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Tuesday, 30 November 2010

Difference between severe hyperinflation and a monetary meltdown

The monetary economy (the total real value of a fiat money supply) can disappear completely. It can be totally eroded like in the case of the Zimbabwe Dollar, not simply as a result of hyperinflation, but, as a result of a total monetary meltdown after a period of severe hyperinflation. Hyperinflation only erodes the real value of the hyperinflationary currency extremely rapidly. Hyperinflation has no effect on the real value of non-monetary items. All non-monetary items maintain their real values when they are updated daily in terms of a daily non-monetary index normally based on the daily USDollar exchange rate as Brazil did during 30 years of very high and hyperinflation. The stable measuring unit assumption (Historical Cost Accounting) unnecessarily erodes the real value of constant real value non-monetary items, e.g. salaries and wages not updated daily during hyperinflation, as fast as hyperinflation erodes the real value of the local currency and other monetary items, e.g. all loans stated in the local currency. A monetary meltdown erodes all real value only in the monetary economy; i.e. in the money supply. The stable measuring unit assumption (HCA) unnecessarily erodes the real value of all constant real value non-monetary items never maintained during inflation and hyperinflation.

Hyperinflation is not always stopped with first a period of severe hyperinflation in the final stage and then a complete monetary meltdown. Hyperinflation was successfully overcome by various countries, e.g. Turkey, Brazil and Angola, without dollarization or a monetary meltdown. However, severe hyperinflation would normally lead to a complete monetary meltdown as happened in 2008 in Zimbabwe. 

Brazil actually grew their non-monetary economy in real value during 30 years of very high and hyperinflation of up to 2000 per cent per annum from 1964 to 1994 and never had severe hyperinflation followed by a complete monetary meltdown at the end. Brazil managed to have positive GDP growth during 30 years of hyperinflation because the various governments during those three decades supplied the population with a daily non-monetary index based almost entirely on the daily US Dollar exchange rate with their functional currency which was used to update all non-monetary items (variable and constant items), e.g. equity, trade debtors, trade creditors, salaries payable, taxes payable, etc., in the economy daily.

Brazil would not have been able to do that if they had applied the IASB´s IAS 29 Financial Reporting in Hyperinflationary Economies simply because IAS 29 does not provide for continuous daily updating of all nonmonetary items during hyperinflation. IAS 29 was published in 1989. IAS 29 does not provide for continuous daily updating in terms of the US Dollar parallel rate. IAS 29 simply requires restatement of Historical Cost and Current Cost Accounting financial statements during hyperinflation applying the monthly Consumer Price Index (generally available a month after the current month) to make these financial statements "more meaningful". It is not the intention of IAS 29 to, and in it´s current form it cannot, stop the continuous daily rapid erosion of the real value of constant real value non-monetary items (e.g. salaries, wages, rentals, etc.) as Brazil did for 30 years of hyperinflation generating positive economic growth because IAS 29 does not provide for the continuous daily updating of constant items in terms of the parallel USDollar reate. This daily very rapid erosion is caused, not by hyperinflation, but, by the implemention of the stable measuring unit assumption (HCA) during hyperinflation. Applying the monthly CPI a month after the current month is very ineffective during hyperinflation as far as salaries, wages, rentals, positive economic growth, economic stability, the maintenance of internal demand and the continuous daily maintenance of the real value of these items are concerned. All non-monetary items have to be updated daily in terms of the parallel USDollar rate during hyperinflation as Brazil did for 30 years. That is financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) during hyperinflation.

The Framework, Par. 104 (a) states:

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

The IFRS authorized financial capital maintanence in units of constant purchasing power during low inflation and deflation (Constant ITEM Purchasing Power Accounting - CIPPA) under which only constant real value non-monetary items (not variable real value non-monetary items) are updated monthly in terms of the CPI during low inflation and deflation) as well as hyperinflation (Constant Purchasing Power Accounting - CPPA) whereunder all non-monetary items - constant and variable real value non-monetary items - are updated daily in terms of the US Dollar parallel rate). IFRS authorized it at all levels of inflation and deflation.

The stable measuring unit assumption (HCA or finanancial capital maintenance in nominal monetary units, also authorized in IFRS in the Framework, Par 104 a )  assumes there was, is and never ever will  be inflation or hyprinflation as far as the valuation of constant real value non-monetary items (e.g. equity, trade debtors, trade creditors, taxes payable, etc) never maintained are concerned. The stable measuring unit assumption (HCA) assumes that money was forever in the past, is and will always be perfectly stable under any level of inflation, hyperinflation and deflation.

Various authoritative commentators in the accounting profession are requesting the IASB for a fundamental revision of IAS 29.

Severe hyperinflation is defined as a period at the end of completely uncontrolled hyperinflation when exchangeability between the hyperinflationary functional currency and most relatively stable foreign currencies does not exist. However, at least one exchangeability has to exist for prices to be established in the hyperinflationary functional currency. Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency in order for prices to continue to be set in the hyperinflationary functional currency in terms of this final exchangeability. The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR).

“The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate." p8  1

Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist.

“Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” p 9-10  2

There was severe hyperinflation in Zimbabwe while there was exchangeability (prices could still be set in the ZimDollar) with at least one relatively stable foreign currency – the British Pound in this case as made possible via the OMIR. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and severe hyperinflation stopped: no exchangeability means no severe hyperinflation. That was a monetary meltdown. The ZimDollar had no value as from that moment.

No exchangeability with all relatively stable foreign currencies means no exchange rates which means no severe hyperinflation (no prices being set in the local currency) and vice versa: no exchange rates with all relatively stable foreign currencies means no exchangeability which means no severe hyperinflation (no prices being set in the local currency).

No prices being set in the local currency means monetary meltdown: the total money supply and all money and other monetary items stated in the local currency have no value.

The real or non-monetary economy (houses, properties, buildings, infrastructure, inventories, finished goods, consumer goods, trademarks, goodwill, logos, copyright, trade debtors, trade creditors, royalties payable, royalties receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc,) can not be eroded by hyperinflation or a total monetary meltdown: inflation is always and everywhere a monetary phenomenon. Inflation and hyperinflation have no effect on the real value of non-monetary items.

The International Accounting Standards Board is currently requesting comment letters on their Exposure Draft Severe Hyperinflation.

1,2 Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation, Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-64


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