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Thursday, 1 July 2010

Bye bye CPI, Hello Dollarization

A non-barter economy needs an internal medium of exchange, i.e. money. The rate of change in the Consumer Price Index indicates the rate of inflation, i.e. the annual rate at which the real value of the your money is being destroyed inside your economy.

There are three fundamentally different basic economic items in the economy:

1. Monetary items: money held and items with an underlying monetary nature; basically money and money loans.

2. Variable real value non-monetary items; e.g. property, plant, equipment, raw materials, finished goods, etc.

3. Constant real value non-monetary items; e.g. salaries, wages, rentals, issued share capital, retained profits in companies, debtors, creditors, taxes payable, taxes receivable, etc.

1. Inflation automatically determines the real value of your money inside your economy; i.e. the value of money and other monetary items in the economy. You cannot inflation-adjust or update money or monetary items during the current financial period.

2. Variable item prices are ideally determined in a free market where demand and supply determine the prices of these items. Inflation is automatically taken into account in the process.

3. Constant item values (prices) e.g. salaries, wages, rentals, issued share capital, retained profits in companies, capital reserves, debtors, creditors, taxes payable, taxes receivable, etc., have to be inflation-adjusted on a monthly basis in an inflationary economy by applying the change in the CPI in order to keep the economy stable.

If a country does not calculate its CPI correctly, then it is playing with fire – like Argentina and Venezuela are doing.

The final solution in these cases are always Dollarization.

Why? Because you need a relatively stable unit of measure in an economy.

When you inflation-adjust all constant real value non-monetary items e.g. salaries, wages, rentals, issued share capital, retained profits in companies, capital reserves, debtors, creditors, taxes payable, taxes receivable, etc., on a monthly basis by means of the monthly change in the CPI, then you keep your economy stable because you measure you constant real value non-monetary economy in units of constant purchasing power – as Brazil did with a daily index supplied by the government during 30 years of high and hyperinflation.

For that you need a correctly calculated CPI.

When you mess around with your CPI which is a basic essential in your economy, then you are on your way to Dollarization.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith