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Monday, 5 October 2009

Mboweni´s R120 billion annual gift to South Africa

Money illusion is still very evident today in most economies in money, monetary items and constant items that are mistakenly considered to be monetary items, for example, trade debtors and trade creditors.

The incorrect treatment of trade debtors and trade creditors as monetary items is mainly due to the incorrect definition of monetary items in IFRS. IAS 29, Par. 12 defines monetary items incorrectly as follows:

Monetary items are money held and items to be received or paid in money.

Not all items to be received or paid in money are monetary items – per se. Money is simply used as the generally accepted medium of exchange to transfer monetary items as well as most non-monetary items from one economic entity to another. Most non-monetary items are transferred from one entity to another by generally accepted mutual agreement to use money as the medium of exchange.

Money has the legal backing of being legal tender. Legal tender is an offered payment that, by law, cannot be refused in settlement of a debt. Legal tender is anything which, when offered, extinguishes the debt. Credit cards, debit cards, personal cheques and similar non-cash methods of payment are not usually legal tender. The law does not relieve the debt until payment is accepted which explains the practice in some economies of making out receipts for most payments. Bank notes and coins are usually defined as legal tender.

Monetary items are incorrectly defined in IAS 21, Par. 8 too:

Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.

Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se.

The correct definition of monetary items:

Monetary items are money held and items with an underlying monetary nature.

Money illusion is the mistaken belief by people in general that money’s real value is maintained in the short to medium term in low inflationary economies. Central bank governors aid and abet money illusion by regularly stating in their monetary policy statements that they are “achieving and maintaining price stability.”

“The MPC remains fully committed to its mandate of achieving and maintaining price stability.”

TT Mboweni, Governor. 2009-06-25: Statement of the Monetary Policy Committee, SARB.

It is not always pointed out by governors of central banks that the “price stability” they mention, refers to their definition of “price stability”. Jean-Claude Trichet, the President of the European Central Bank, is a central bank governor who regularly mentions that 2% inflation is their definition of price stability. Absolute price stability is a year-on-year increase in the Consumer Price Index of zero per cent. The SARB´s definition of “price stability” “is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”

The SARB would aid in reducing money illusion by stating:

The MPC remains fully committed to its mandate of achieving and maintaining the SARB´s chosen level of price stability which is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. Absolute price stability is a year-on-year increase in the CPI of zero per cent. Current 6.4% annual inflation destroyed about R124 billion of the real value of the Rand over the past 12 months to the end of August, 2009. A one per cent decrease in inflation would maintain about R19 billion per annum of real value in the SA monetary economy.

Tito Mboweni, the highly respected outgoing Governor of the SARB, has achieved the remarkable distinction of reducing the average annual destruction of the real value of the Rand by inflation by 50% during his 10 year tenure at the helm of South Africa’s central bank. In the 18 years before his arrival, average annual destruction of the real value of the Rand by inflation was 12 % or R240 billion per annum in August, 2009 CPI value terms – ceteris paribus. This means that Mr Mboweni and his excellent team at the SARB managed to maintain, on average, an extra R120 billion per annum in the SA monetary economy over the last 10 years. This annual R120 billion benefit to the SA economy will remain in place as long as average annual inflation stays at 6% or lower – all else being equal.

A further reduction of average annual inflation to 3% - the bottom level of the SA´s inflation target range – would maintain an additional R60 billion per annum in the SA monetary economy. That would bring the total real value maintained to R180 billion per annum compared to the R240 billion real value destroyed per annum during the last 18 years before Mr Mboweni´s arrival at the SARB.

Kindest regards,

Nicolaas Smith