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Saturday, 8 May 2010

Protecting yourself against automatic real value loss in Venezuela´s hyperinflationary economy

You can protect yourself against real loss in a hyperinflationary economy by avoiding automatic real value destruction by the two enemies in the economy. The first enemy you know very well. The second enemy you do not know. The second enemy is camouflaged by general acceptance and authorization in International Financial Reporting Standards; so, you do not know that the second enemy is automatically destroying your wealt: during low inflation, but, obviously much, much faster during hyperinflation.


The first enemy is inflation or hyperinflation, which is simply inflation at a much, much higher rate. What I state about hyperinflation, applies to low inflation too. Hyperinflation can only automatically destroy the real value of Bolivars OVER TIME: nothing, nothing else. So, keep no Bolivars OVER TIME and you lose no real value. As simple as that.

Put your wealth in non-monetary items that will keep pace with the parallel rate as well as with inflation. The best non-monetary items to buy in Venezuela are actual US Dollars. I don´t know whether it is legal to hold US Dollars in Venezuela. I am not promoting anything that is illegal in Venezuela.

There are not just two basic economic items in the economy as it is generally accepted, namely monetary and non-monetary items. There are three fundamentally different basic items in the economy.

(1) Monetary items, e.g. Bolivar notes and coins and loans in Bolivars;

(2) Variable real value non-monetary items, e.g. land, buildings, machines, cars, raw material stock, finished goods stock, US Dollars, etc.; Variale items´ prices are ideally set in the free market, e.g. at the parallel rate or at the other market rates in Venezuela. If you work at the 4.3 rate then you have to update these prices a the monthly inflation rate. If you work at th parallel rate then you have to continuously update these values at the parallel rate – if that is legal in Venezuela. I do not promote anything that is illegal in Venezuela.

(3) Constant real value non-monetary items, e.g. issued share capital, retained profits, capital reserves, debtors, creditors, taxes payable, taxes receivable, royalties payable, royalties receivable, dividends payable, dividends receivable, etc. Constant items have to be updated monthly at the inflation rate if you work at the 4.3 rate and at the parallel rate if you work at the parallel rate. I don´t know if it is legal to update at the parallel rate in Venezuela. I do not promote anything that is illegal in Venezuela.

The second invisible, untouchable enemy is the stable measuring unit assumption: Venezuelan accountants assume there is no hyperinflation at all and they do not update cost prices, raw material stock prices, companies´ capital, companies´ retained profits, companies´ capital reserves, debtors, creditors, taxes payable, taxes receivable, salaries payable, salaries receivable, etc. The whole world have been doing this for the last 700 years. So, no-one realizes that accountants are unknowingly destroying that portion of their shareholders´ equity in companies that is never backed by revaluable fixed property under the Historical Cost Accounting model.

So, to avoid automatic real value destruction in monetary items, you must not hold Bolivars over time.

If you cannot keep your wealth in USD then you have to keep your wealth in products whose prices keep pace with the parallel rate as well as inflation. The best is land and buildings. Otherwise products whose prices are updated in terms of the parallel rate – if that is legal.

If you have your wealth only in products whose prices are updated in the market in Venezuela at the parallel rate, neither an increase in the parallel rate nor devaluation will affect you. Your prices (wealth) are automatically updated at the parallel rate. You can never lose any real value.

When you trade you have to update your costs – at the inflation rate if you deal at 4.3 and at the parallel rate if you trade at the parallel rate. You obviously update you selling prices all the time too – if that is legal.

Your accountant has to update all your constant items in your business – capital, retained profits, capital reserves, trade debtors, trade creditors, provisions, taxes payable, taxes receivable, all non-monetary item payable and all non-monetary item payables either at the inflation rate – if you use the 4.3 rate or at the parallel rate if you use the parallel rate if that is allowed.

I do not know whether it is legal to update your values at the parallel rate in Venezuela. I do not promote anything that is illegal in Venezuela.

When you update all your variable and constant items as above, you also have to calculate the net monetary gain or loss from holding Bolivars in order to make your books balance.

The above is Constant Purchasing Power Accounting (CPPA) during hyperinflation and Constant ITEM Purchasing Power Accounting (CIPPA) during low inflation. CPPA is required during hyperinflation in IAS 29 Financial Reporting in Hyperinflationary Economies and CIPPA is authorized in International Financial Reporting Standards during low inflation in the Framework, Par 104 (a) twenty one years ago in 1989 which states: “Financial capital maintenance can be measured in nominal monetary units (traditional Historical Cost Accounting that all accountants in Venezuela implement) or units of constant purchasing power” which is CIPPA as it appears in the Wikipedia article Constant Purchasing Power Accounting.

http://en.wikipedia.org/wiki/Constant_Purchasing_Power_Accounting

Kindest regards


Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith