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Wednesday, 6 January 2010

The failure of IAS 29

The combination of hyperinflation, accountants implementing HCA and inappropriate economic and monetary policies in a country destroy the real economy, because it is impossible for hyperinflation – per se – to destroy the real value of non-monetary items. For example: Salaries and wages: Salaries and wages are constant real value non-monetary items. Hyperinflation can not destroy their real values. Hyperinflation can only destroy the real value of the hyperinflationary currency and other monetary items. Salaries and wages are not monetary items. They are simply paid in money as the medium of exchange. They can be paid in Big Macs / beer / food supplies too. Hyperinflation destroys the real value of the monetary medium of exchange. They can also be paid in foreign exchange (e.g. in US Dollars) or in kind when their real values would not be destroyed no matter what the rate of hyperinflation. The real values of salaries and wages are destroyed in a hyperinflationary economy when they are fixed; i.e., they are valued in nominal monetary units.

Their real values are destroyed when they are not updated or they are updated at a rate lower than the rate of hyperinflation. Their real values are not updated because of an accounting practice: valuation in nominal monetary units. Their real values would be maintained when a different measurement basis is chosen, namely, units of constant purchasing power by applying the parallel rate in a hyperinflationary economy. So, it is the choice of measuring them in nominal monetary units which destroys their real value and not hyperinflation because when they are measured in units of constant purchasing power by applying the daily parallel rate their real values would be maintained no matter what the rate of hyperinflation.

The result of not updating salaries and wages in a hyperinflationary economy is that internal demand in the country contracts dramatically. Workers don’t receive enough money to make their normal monthly purchases because the goods they normally buy are variable items. These variable items´ prices are updated in terms of the daily parallel rate, but not their salaries.

There would be no destruction of real value in the real or non-monetary economy at all when all constant items (salaries, wages, rent, capital, retained profits, trade debtors, trade creditors, taxes payable, etc.) and variable items are updated daily in terms of the parallel rate – no matter what the hyperinflation rate is. That would be continuous financial capital maintenance in units of constant purchasing power: at the parallel rate in a hyperinflationary economy. This does not happen when IAS 29 is applied. IAS 29 simply requires simple financial statement restatement in terms of the CPI at the financial year end which produces meaningless results at a historic rate that is meaningless since the current parallel rate would make reading or analyzing those financial statements a complete waste of time in a hyperinflationary economy.

Some companies in Zimbabwe and elsewhere refused to implement IAS 29 for this reason. Towards the end of the hyperinflationary spiral created by the Zimbabwe government and central bank that wiped out all the real value of the Zimbabwe Dollar prices doubled every 24.7 hours according to Prof Steve Hanke from Cato Institute. http://www.cato.org/zimbabwe The Zimbabwe government did not even supply the CPI for a number of months. It is obviously impossible to apply IAS 29 in a scenario like that. The parallel rate (not always the same one) was available 24/7 throughout the country 365 days a year.

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