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Saturday, 24 May 2008

Accounting for Inflation


Financial Mail 09 May 2008


Accounting for inflation

Nicolaas Smith, Lisbon

DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).


SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.


There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.


We have to remember that inflation is the destruction of value in monetary and constant items over time.


Inflation has two components: a monetary component - cash inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.


The 10,6% (March) cash inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.


Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.


The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.


We will still have 10,6% cash inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.


Inflation would then have only a monetary component, namely, cash inflation.


No-one stops us from revoking the stable measuring unit assumption.


The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.