An eye-opening walkthrough of the modern fiat economy, and how riba (usury) makes up every part of it, by MUSLIM BITCOINER

One of the subjects that many Muslims, including some scholars, don’t seem to have a good understanding of is how Riba manifests itself in our current financial system. This stems from a lack of understanding of how money, banking, and markets generally work. For this essay, we’ll walk through how ‘fiat’ currency is created and disseminated throughout our economy, and how Riba is entrenched in the whole process. But first, before diving into how our money system works, let’s do a quick history lesson of money and the evolution of fractional reserve banking. Looking at the history of money and banking will give us a better appreciation and understanding of how Riba became the central feature of our current monetary system.

History of money and banking

In early human societies before the technology of money was discovered, barter was the primary means of exchange. Of course, it had its limitations because it was difficult to find someone who had exactly the goods or services that one wanted. And bartering made it difficult to determine the relative value of different goods and services. Furthermore, there was the issue of divisibility. For example, how would someone divide a part of a house in order to buy a few dates?

Eventually, humanity developed an ingenious technology to overcome these obstacles through the convergence of a single common medium of exchange. This technology is called money.

People began to use things like beads, seashells, stones, and metals as money. Eventually people settled on gold as the global standard for money. This makes sense, as gold has suitable properties that make it an effective medium of exchange, namely its durability, divisibility, fungibility, portability, and most importantly, its scarcity. Gold is great because it’s extremely difficult to get more of, where one must expend time and energy to mine more of it. But gold did have one major flaw.

As people accumulated gold, they needed a place to hold it as it became cumbersome and risky to hold on to, especially in large amounts. So people naturally went to their local trustworthy goldsmith to store their gold. In return, the goldsmith charged a small storage fee and issued a promissory note allowing for gold redemption. But then people started using those promissory notes to trade with instead of the actual gold. After all, it was worth just as much as the gold metal. All one needed to do was exchange it for gold at the local goldsmith’s vault. This seemed to work for some time, and the goldsmith noticed that people came to redeem their gold metal less and less frequently, and he noticed all of this gold just sitting there in the vault. Then he had an idea.

What if the goldsmith issued loans using the idle gold and generated revenue from the interest from those loans? Actually, why even loan out the actual gold metal? Everyone was transacting with paper money. Why not just lend out newly created paper notes and receive interest payments on the loaned notes? This was the start of “fractional reserve banking”, as the goldsmith can now just create new notes, or create money, without having the necessary gold to back it up, as Tarek El Diwany explains in his book “The Problem of Interest”:

“…it became apparent to the bankers that there was in fact no need to lend the physical gold in their vaults. Since their own receipts were equally regarded as money by the general public, it would suffice for these receipts to be lent out as a proxy for gold coins. Such a policy had a great advantage for the bankers since they could manufacture their paper receipts at almost no cost, whilst gold itself could not be produced so cheaply….”

But wait. Can’t the goldsmith just transact with newly created notes instead of loaning out the notes with interest? El Diwany goes further to explain why the goldsmith would rather generate revenue from interest instead of only creating new paper receipts:

“The ‘fractional reserve’ banking system… relied crucially upon the use of interest in its operation. Why, it might be asked, did the banker not print receipts and spend them on his own consumption if it is in fact true that he had the power to manufacture money? The answer is that the act of spending his own receipts would lose the banker ownership of those receipts. It would then be certain that, at some future time, the receipts would return to his institution for redemption in gold – gold which never existed in the first instance. By lending the receipts instead, the banker could charge interest on the amount lent. Upon repayment, the receipts could be destroyed as easily as they had been manufactured, but the interest charge would remain as revenue.”

The history of the goldsmith getting into the business of fractional reserve banking is a necessary prerequisite in grasping the full scope of the modern Riba problem. See, this is the beginning of when “institutional Riba” would be unleashed at a global scale. This fractional reserve system would be used as a model for all the world’s banks to follow. That is, until the creature from Jekyll Island is born, and unleashes Riba upon the world even more.

The creature is born

In 1910, there was a secret meeting held on an island just off the coast of the state of Georgia. This meeting was held by a group of 6 people, some from the banking industry, like senior executives from J.P. Morgan, and some from the US government, like Republican Senator Nelson Aldrich. What’s interesting about this gathering was that it was shrouded in secrecy and deceit, where the attendees were only allowed to use their first names, and when asked by the press why such prominent figures were gathered, they mentioned that it was for a duck hunting trip. G. Edward Griffin describes the secrecy in his book “The Creature from Jekyll Island”:

“Even after arrival at the remote island lodge, the secrecy continued. For nine days the rule for first-names-only remained in effect. Full-time caretakers and servants had been given vacation, and a new, carefully screened staff was brought in for the occasion. This was to insure that none of the servants might recognize by sight the identities of these guests. It is difficult to imagine any event in history, including preparation for war, that was shielded from public view with greater mystery and secrecy.”

Obviously, this was no duck hunting trip. The purpose of this meeting was to come up with an agreement to set up a central bank. The Jekyll Island attendees came together to write the first draft of the Federal Reserve Act. In 1913, after being approved by the House and the Senate, US President Woodrow Wilson signed the Federal Reserve Act. This act created the Federal Reserve System, which consisted of 12 regional central banks throughout the US located in major cities. Keep in mind that this legislation was marketed as a way to protect the public from banking failures and act as a “lender of last resort”, but of course the real purpose was for the biggest banking institutions at the time to control the money. But Congress amended the federal reserve act several times to further centralize the power of the central bank. Robert Murphy, in his book “Understanding Money Mechanics”, gives an example of one such amendments passed in 1935:

“…the most significant changes to the structure of the Federal Reserve System itself came in the Banking Act of 1935. This new legislation strengthened the overall power of the Federal Reserve System and consolidated it in Washington, DC, away from the Fed’s own Reserve Banks. However, the Banking Act of 1935 also served to make the Fed more autonomous from the federal government.”

While the Federal Reserve System was conceived to control the issuance, distribution, and lending of money, it was still somewhat tied to gold. The Fed attempted to keep the dollar pegged to gold and keep that peg at a somewhat stable value. But the creature from Jekyll Island needed a way to export its fiat currency to the rest of the world, and the resulting economic turmoil in the aftermath of World War II was the perfect opportunity for the creature to strike.

Bretton Woods and the Nixon Shock

The Bretton Woods Agreement was an effort to rebuild the global economic system after the devastation of World War II. It was a set of agreements reached by representatives of 44 nations at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, in July 1944. The goal of the conference was to create a new international monetary system where each nation’s currency was pegged to the dollar, which was set at a fixed exchange rate versus gold at $35 per ounce. The agreement also resulted in the creation of two key international organizations: the International Monetary Fund (IMF) and the World Bank.

Predictably, the Federal Reserve was not able to maintain the $35 per ounce peg to gold as they kept on inflating the money supply. In the late 1960s and early 1970s, the US was facing a series of economic problems, including an increase in budget deficits, high inflation, and a decline in the value of the dollar on international markets. The Federal Reserve’s gold stockpile kept dwindling as governments kept redeeming their gold using their dollar reserves, as per the Bretton Woods Agreement. So, in response, President Richard Nixon announced in 1971 that the US would no longer convert dollars into gold. The “Nixon shock” was a huge turning point for the future of the dollar, as this effectively took the US off the gold standard completely, and marked the end of the Bretton Woods system. The dollar had become truly fiat, where its value was declared by decree since there was no gold to back it.

So the question arises, what is the dollar backed by today? Let’s investigate the answer to that question by seeing how the Federal Reserve currently operates. Let’s also examine how dollars are created, and how Riba is tied to the dollar.

The Riba is in the money

Before diving into the mechanics of fiat, we want to restate that looking at the history of money and banking gives us a better understanding of how Riba is tied to our current monetary system, hence the history lesson above. For the majority of the history of civilization, humanity has used actual physical commodities, or bearer instruments, as mediums of exchange. But from our very brief look at the history of money, we can get a sense that there was always a tendency for a group of people that sought to exploit the limitations of gold to propagate institutional Riba and central banking and force it upon mankind. With that being said, our current global configuration of Riba-based fiat money that we find ourselves in is a very new and recent phenomenon. It was not always this way.

To understand how Riba is tied to fiat, let’s look at how dollars are created at the commercial bank level. All commercial banks, by law, must operate with fractional reserves. So they are required to lend out some of their deposits from their customers, and this act of lending is what actually creates money. Let’s walk through an example to illustrate how fractional reserve banking creates money.

Let’s say Ahmad deposits $100 at a bank. If the bank has a reserve requirement of 10%, then the bank only needs to keep $10 in reserve and can loan out the other $90. Now keep in mind that Ahmad can still withdraw his entire $100 from the bank whenever he wants so that loaned $90 has technically been created from nothing. Now consider that that loaned $90 finds its way back to the bank. Again, under a 10% reserve requirement, the bank only needs to keep $9 and can subsequently loan out $81. If we keep iterating, we see that the original $100 deposit made by Ahmad enables the banks to create $1,000.

We used a 10% reserve requirement in the above example to illustrate how fractional reserve banking typically works, but since March 2020, the Federal Reserve has actually set the reserve requirement to 0%. This means that banks are legally not required to keep any cash in reserve when they create money!

The above example also highlights the point that the majority of dollars are created through banks issuing debt, not from printing physical dollar bills. Saifedean Ammous in his book, The Fiat Standard, explains this succinctly:

“While a small percentage of a country’s currency exists in the form of physical cash, the majority exists in digital form, created whenever a financial institution backed by the central bank lends. New money is not created when currency bills are printed, but rather whenever new debt is issued.”

Keep in mind that these debts are always tied to some interest rate. The interest is already embedded in the contract of debt issuance. Therefore, whenever Ahmad makes a deposit at the bank, he’s essentially telling the bankers “please create more money by issuing debt, and you can make money off of this debt through interest”. Essentially, every dollar is created through interest. This point is also made in Tariq El Diwany’s book, The Problem with Interest:

“Bank money cannot be created other than by a loan, and therefore almost inevitably bears interest as a condition for its existence.”

It’s important to add that, in addition to commercial banks, there’s also an entire “non-banking” financial sector, ominously referred to as “shadow banking”, that is also involved in the creation and distribution of money. Shadow banks refers to institutions that include money market funds, hedge funds, and private equity firms. What’s interesting about shadow banks is that they are not subject to the same regulations as traditional banks, but they are still involved in the creation of money through the issuance of debt-based products. We won’t delve too much into the infrastructure and mechanics of shadow banks, but we want to highlight that shadow banks make up a significant portion of the global banking system, and they are in the business of pushing out debt based financial instruments that are all tied to Riba.

Let’s now pivot the discussion from how dollars are created at the commercial bank level to the central bank level.

The process where the Federal Reserve creates money, not too unlike the dollar creation process described above concerning commercial banks, also involves interest. To simplify, the Fed can “create” dollars when it needs to inject them into the economy to increase the money supply. It achieves this by conducting “Open Market Operations”, where the Fed can increase the money supply by purchasing treasury bonds. Conversely, it can also sell treasury bonds to decrease the money supply. A treasury bond is simply a government issued debt instrument that brings in interest payments to the owner of the bond, and they have different maturities up to 30 years in duration.

In essence, the treasury bond can be considered as the “base” layer that constitutes the foundation of the current fiat monetary system. A treasury bond is what ultimately backs the dollar, and remember that the treasury bond is just a government security that bears interest. If we think of money in the current monetary system in hierarchies or layers made up of different forms of money (like cash, bank deposits, etc.), treasuries would be at the top layer. See the graphic below from Nik Bhatia’s book “Layered Money”. Treasuries are considered to be the “strongest” and least risky form of fiat money with the least amount of counterparty risk.

So we can see that the current global monetary order depends entirely on Riba, and it cannot function without it. Even if a government enacted a zero-interest rate policy, it could only exist as a temporary measure, as such a policy would lead to rampant inflation due to excessive borrowing. And the only way that governments can mitigate inflation is through increasing interest rates, which discourages borrowing. This means that each time we spend or save a dollar, we are doing so with a currency that is literally backed by Riba.

The final point to drive home about the current monetary system is that fiat money is specifically designed in such a way that Riba cannot be separated from the money.

In the beginning, we discussed the history of money to illustrate how money evolved into the Riba based system of fiat that we live in today. The Riba embedded in today’s fiat currency is not an accident or something that was conceived randomly. Rather, it is the result of the actions of many groups of powerful people. These “powers that be” try to hijack the production of money for the purpose of controlling the masses through the institution of Riba. From the first instance of the goldsmith practicing fractional reserve banking all the way to the complete severance of gold backing in 1971, these elites seek to institutionalize Riba to force humanity into slavery. Once one examines the catastrophic consequences of Riba (which is not covered in this essay), it becomes evident that this particular sin is a favorite of the shaitan to steer humanity away from the worshiping of Allah to the worshiping of the state and central bank. This is the reality of Riba in our current financial system, and Muslims need to understand that reality before haphazardly looking for solutions.

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