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Wednesday, 10 August 2011

Unstable unit of account

Unstable unit of account

Unstable money’s third function is that it is the unstable unit of account in the economy. It is a monetary standard of measure of the real value of economic items to facilitate exchange without barter in order to overcome the double coincidence of wants problem. Inflation erodes the real value of money and deflation increases the real value of money. Money has never been perfectly stable in real value over an extended period of time. However, money illusion makes people believe that money maintains its real value stable over the short to medium term. Money is the only standard unit of measure that is not a fundamentally stable or fixed unit of account. All other standards of measure are perfectly stable units.

Accounting transformed money illusion into a generally accepted accounting principle with the very destructive stable measuring unit assumption, also called the Measuring Unit Principle.

The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial reports.

Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.

The very erosive stable measuring unit assumption is based on the fallacy that changes in the general purchasing power (real value) of unstable money are not sufficiently important to require adjustments to the basic financial reports; i.e. not sufficiently important to require financial capital maintenance in units of constant purchasing power during inflation and deflation.

In an inflationary economy depreciating money is used as a depreciating monetary unit of account to value and account economic activity. It is very tempting to state that it is very clear that you cannot have a unit of account that is not stable – as in fixed – in real value for accounting purposes. However, we have been doing exactly that since the start of inflation in the economy; i.e. for about the last 3000 years. The problem stems from the difficulty in achieving zero inflation on a sustainable basis (never achieved to date) and the difficulty in defining a universal unit of real value (also never achieved to date).

The only perfect solution to eliminate the erosion of real value in constant items never maintained constant during inflation and deflation is financial capital maintenance in units of constant purchasing power; i.e. the measurement of all constant items in units of constant purchasing power in terms of a Daily Index during inflation and deflation (CIPPA).

Financial capital maintenance in units of constant purchasing power is, in principle, required by IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation under which all non–monetary items (variable real value non–monetary items as well as constant real value non–monetary items) are inflation–adjusted in terms of the period-end CPI. This does not result in stabilizing the real economy during hyperinflation since IAS 29 simply requires the restatement of HC or CC financial statements. Stabilizing the real economy during hyperinflation is only possible with either daily updating of all non–monetary items in terms of the daily change in the US Dollar parallel rate – where the parallel rate exists officially or unofficially – or with Brazilian–style daily updating in terms of a Daily Index supplied by the government.

Measurement in units of constant purchasing power is implemented under the traditional Historical Cost Accounting model with the valuation of only some – not all – income statement items, e.g. salaries, wages, rentals, etc. but no balance sheet constant items in units of constant purchasing power during low inflation.

The real value maintaining function (effect) of measuring financial capital maintenance in units of constant purchasing power is not generally realized as it relates to balance sheet constant items. If it were realized, the very erosive stable measuring unit assumption would have been stopped by now. Its implementation unknowingly, unintentionally and unnecessarily erodes hundreds of billions of US Dollars per annum of real value in constant items never maintained constant under HCA in the world economy.

The erosive effect of the stable measuring unit assumption as far as using it to measure salaries, wages, rentals, etc. during low inflation is concerned, is very well understood. But, not as far as balance sheet constant items never maintained constant under HCA during low inflation is concerned.

Inflation is the problem or number one enemy – as everyone knows – in the money supply or monetary economy since real value or purchasing power is the most fundamental economic concept in any economy under any economic model including the Historical Cost Accounting model and not unstable money as is generally accepted under the mistaken belief (money illusion) or assumption (stable measuring unit assumption) that changes in the purchasing power of money is not sufficiently important during low inflation and deflation to require financial capital maintenance in units of constant purchasing power.

The stable measuring unit assumption is the second enemy in the constant item economy – and not inflation as everyone so mistakenly believe. Inflation has no effect on the real value of non-monetary items. Money’s function as depreciating unit of account is of critical importance. The implementation of this very erosive assumption in the world´s inflationary economy is the second, unknown and hidden (camouflaged by IFRS authorization of financial capital maintenance in nominal monetary units) real value erosion process or enemy whereby the HCA model unknowingly erodes significant amounts of real value in the real economy each and every year.

Nicolaas Smith

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