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Tuesday, 10 April 2012

Valuing monetary items during deflation

Valuing monetary items during deflation
The whole money supply would be deflation-adjusted daily under complete coordination and perfect financial capital maintenance in units of constant purchasing power during deflation. It is highly unlikely that this would happen right from the start in any economy which decides to abandon the HCA model while it is in deflation and adopt financial capital maintenance in units of constant purchasing power (CIPPA). Monetary items not deflation-adjusted daily in bank and ledger accounts would continue to be valued in nominal monetary units and the net monetary gain or loss would be calculated and accounted under financial capital maintenance in units of constant purchasing power (CIPPA).

Monetary items not deflation-adjusted daily are valued in nominal monetary units under the HCA model during deflation. Their real values thus increase daily. The net monetary gain or loss is not calculated under HCA during deflation.

Not all inflation-indexed government bonds become deflation-indexed bonds during deflation. US Treasury Inflation-Protected Securities (TIPS) and most euro-denominated sovereign inflation-indexed bonds, for example, contain a clause that states that when the nominal value of the capital amount adjusted for deflation is less than the original nominal amount, the original amount would be repaid. These bonds would thus be nominal bonds and the capital amounts would gain in real value during deflation.

‘The presence of this guarantee, which is beneficial for the investor in the event of deflation, is mainly due to accounting considerations: in a lot of countries, bonds must have a minimum redemption price:’


This does not apply to the coupon payments. They stay the same in real value during inflation and deflation, i.e., they would be lower in nominal value during deflation, but the same in real value.

 Some countries´ government inflation-indexed bonds do not contain the above clause and thus become deflation-indexed bonds during deflation, i.e., they are real constant value bonds. Their capital amounts and their coupon payments would be constant in real value during inflation and deflation.

 ‘The UK, Canada and Japan, do not guarantee a minimum redemption price for their indexed issues.’

CNO Inflation-linked bonds, p. 15.

Nicolaas Smith

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