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Time Value of Money, A Revisit

One of my favorite topics apart from my digital gadgets is macro economy and financial system. I am an engineer by background and that my passion toward gadget is fully justified but my interest toward macro economy? How it can be…

I still recalled when I was in the final year of my college where I took Introduction to Finance. I scored the highest in the class and received public compliment from my lecturer at that time.

At that time, one of the concepts that were made for me to believe is the concept of “time value of money.” It is written in almost all financial textbooks. In simple words, what it means is, the price of a glass of soda in the future will always be higher than the price of it today. To put it in a formulae, it will be something like this:

Price of sodain the year 2030 = Price of sodain the year 2008 x (nominal interest rate)

From this concept, interest either nominal or effective should be accepted as part of our daily life.

But remember that this concept is different from the fundamental price escalation due to variance in supply and demand where it price escalation based on variance in supply and demand is fully justified throughout human civilization.

The time value of money that I explained above is solely with regard to the financial system related to money and its derivatives.

Before I finished my study at college, I was further fortified with this concept when I was sponsored to joint a summer business school program in Lee Iacocca Institute, Lehigh University in Bethlehem, Pennsylvania.

During the one and half month program, I was given the opportunity to meet top executives of multinational company, handle real life finance, marketing project with real company, visit United Nation offices and other Breton Wood institutions e.g. World Bank and International Monetary Fund (IMF) in New York and also New York Stock Exchange (NYSE) trading floor.

I fully accepted this concept until now and it is about to change.

From my research and I think almost everybody know this fact clearly which have to attend Finance class, it is:

“A critical point is that gold is always the same — an ounce of gold today is the same as it was 5000 years ago and the same as it will be in 5000 years time — whereas the US$ and all other forms of paper money are constantly changing. The US$, for example, might not exist in 20 years — let alone 5000 years — time, and even if it does exist it is certain to be a lot different than it is today.”

Excerpt from:

http://www.safehaven.com/article-3511.htm

This fact is proven by the fact that, almost everyone is advised by their so-called Financial Planner (aka insurance, unit trust marketing agent) to have some portion of their wealth in gold). They said it is because the gold will protect them in case of other investments e.g. stock, bond, etc do not yield good return.

Let’s now, try to understand the exact meaning from the above excerpt before we proceed further. It says the value of gold is always constant. Remember to read properly here  as “value of gold” not price of gold” because those two will give different contrasting meaning all together.

Price of gold might change as shown from the graph below:

You may get the price of gold against other currencies from this link, HERE.

Now let’s us further understand this.

The value of gold is always constant (as per the excerpt)

BUT

The price gold (as we can see from the above graph) is increasing

So what it actually tells us??

It is our currencies (aka money) that are decreasing (read also as inflation) in value while the gold maintains its value.

So here, we can conclude that time value of money does not apply to GOLD!

At this point, I want to draw our attention to what Islam preaches us. In Islam, all economic measurement e.g. the amount of zakat needs to be paid is always fixed to gold.

That’s how, Allah ensure the amount of zakat that I pay today for my net present wealth is equal to anyone 50 years before or after me pay for the same amount of my net present wealth. In other words, Islam practices justice to all humankind throughout time.

On the other hand, Islam strictly forbids the practice of riba (charging interest). In other words, Islam doesn’t recognize the concept of time value of money.

Now, I really can appreciate one beauty aspect of Islam…

In conclusion, I would say, we were forced to believe about this interest and time value of money concept so that those blood sucker banks and financial institutions can charge interest to us!

21/12/2008 - Posted by | Economy, Finance | , , ,

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