide resource cost of mining, refining and distributing gold bullion to the markets. But USD20 billion is less than the profit that banks in the United Kingdom alone have made in each of the last three years. It is probably less than 3% of the interest spread earned by banks globally on the money that they create out of nothing through credit creation. So if it is a waste of resources to produce gold for use as money, then it is a massively greater waste to use the current system of money creation.
>>What is more intriguing is that even if all this is ignored, money, any kind of money, cannot manage itself. It has to be managed by us, human beings with all their failings. So we are back to square one.
I have always advocated the imposition of suitable quality standards and audit procedures in the event that a commodity currency is adopted, just as we regulate the present monetary system. We are not back to square one. We just have to adopt sensible prudential measures.
>> What pains me most is your quoting Qur'an. That verse does not describe human nature. It describes a kind of person, oblivious of life after death and the Creator, indulging in worldly wealth. Read it in context.
Ibn Kathir's tafsir of verse 14 in Surat al-'Imran ("Beautified for men in the love of things they covet, women, children, heaps of gold and silver ...") gives no indication that it relates to any particular kind of person. In fact he is rather clear that it describes the nature of man in general. Mawdudi's tafsir translates the verse into English as "Men are naturally tempted by the lure of women and children, treasures of gold and silver ...", which is my point precisely.
>> Ibn Khaldun was an empiricist. He wrote what he observed, in the language of his times, stating observed facts as eternal truths. The reality has changed.
When in Muqaddimah ibn Khaldun writes that "God created the two mineral stones gold and silver as the measure of value for all capital accumulations" this sounds to me very much like someone who is stating what he sees as an eternal truth. I remember being in Indonesia in 1997 when the Rupiah fell 50% in a few days, and inflation rocketed. In what form would you have wanted to hold your savings in those days? Paper money, or gold? I know of no instance in history when money "with no corporeal existence", as you describe it, has not eventually been debased to a state of worthlessness by those who had the authority to manufacture it. It is happening today before our very eyes. For Indonesians, and indeed for most of the developing world, the reality has definitely not changed. Commodities cannot be manufactured from nothing, they have a factor cost, and that is exactly the protection that society needs against monetary manipulation.
It would be a sad day if you saw no redeeming features in my position. I can't have got it all wrong, surely? Anyway, if I have, may Allah forgive me and help you to expose the flaws in my arguments. To this end, I would very much appreciate a written record of your responses to the above points.

MNS:
Salam alaikum and thank you for your patience.
I may try a written response later as I am currently very busy researching for a book in URDU on Maqasid e Shari`ah. Meanwhile may I in all humility refer to what I wrote already on this subject. The name of article I will be able to give later as I am not responding to your mail from my office but from another place. But I think it was titled: An Islamic Approach to Economics, presented in Islamabad in 1982, published in my book (Economics, An Islamic Approach) published from Islamabad but also available at Islamic Foundation, Leicester, UK.
About the verse of Qur'an, we face this problem in other places too. Qur'an depicts men as found (especially in the Meccan society of the time) and then says: ...illa al- musalleen[ Quran,70:22] or illa al-lazeena aamanu [Quran,26:227;38:24;95:6 and 130:3].
Someday I may clarify further with reference to Surah and verse, but despite the translation from Mawlana Mawdoodi that you quoted, believe me it is not valid to claim: Qur'an says this is human nature.
If you are in search of human nature go to verses which specifically describe FITRAH (fitratallah allati fatarannas alaiha) [Quran, 30:30].

Editor:
I was looking back over our dialogue with the idea of publishing it at www.islamic-finance.com for the benefit of others, with your permission of course.
What comes through rather strongly from the discussion is your dismissal of my position. Most of my points remain unanswered. If the weight of opinion was that one-sided then perhaps such a treatment would be warranted, but I continue to find scholars who support commodity money or view modern Islamic banking as a Trojan Horse. For example, I discussed verse 14 in Surah al-'Imran with a Shari`ah scholar in London. He pointed out that the meaning of the Arabic is that "man has been created" with a love for women and sons, heaps of gold and silver, and so on. Your restriction of inferring man's nature only from verses in which the word "fitrah" appears was something new to him. So can we at least agree there is a case to answer?
By the way, I know you have been described in the past as the "father of modern Islamic banking", so please don't think I'm trying to get at you when I call the industry a Trojan Horse. I just happen to think that's what it has become, despite some honourable intentions at the outset.

MNS:
For the sake of clarity let us first take the issue of commodity money, apart from our discussion on current state of Islamic banking on which my survey article and Harvard paper has already given you my thinking, for the present.
Efficiency and fairness are the two major criteria on which our choice of what should constitute money should be based. If you think commodity money is more efficient you have to counter the arguments in economic literature against it, especially since man did have commodity money most of his history till now. As regards fairness you would appreciate that free working of market is incapable of ensuring fairness. Social authority (exercised in different ways in different times and places) has to intervene and regulate in order to ensure (a degree of) fairness. If you think commodity money is easier to regulate, argue your case, empirically as well as theoretically. I hope you do NOT think no regulation to ensure fairness is needed in case of commodity money. Such a stand is wrong.
I have objected to your ascribing to Islam the position that we should have commodity money. Such a position is not established on the basis of Text, Qiyas, or Ijma'. If you think it can be established on the basis of Maqasid al-Shari`ah or Masalih, you have yet to argue your case.
I do not think agreement or disagreement on the implications of verse 14 of Surah Aal e Imran has much to do with this debate.

Editor:
Thank you for this speedy response. I now think I see what the problem is.
You believe that I subscribe to the view that commodity money is required in Islam. In fact, my argument is that the people should have freedom (within the regulations of Islam) in choosing what sort of money to use. If they are given that freedom, they will tend to choose gold and silver because of their natural preference for these items. For me, that is the relevance of the aya in Surah al-`Imran, and it is borne out by empirical evidence across the ages.
Conversely, for much of the last century the British and American governments have prohibited the purchase of gold bullion by domestic residents. They have prohibited what Allah has allowed, which is a certain sign of dysfunction within an economic system. If a man is faced with a choice between selling his goods in exchange for a deflating piece of paper or a piece of gold, he will tend to choose the gold. The commercial banks cannot manufacture gold out of nothing, but neither can their own form of money compete with it. Hence, much of banking history has been about the efforts of the banks to remove precious metals from the circulating medium and replace it with their own token money. A reading of 19th century politics in America strongly indicates the existence of these efforts, as the statements of Jefferson, Jackson and Lincoln make very clear.
There is a great deal of empirical evidence to recommend commodity money over token money as a store of value, from the data in Jastram's "Golden Constant" to the ahadith of the Prophet, pbuh. In the latter we can find a series of dinar and dirham prices for such items as dresses, axes, houses and sheep that wouldn't be out of place today. Such maintenance of purchasing power has never been achieved over even a few decades with a token based monetary system, let alone over 1400 years. Presumably you do agree that a money which holds its value is fairer than one that doesn't? But given your aversion to commodity money, could I ask you to name one period of fifty years in history, anywhere in the world, when token money has held its value as well as gold or silver?

MNS:
A natural preference for any thing does not necessarily imply its suitability as money. Anyway, in the light of your clarification, there remains no quarrel between us. As long as you do not claim an Islamic mandate for commodity money, it is fine with me. The matter is left to what serves MASLAHA best. You have every right to the views you propound. I already indicated to you what little I wrote on the subject. If and when I do more I will send it to you, inshaAllah.
I am not aware of any study of ahadeeth that demonstrates price stability during early Islamic history. What is well documented is that after the influx of gold and silver from conquered regions, prices rose sharply during the rule of Syedna Umer Farooq and Syedna Usman.

June 2006