Pages

Wednesday, 7 October 2009

Real value destruction in the South African economy

There are two processes of economy wide real value destruction operating in the SA economy. The one overall real value destruction process is well known and generally accepted. It is inflation. Inflation is the enemy in the monetary economy and the Governor of the Reserve Bank is the enemy of inflation. Everybody knows that inflation is destroying the real value of their Rands and all other monetary items at the rate of 6.4% per annum, at the moment. Value date: August 2009 CPI 108.5

The second process of economy wide real value destruction is the unknowing, unintentional and completely unnecessary destruction by SA accountants of the real value of constant items never maintained in the SA constant item economy. This is the result of their implementation of the very destructive stable measuring unit assumption during low inflation as part of the real value destroying traditional Historical Cost Accounting model used by most SA companies. The enemy is SA accountants´ stable measuring unit assumption. In principle, they assume the unit of measure, the Rand, is perfectly stable during inflation; that is, they assume that changes in its general purchasing power are not sufficiently important to require the inflation-adjustment of the nominal values of all constant items in the SA economy in order to maintain their real values constant. In so doing, they unknowingly destroy the real values of constant items never maintained during inflation.

SA accountants´ stable measuring unit assumption is a stealth enemy: hardly anyone understands that when accountants implement it they are unknowingly and unintentionally responsible for the destruction of the real values of constant items not maintained under HCA during inflation.

Table 1: Real value destruction: Historical Cost Paradigm

Monetary aggregate: M3 R1 952.799 billion SARB: Value date: August 2009
Estimated value of constant items not maintained in SA economy: R 3 333 billion

Table 2: Real value destruction: Const. ITEM Purch. Power Accounting

Table 1 above gives us a close estimate of the state of real value destruction in the SA economy at the moment: In the 12 month period ending in August, 2009, inflation actually destroyed R1 952.799 billion x 0.064 = R124.9 billion in the real value of the Rand in the SA monetary economy. At the same time SA accountants unknowingly, unintentionally and completely unnecessarily destroyed about R200 billion in the real value of constant items never maintained in the SA constant item economy. About R324 billion in real value was thus destroyed in the SA economy in the 12 months to August, 2009 by inflation and by SA accountants implementing their very destructive stable measuring unit assumption.

If inflation stays at 6.4% for the next five years and SA accountants keep on unknowingly destroying the real values of constant items not maintained with their very destructive stable measuring unit assumption then a cumulative total of R1 620 billion in real value would be destroyed in the SA economy – all else being equal. The cumulative totals of real value destruction under these circumstances for 10, 20 and 30 years would be R3 240 billion, R6 480 billion and R9 720 billion respectively – ceteris paribus. These are huge values of real value destruction in the SA economy of which the part for which SA accountants are unknowingly responsible, is completely unnecessary and can easily be prevented.

We can see from Table 2 what the difference would be when SA accountants freely decide to measure financial capital maintenance in units of constant purchasing power as the IASB authorized them to do 20 years ago in the Framework, Par. 104 (a).

The destruction of real value in constant items would stop completely. There would only be real value destruction in the real value of the Rand because of inflation. At 6.4% annual inflation only R124 billion in real value would be destroyed in the economy as a whole instead of the current about R324 billion over a period of 12 months. Over five years the cumulative total of real value destruction would drop from R1 620 billion to R 624 billion, over 10 years from R3 240 billion to R1 249 billion, over 20 years from R6 480 billion to R2 498 billion and over 30 years from R9 720 billion to R3 747 billion.

SA accountants unknowingly destroy existing real values in existing constant items with their very destructive stable measuring unit assumption. When they stop their stable measuring unit assumption they would knowingly maintain about R200 billion in existing constant item real values during every period of 12 months in the SA real economy amounting to R1 000 billion over 5 years, R 2 000 billion over 10 years, R4 000 over 20 years and R6 000 billion over 30 years. Boosting the real economy with these real values would make a very big difference to the SA economy as a whole, to growth and to employment in the economy over that period.

Obviously a further reduction of inflation to an annual average of 3% would improve the SA economy even more. Over 30 years it would boost the economy by a further R2 000 billion on top of the R6 000 to be gained when SA accountants freely switch over to financial capital maintenance in units of constant purchasing power.

Kindest regards,

Nicolaas Smith