**Two per cent inflation also erodes real value**

There is a school of thought that the effects of two per cent inflation
are not more harmful than zero per cent inflation. This school of
thought is incorrect in two of the three valuation processes in our current HC
economy and would also be mistaken in one of the three valuation processes
under continuous financial capital maintenance in units of constant purchasing
power, i.e., the Constant Item Purchasing Power paradigm during low inflation. The three valuation processes in our economy
under both the HC and CIPP paradigms are the valuation of monetary, variable and
constant items.

Variable items
are valued in terms of IFRS under both the HC and CIPP paradigms with the
stable measuring unit assumption being applied under HCA. The stable measuring
unit assumption is never implemented under the CIPP paradigm. The two paradigms
are fundamentally different paradigms.

The view that a high degree of price stability of a positive
inflation rate of up to two per cent per annum is completely unharmful and that it has no disadvantages compared to absolute
price stability is never true in the case of
monetary items under any accounting model, either the HCA model or the CIPPA model,
since inflation always erodes the real value of monetary items. A high degree
of price stability of two per cent per annum in this case erodes two per cent
per annum of the real value of money and other monetary items which equates to
the erosion of 51 per cent of real value in all current monetary items over the
next 35 years. It will over a long enough time period lead to all current monetary
items arriving at the point of being completely worthless in economies with
continuous two per cent inflation. The five cents coin was recently withdrawn
from the South African money supply since it was practically worthless. South
Africa has an inflation target of three to six per cent per annum. Swedish rounding
whereby the cost of a purchase paid for in cash is rounded to the nearest
multiple of the smallest denomination of currency is implemented in a number of
countries.

In the case of monetary items we can thus confidently disagree with
those who assume that a high degree of price stability of above zero and up to
two per cent per annum is unharmful in all respects and that it has absolutely
no disadvantages compared to absolute price stability or zero inflation.

The assumption that two per cent inflation is unharmful and that it has
no disadvantages compared to zero inflation is acceptable in the case of variable
real value non–monetary items valued continuously in terms of IFRS (excluding
the stable measuring unit assumption) under the CIPPA model. The nature of the
valuing processes in valuing variable real value non–monetary items
continuously, for example, at fair value or the lower or cost and net
realizable value or market value, etc., in terms IFRS (excluding the stable
measuring unit assumption), allows this idea to be justifiable under CIPPA.

The above view is acceptable in this instance, because, in principle,
any level of inflation or deflation – high or low – is automatically adjusted
for in determining the price of a variable real value non–monetary item at the
moment of a transaction in terms of IFRS, excluding valuation in nominal
monetary units, under CIPPA.

The above assumption relating to two per cent inflation is acceptable under
the HC model with the valuation of variable items in terms of IFRS accept in
the case where the stable measuring unit is implemented. It is thus not
acceptable

*per se*with reference to variable items under the HC paradigm.
Two per cent inflation erodes two per cent per annum – i.e., 51 per cent
over 35 years – of the real value of constant real value non–monetary items
never maintained, e.g., retained profits, etc. under the current HC paradigm. The only
constant items generally maintained constant with annual measurement in units
of constant purchasing power under the HC paradigm are certain (not all) income
statement items, e.g., salaries, wages, rentals, etc. They are, however, paid
monthly at the same value after being updated annually. All existing constant real
value non–monetary items´ real values would automatically be maintained
constant with continuous measurement in units of constant purchasing power at
any level of inflation or deflation under the CIPP paradigm for an unlimited
period of time in entities that at least break even in real value –

*ceteris paribus.*
We can thus safely disagree in the case of constant real value non–monetary
items under the HC paradigm too, that the effects of two per cent inflation is
completely unharmful. Two per cent inflation – in fact, any level of inflation
or deflation – would be the same as zero inflation as far as the valuation of
constant real value non–monetary items under the CIPPA model is concerned.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.