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Tuesday, 10 August 2010

Would we be able to borrow more?

Bertie: Nicholaas, how would business be different in SA if that value was not being destroyed? In practical terms. I now buy into your point. But blog for us on what difference the opposite approach would have for everyday business in SA. Would we be able to borrow more? Lend more? Produce more? Market more lavishly?

Would we be able to borrow more?

Yes.

With all capital and retained profits revalued monthly, it means that the real value of the part of SA´s investment capital base represented by companies´ equity will be maintained constant in real value terms on a national and company by company basis: in units of constant purchasing power.

The company with R1 million in capital on 1st Jan 1981 still has R1 million today under the current 3000-year-old Historical Cost paradigm and is able to borrow accordingly from the banks today as well as in 29 years time from today if inflation is exactly the same over the next 29 years as it was over the last 29 years and we maintain the Historical Cost paradigm. In 29 years´ time the company will still have R1 million capital - but at the 2039 price level; i.e. 1/14th of today´s real value exactly the same when today´s R1 million is 1/14th of the real value of what it was on 1st Jan 1981.

Under the Constant Item Constant Purchasing Power (CICPP) paradigm, the company with R14 million in capital on 1st Jan 1981 (today´s price level; R1 million at 1981 price level: the 1981 value simply being a Historical Cost reference item, not a value in terms of today´s price level) would still have R14 million at today´s price level and would be able to borrow accordingly from the banks today as well a in 29 years time from today when the nominal value would be 14 X 14 million at the 2039 price level but still R14 million for us at today´s price level. We live today. Our minds can only evaluate the value of the Rand at today´s price level. We cannot put our minds (value evaluation mind processes) back or forward – although we imagine that we are doing that today and did in the past.

The multiplier effect would come into play and the economy as a whole would benefit.

We would have fewer banking crises as a result of insufficient bank capital. Banks´ capital would be automatically maintained at its constant real value over time - not like today when that portion of banks´ (and companies´) capital NEVER backed by sufficient revaluable fixed assets is unknowingly and unnecessarily being destroyed by the banks´ accountants implementing the stable measuring unit assumption as part of the Historical Cost Accounting model.

The CICPP paradigm would be the same as zero inflation ONLY for constant real value non-monetary items, e.g. companies´ shareholders´ equity, salaries, wages, rentals, all other items in the income statement, trade debtors, trade creditors, taxes payable, taxes receivable, all non-montary payables, all non-monetary receivables, provisions, etc.

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith