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Wednesday, 6 October 2010

There is no such thing as "severe hyperinflation" as defined by the IASB.

The IASB published for public comment an exposure draft Severe Hyperinflation, a proposed amendment to IFRS 1 First-time Adoption of IFRS on 30th September, 2010.

The IASB proposes to define "severe hyperinflation" in the ED as follows:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
(a) a reliable general price index is not available to all entities with

transactions and balances in the currency.

(b) exchangeability between the currency and a relatively stable

foreign currency does not exist.

I am of the opinion that there is no such thing as "severe hyperinflation" as the IASB defined it. To have hyperinflation you need two different sets of prices: one at time A and another at time B - a different time, e.g. one month or one year later, or other time periods (hours or days or months during hyperinflation) later. I worked for 2 ½ years in Angola´s hyperinflationary economy in the 1990´s and have studied the effect of the stable measuring unit assumption ever since. I also followed Zimbabwe´s monetary meltdown on a day by day basis during the last two years of your hyperinflation.

When characteristic (b) exists – no exchangeability - then it is not possible to have two different sets of prices: so, you cannot have hyperinflation or "severe hyperinflation" when you do not de facto have a currency any more: there is no hyperinflation because there is, in fact, no currency used as a medium of exchange in the market although the government may have not yet stated officially that the currency does not have legal tender in the economy any more.

When (b) exists – no exchangeability – then transactions are impossible. (a) uses the term “transactions”. Transactions are impossible when (b) exists. A general price index is also impossible when (b) exists because there are no prices being set in the previously hyperinflationary currency any more.

Once a currency loses its exchangeability with relatively stable currencies, it is de facto dead. It is not exchangeable for stable currencies or any item: thus, it is not a currency any more: it is de facto dead – although the government has not yet officially removed it as legal tender.

So, in my opinion, it is wrong to propose that there was a period of hyperinflation in Zimbabwe , while there was a parallel rate for the USD and then at the end there was a period of this so-called "severe hyperinflation" when there was no CPI and no parallel rate for the USD. There was no hyperinflation during that period. The market already de facto Dollarized the economy although the ZimDollar still, officially, had legal tender: in the market it did not. The fact is there was no hyperinflation: the market was already Dollarized.

As soon as there was no parallel rate for the USD the ZimDollar was de facto dead: it stopped being money and a currency. It does not matter that the notes were still around: absolutely no-one would accept them as payment for items/goods/property/assets/anything.

It is wrong to me to name a period with no hyperinflation as a period of "severe hyperinflation". There was no hyperinflation, because there were no prices being set in ZimDollars. People stopped accepting the ZimDollar for any payment for goods at all.

It is misleading to state that there was a period of "severe hyperinflation" different from hyperinflation. Hyperinflation ended the moment the ZimDollar was not accepted as payment for items anymore. There was no more hyperinflation and it is wrong to call the period after that "severe hyperinflation" when there was, in fact, no hyperinflation.

As an article in the SA Mail and Guardian states:

“Inflation, identified by central bank governor Dr Gideon Gono as "the number one enemy", was stopped dead in its tracks.”

http://www.mg.co.za/article/2010-02-05-in-god-we-trust

So, it is better for the IASB to state that when a currency, after a period of hyperinflation, loses its monetary function of exchangeability, then the rules of this Exposure Draft apply and companies can fairvalue assets and use that fair value as deemed cost for IFRS 1 purposes without giving this period a name, especially not “severe hyperinflation” when, in fact, there was no hyperinflation anymore.

(b) excludes transactions as stated in (a): when there is no exchangeablity, there are no transactions.

So, (a) is logically wrong: the term transactions should be removed from (a)

I am concerned about the fact that the IASB now wants to invent this new phrase "severe hyperinflation" for the period immediately after hyperinflation when the currency is not accepted in the economy any more, although the government has not yet officially withdrawn its legal tender status: de facto the currency does not exist as a currency any more: so, setting prices in it is impossible, thus, there is no more hyperinflation. The IASB wants to call this period just after the exchangeability of the currency ended and there is no actual hyperinflation because no prices are set in the de facto dead currency, the IASB wants to call this period "severe hyperinflation". I oppose this move.

What is wrong is the actual misleading name the IASB wants to give to this period: namely "severe hyperinflation". I am against using the term for that period because there were no prices quoted in the ZimDollar during that period, thus, there was no hyperinflation.

I agree that the economy was still in the same state that caused actual hyperinflation. But, to have hyperinflation you needed prices in ZimDollars, but, there were no new prices set in ZimDollars.

It is important to get the technicalities right too if we really want to understand what actually happened.

I am of the opinion that the introduction of this new term "severe hyperinflation" should be stopped.

Once it is in the final International Financial Reporting Standard it will be in accounting and economic literature. Then hyperinflation will be, incorrectly, divided in hyperinflation and this "severe hyperinflation" as incorrectly defined by the IASB. I don´t agree with that.

I think the IASB should not introduce this new term "severe hyperinflation" into economic and accounting terminology. They should remove their definition since the term “severe hyperinflation” is used in the hyperinflation literature for periods of actual extreme hyperinflation when prices are still being set in the hyperinflationary currency. The IASB should simply state that after a currency failed or lost its exchangeability then the new ED applies: they should not give that period a misleading name. They should not give it any name.

Naming a period with no hyperinflation as "severe hyperinflation" is obviously wrong.

Someone in Zimbabwe suggested that the period immediately after the currency lost its exchangeability in the market although the government has not yet officially withdrawn its characteristic as legal tender could be called the Zimbabwean Syndrome. This person agreed that the term “severe hyperinflation” is misleading for that period of no hyperinflation.

This period is a period when the currency has no exchangeability. It should just be described as that. It should not be called a period of “severe hyperinflation” when there is no actual hyperinflation. It is obviously a mistake.

Copyright © 2010 Nicolaas J Smith