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Saturday, 27 March 2010

Inflation is not a solution

According to The Economist the merits of inflation as a solution to the rich world’s problems are easily overstated.

Inflation is always and everywhere a monetary phenomenon: Milton Friedman. Inflation only destroys the real value of money and other monetary items, e.g. bonds – nothing else. Inflation has no effect on the real value of non-monetary items. It is impossible for inflation per se to destroy the real value of any non-monetary item.

Banks´ and companies´ capital and profits are constant real value non-monetary items. Constant items, e.g. shareholders´ equity, trade debtors, trade creditors, taxes payable, taxes receivable, all items in the income statement, etc, have constant real non-monetary values over time. Inflation can thus not destroy the real value of banks´ and companies´ capital and profits.

However, everybody believes the fallacy that the erosion of banks´ and companies´ capital and profits is caused by inflation, including the IASB, FASB and most accountants. They and other accounting authorities, accounting professors and lecturers thus clearly know and admit that real value is currently being destroyed in banks´ and companies´ capital and profits. Everyone mistakenly think it is inflation doing the destroying.

It is not inflation, but, accountants´ choice of financial capital maintenance in nominal monetary units, another fallacy, as authorized by the IASB in the Framework, Par 104 (a) in 1989 which states: “Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power” which is doing the destroying. Financial capital maintenance in nominal monetary units is the 700 year old, generally accepted, traditional Historical Cost Accounting model which includes accountants´ very destructive stable measuring unit assumption based on the fallacy that changes in the purchasing power of the monetary unit of account is not sufficiently important during low inflation to require them to measure financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) in 1989. It is impossible to maintain the real value of financial capital constant in nominal monetary units per se during low inflation and deflation as stated by the IASB.

Accountants unknowingly and unnecessarily destroy the portion of the real value of banks´ and companies´ capital and profits generally never maintained with sufficient revaluable fixed assets under HCA during low inflation at a rate equal to the annual rate of inflation amounting to hundreds of billions of Euros (probably much more) in the world economy every year. Everyone mistakenly thinks it is inflation doing the destroying. Accountants would knowingly stop this destruction and boost the world economy by hundreds of billions of Euros (probably much more) every year with financial capital maintenance in units of constant purchasing power as authorized by the IASB in the Framework, Par 104 (a) 21 years ago – for an unlimited period of time in all entities that at least break even – ceteris paribus – without extra money or extra retained profits to maintain the existing real value of capital and profits. They would maintain existing constant item real values by not destroying existing values with their very destructive stable measuring unit assumption in a double entry accounting model in real value maintaining units of constant purchasing power instead of in real value destroying nominal monetary units during inflation.

The real value of the portion of capital and profits generally never maintained with sufficient revaluable fixed assets under HCA (normally at least retained profits) are treated like monetary items by accountants with their real values destroyed not by inflation, but, unknowingly by accountants implementing their very destructive stable measuring unit assumption at a rate equal to the annual rate of inflation.

An increase of inflation from 2% to 4% would double the unknowing destruction by accountants in banks´ and companies´ long term capital and investment base besides the effects as stated in the article.

The current 2% or an increased 4% unknowing destruction can knowingly be stopped by entities freely choosing financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized by the IASB in the Framework, Par 104 (a) 21 years ago. There is no other way during inflation and deflation. It is complaint with IFRS. Currently IFRS are based on fallacies. IFRS should not be based on fallacies.

Copyright © 2010 Nicolaas J Smith