Monday, 3 September 2012

Definition of hyperinflation

Definition of hyperinflation

Hyperinflation only affects the real value of money and other monetary items – and nothing else. Hyperinflation has no effect on the real value of non-monetary items.

The stable measuring unit assumption (not hyperinflation, as generally accepted) as it is implemented as part of the 3000-year-old, generally accepted, globally implemented, traditional Historical Cost Accounting model even during hyperinflation (as supported by the IASB and Big Four accounting firms like PricewaterhouseCoopers), erodes that portion of companies´ equity in only the non-monetary or real economy not backed by the equivalent real value of their net assets during hyperinflation (exactly the same as during low inflation).

So, who needs the definition of hyperinflation:

  1. Millions of accountants worldwide - representing almost the entire world economy - who have to value and account economic items in the world economy on a daily basis. These accountants generally implement International Financial Reporting Standards as authorized by the International Accounting Standards Board. American accountants, valuing and accounting economic activity in the world´s biggest economy follow US GAAP. IFRS and US GAAP are in a definite process of convergence (2012).
  2. Some academics who write research papers and books about hyperinflation.
The millions of accountants in the world economy implementing IFRS follow the IASB´s definition of hyperinflation, namely:

‘Hyperinflation is indicated by characteristics of the economic environment of a country which include, but are not limited to, the following:

(e) the cumulative inflation rate over three years is approaching, or exceeds, 100%.’

IAS 29 Par. 3 (e)

The above is the widely-accepted definition of hyperinflation since 1 April 1989, the date IAS 29 Financial Reporting in Hyperinflationary Economies was authorized by the IASB.

Some academics follow Philip Cagan´s definition of hyperinflation which has never been implemented in practice in any company or country since 1 April 1989:

´A price-level increase of at least 50% per month.´ (Cagan 1956)

The IASB´s definition is the generally accepted definition:

(1) as a result of its current (2012) worldwide acceptance

(2) and practical application as from 1989 and

(3) due to the fact that Cagan´s definition has never been implemented in practice in any company or country since that date

(4) and would almost certainly not be implemented in practice in a company or country in the future because of

(a) the wide acceptance of the IASB definition and

(b) the devastating effect of hyperinflation in only the monetary economy and the equally devastating effect of the stable measuring unit assumption in only the constant item economy during hyperinflation: no country in the world would currently (2012) wait for hyperinflation of 50 per cent per month before declaring that the country is in hyperinflation and taking preventative actions: the IASB´s definition would be followed.

The US government, the Federal Reserve Bank, the US Financial Accounting Standards Board  and the Securities Exhange Commission would almost certainly not apply Cagan´s definition if hyperinflation should ever come about in the US economy (extremely unlikely). They would apply the IASB´s definition. US GAAP and IFRS are in convergence (2012).

The Argentinean Accounting Federation (2010) and I (2012) suggested preventative actions to the IASB at 10 per cent annual inflation or 26 per cent cumulative inflation over three years. The 10 and 26 per cent limits, however, do not relate to hyperinflation: they relate to high inflation. The IASB has unanimously voted to submit these suggestions regarding the replacement of IAS 29 to research (2012).

Thus the IASB´s widely-accepted definition of hyperinflation is the following in 2012:

Hyperinflation is indicated when the cumulative inflation rate over three years is approaching, or exceeds, 100 per cent.

Steve Hanke and Nicholas Krus use Cagan´s definition in their latest research paper World Hyperinflations.

The IASB’s definition - despite the use of the term ‘approaching’- has resulted, in practice, in a generally accepted precisely defined limit as from when an economy enters into hyperinflation: cumulative inflation equal to 100 per cent over three years.

The term ‘approaching’ makes it appear vague. However, what happened in practice since 1989 resulted in the IASB´s definition now (2012) being widely accepted by millions of accountants in the world economy, namely that an economy enters into hyperinflation at 100 per cent cumulative inflation over three years as happened in the case of Venezuela in 2009.

It appears vague because of the term ‘approaching’. However, in practice, it is strictly applied as hyperinflation coming into effect at 100 per cent cumulative inflation over three years. Its actual application is thus not vague: hyperinflation is, in practice, confirmed in companies and countries, only at 100 per cent cumulative inflation over three years. See hyperinflation in Venezuela in 2009.

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Nicolaas Smith

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