Pages

Friday, 2 November 2012

IRAN´S SECOND ENEMY


IRAN´S SECOND ENEMY

 

Hyperinflation is Iran´s first enemy. It destroys the real value of only the Iranian monetary unit, the rial, and all other monetary items expressed in the rial in Iran, currently at about 70 percent per month. Hyperinflation has no effect on the real value of any non-monetary item in Iran.

 

Property, plant, equipment, raw material stock, finished goods inventories, foreign exchange, groceries, milk, coffee, rice, bread, chickens, etc. are variable real value non-monetary items. Their variable market values are determined daily in their respective markets in Iran – when they are traded in free markets. However, their US Dollar prices generally stay the same in Iran. Their nominal prices in rials are simply adjusted daily in terms of the rapidly depreciating real value of the Iranian rial as indicated by the rapidly increasing US Dollar daily parallel rate.

 

When they are subsidised by the government, their nominal prices change as government officials change these prices.

 

It is impossible for hyperinflation to erode non-monetary items´ real values. As the real value of the rial falls – as indicated by the increase in the US Dollar daily parallel rate – these items´ nominal prices are simple adjusted to keep pace with the fall in the real value of the rial while their own real values generally stay the same. Keep your wealth in variable items and you are protected during hyperinflation.

 

Iran´s second enemy is perfectly camouflaged

 

Iran´s second enemy is completely camouflaged by being generally accepted worldwide by all countries including Iran itself since before the inception of the country.

 

Iran´s second enemy is authorized and promoted by the most important economic institutions in the world. It is implemented by all countries and all economic entities worldwide since long before 1494 when its application was first comprehensively documented.

 

Iran´s second enemy perhaps destroys / erodes more real value in the Iranian economy than hyperinflation. Most of the world´s best economists think the destruction caused by Iran´s second enemy is caused by hyperinflation and there is nothing anyone besides the Central Bank of Iran can do about it. That is not correct.

 

All economics and accounting text books are void of naming it as the cause of erosion / destruction in the economy because their authors all think  - have themselves been taught that -  this destruction / erosion is caused by inflation and hyperinflation. US Financial Accounting Standards actually state that the erosion of companies´ invested profits and capital is caused by inflation, when it is, in fact, impossible for inflation and hyperinflation to cause such erosion / destruction since inflation and hyperinflation only erode / destroy the real value of money and other monetary items – nothing else. Companies´ invested profits and capital are non-monetary items. Inflation and hyperinflation have no effect on the real value of non-monetary items.

 

Iran´s second enemy is an Iranian GAAP

 

Iran´s second enemy is an Iranian Generally Accepted Accounting Practice. It is also a US, EU, UK, Canadian, Australian, Portuguese, South African, New Zealand, Chinese, Japanese, Indian, Brazilian, etc. GAAP. It is a Generally Accepted Accounting Practice in all economies.

 

Iran´s second enemy is the stable measuring unit assumption: implementing the Historical Cost Accounting model during hyperinflation.

 

“The Measuring Unit Principle: The unit of measure in accouting 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 sufficiently important to require adjustments to the basic financial statements.”

 

Walenbach, Dittrich and Hanson 1973, p. 429

 

Iranian Accounting Authorities, all Iranian accountants and business people, in practice,  assume the rial is perfectly stable during hyperinflation as far as the measurement and accounting of certain constant real value non-monetary items – e.g., companies´ capital (all items in shareholders´ equity), trade debtors, trade creditors, taxes payable and receivable, all non-monetary payables and receivables, etc. - is concerned; as it forms part of the globally implemented, generally accepted, traditional Historical Cost Accounting model. They do not measure these items in units of constant purchasing power on a daily basis in order to keep their constant purchasing power constant during hyperinflation: they implement traditional Historical Cost Accounting and measure these items in nominal monetary units, i.e., they implement financial capital maintenance in nominal monetary units. This is true for all economies - not only in the Iranian economy.

 

The real values of  constant items not maintained constant by measuring them in units of constant purchasing power in terms of a daily index or rate are being eroded / destroyed by the implementation of the stable measuring unit assumption during hyperinflation.

 

All Historical Cost Accounting financial reports currently being prepared in Iran are completely useless. They are all out of date (worthless) the moment the US Dollar daily paralllel rate changes, i.e. the next day.

 

How to stop Iran´s second enemy?

 

Stop assuming money is perfectly stable during hyperinflation as far as the measurement of these constant items is concerned: stop the stable measuring unit  assumption. Financial capital maintenance in units of constant purchasing power was authorized in International Financial Reporting Standards twenty three years ago.

 

Stop Historical Cost Accounting. The Iranian Accouting Standards Authorities have to immediately authorize an Iranian Accounting Standard requiring - not optional- capital maintenance in units of constant purchasing power in terms of a Daily Index or rate - the US Dollar daily parallel rate when CPI data are not available during hyperinflation.

 

All Iranian companies / entities can immediately change over to financial capital maintenance in units of constant purchasing power on their own since it was authorized in IFRS in 1989. The stable measuring unit assumption is never implemented under this accounting model.

 

Under complete co-ordination - everyone doing it correctly- , this would automatically maintain the constant purchasing power / real value  of capital - the capital investement base in the Iranian economy -, as well as all other constant items, constant for an indefinite period of time in all entities / companies that at least break even in real value – all else being equal – at all levels of hyperinflation.

 

Daily measurement of all constant real value non-monetary items in units of constant purchasing power - implementing capital maintenance in units of constant purchasing power - would stop the very destructive effect of the stable measuring unit assumption in the Iranian constant item economy. All salaries, wages, rents, fees, royalties, trade debtors, trade creditors, taxes payable and receivable, all other non-monetary payables and receivables, companies´ capital - all items in shareholders´ equity -, provisions, etc. would automatically be maintained constant for an indefinite period of time in all entities / companies that at least break even in real value – all else being equal – at all levels of inflation and hyperinflation.

 

This solution will be required (not optional) by the International Accounting Standards Board (IASB) in 6 to 8 years´ time from all countries implementing IFRS with inflation equal to or greater than 10 percent per annum or cumulative inflation equal to or greater than 26 percent over three years. It was authorized in IFRS as an option to Historical Cost Accounting twenty three years ago at all levels of inflation and deflation, including during high and hyperinflation.

 

What if Iran does not implement IFRS?

 

It would be even easier to change over to capital maintenance in units of constant purchasing power in terms of a daily index or rate: it is the only way to eliminate the stable measuring unit assumption during inflation and hyperinflation.

 

What about Iran´s first enemy?

 

A regulation by the Central Bank of Iran that all monetary items in Iran have to be inflation-indexed on a daily basis in terms of the Daily Consumer Price Index - or the US Dollar daily parallel rate when CPI data are not available – under complete co-ordination (everyone doing it) would eliminate the total cost of and gain from hyperinflation (not actual hyperinflation) from the Iranian monetary economy. It would be as if there were no hyperinflation in Iran.

 

Then hyperinflation has to be brought down to low inflation levels. Turkey, Angola, Brazil and Chile have beaten hyperinflation without resorting to Steve Hanke´s suggested solutions: spontaneous Dollarization, official Dollarization or a currency board.

 

I agree that these three solutions would stop hyperinflation, but, they are not the only or the best solutions. Official Dollarization and a currency board are very costly solutions. Spontaneous Dollarization normally happens after severe hyperinflation like it happened in Zimbabwe. I would never wish such a solution (severe hyperinflation) for the population of any country.

 

All of the above three solutions remove monetary policy autonomy from the country.

 

What I suggest has a very low cost compared to Dollarization and a currency board solution and it is the natural or logical next step in accounting and monetary policy. The cost of implementing capital maintenance in units of constant purchasing power in terms of a daily index or rate and daily inflation-adjustment of the money supply would mainly involve retraining accounting staff and adapting accounting programs. The benefits would be no cost of hyperinflation and no cost of the stable measuring unit assumption; i.e., constant real value monetary and constant items for an unlimited period of time.

 

Special attention should be paid to how Brazil beat hyperinflation. In principle Brazil beat hyperinflation with financial capital maintenance in units of constant purchasing power in terms of a government-supplied daily index which included daily inflation-adjustment of monetary items.

 

At 70 percent monthly inflation (annualised it amounts to 58 162 percent annual inflation) Iran´s Accounting Standard Authorities have to

 

  1. Require capital maintenance in units of constant purchasing power in terms of a daily CPI (the US Dollar daily parallel rate while CPI data are not available) by banning Historical Cost Accounting in the country, and
  2. The Central Bank of Iran has to require daily inflation-adjustment of all monetary items in Iran´s monetary economy in terms of a Daily CPI (the US Dollar daily parallel rate while CPI data are not available)

 

now not to get to severe hyperinflation in the hundreds of millions percent per annum or even much, much worse.

 

Iran´s monetary and constant item economies would then operate on a constant real value basis. It would be as if there were no hyperinflation in Iran.


Nicolaas Smith

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

Buy the Kindle ebook at Amazon.com for $2.99 or £1.53 or €2.68