Towards an Objective Measure of Gharar in Exchange

Although the legal aspects of gharar are well established in Islamic jurisprudence, researchers in Islamic finance constantly face the dilemma of defining the concept and its precise meaning. For example, Zaki Badawi (1998, p. 16) writes: “The precise meaning of Gharar is itself uncertain. The literature does not give us an agreed definition and scholars rely more on enumerating individual instances of Gharar as substitute for a precise definition of the term.” Frank Vogel (1998, p. 64) expresses a similar tone: “As with riba, fiqh scholars have been unable to define the exact scope of gharar.” These claims might well be exaggerating, but they point to the need for further contemporary formulation of the subject.

This paper is an attempt to develop an objective criterion to identify and measure gharar in exchange. It is shown that a gharar transaction is equivalent to a zero-sum game with uncertain payoffs. The measure helps economists view gharar within an integrated theory of exchange under uncertainty, so that it can be easily communicated to non-Muslim economists. Further, it provides a quantitative measure of gharar that can potentially be applied to innovative risky transactions. A Shari’ah-based measure is also developed, and the two criteria are shown to coincide and integrate each other.

The Islamic principle behind most illegal contracts is eating others’ money for nothing. A zero-sum exchange reflects precisely this concept: It is an exchange in which one party gains by taking away from the other party’s payoff, leading to a win-lose outcome. However, a rational agent will not accept to engage into a certainly losing game; only if loss is uncertain and gain is probable, that such game is played. Hence uncertainty or risk is what tempts rational agents to engage into an exchange which they know in advance that only one will gain from it while the other must lose. This temptation is best described by the term gharar, which means deception and delusion. It follows that a gharar contract is characterized as a zero-sum game with uncertain payoffs. This paper argues that such measure well

defines gharar transactions.

The paper also develops a Shari’ah based measure derived from the hadith: Liability justifies return or utility. It is shown the these two measures coincide and integrate each other. A quantitative formula is developed to examine gharar in nonzero-sum games, which helps formalizing conditions of unacceptable risk or excessive gharar mentioned by fiqh scholars. An examination of well known gharar contracts shows how the zero-sum measure is satisfied. The measure helps explaining why fuqaha take different positions on controversial nonzero-sum contracts, while unanimously prohibit strictly zero-sum contracts. Extending the measure to modern applications generates interesting results on how a certain contract, like the option contract, might or might not be gharar, depending on the structure of payoffs for the two players.

The economic significance of the zero-sum measure provides insights into the Islamic view of economic behavior. Elimination of zero-sum arrangements can be viewed as a paradigm governing Islamic principles of exchange. Not only this paradigm is internally consistent, it is also consistent with rationality as defined by Neoclassical economics. Consequently, modern analytical tools are readily available for Muslim economists without compromising Islamic principles There is much to be studied and analyzed, and I hope that this paper presents a proper starting point for building a coherent theory of exchange in Islamic economics.

18.15 | 0 komentar | Read More

Monetary Management in an Islamic Economy Muhammad Umer Chapra

The monetary system that prevails in the world now has-come-into-existence-after passing.through several-stages-of evolution. The monetary system that prevailed during the Prophet’s (pbuh) days was essentially a bimetallic standard with gold and silver coins (dinars and dirhams) circulating simultaneously. The ratio that prevailed between the two coins at that time was 1:10. This ratio seems to have remained generally stable throughout the period of the first four caliphs. Such stability did not, however, persist continually. The two metals faced different supply and demand conditions which tended to destabilize their relative prices. For example, in the second half of the Umayyad period (41/662-132/750) the ratio reached 1:12, while in the Abbasid period (132/750-656/1258), it reached 1:15 or less.

In addition to this continued long-term decline in the ratio, the rate of exchange between the dinar and the dirham fluctuated widely at different times and in different parts of the then Muslim world. The ratio at times declined to as low as 1:35, and even 1:50. According to both al-Maqrizi (d. 845/1442) and his contemporary al-Asadi (d. after 854/1450), this instability enabled bad coins to drive good coins out of circulation, a phenomenon which became referred to in the 16th century as Gresham’s Law.

When the United States adopted bimetallism in 1792, the gold-silver price ratio was 1:15. However, the fluctuating prices of both metals led the US to demonetize silver in 1873. Experience of several other countries suggests that bimetallism was a fragile standard. There was no dependable way to tie together full-bodied gold and silver coins at fixed rates. This was the main cause of its universal demise.

Monometallism hence took its place. In the beginning, silver and gold both com¬peted, but silver continued to lose ground and the gold standard became prevalent around the world. It emerged as a true international standard by 1880 following the switch by a majority of countries from bimetallism and silver monometallism to gold as the basis of their currencies. Under this standard, the value of a country’s currency is legally defined as a fixed weight of gold, and the monetary authority is under an obligation to convert the domestic currency on demand into gold at the legally prescribed rate. Historically there have been three variants of the gold standard: the gold coin standard, when gold coins were in active circulation; the gold bullion standard, when gold coins were not in circulation but the monetary authority undertook to sell gold bullion against the local currency at the official rate; and the gold exchange standard  (or the Bretton Woods system), when the monetary authority was required to exchange domestic currency for US dollars which could be converted into gold at a fixed parity.
 

The UK was on a gold coin standard until 1914 and then a gold bullion standard from 1925 to 1932. The rules of the gold standard required deficit countries to deflate and the surplus countries to reflate their economies. This seemed unrealistic during the Great Depression when the deficit countries had no alternative but to reflate their economies to reduce unemployment. The United States and France, the two major surplus countries, also did not find it practical to follow the rules of the game. Instead of reflating their economies, they persistently sterilized their balance of payments surpluses, thus accentuating the deflationary pressure on the deficit countries. Such policies undermined the effective operation of the gold standard and it was abandoned after the Great Depression.

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