Thursday, 19 September 2013

Implementing daily indexing in Venezuela - Part 2

Implementing daily indexing in Venezuela - Part 2

(First read) Comment from extorres

“You seem to imply that no one loses, but those who are currently taking advantage of the seigniorage would stop reaping its benefits, which is tantamount to their losing.”

Daily indexing results in the items being indexed daily being maintained constant in real value over time at whatever rate of low inflation, high inflation or hyperinflation. It does nothing to hyperinflation - over the short term. Brazil had daily indexing for 30 years during 30 years of high and hyperinflation. They had a relatively stable non-monetary economy as well as many monetary items inflation-indexed daily, but they continued to have an unstable monetary economy with high and hyperinflation of up to 2000 percent per annum from 1964 till 1994. They only stopped hyperinflation with their Real Plan in 1994.

Gustavo Franco, the Governor of the Central Bank of Brazil and one of the architects of the Real Plan explained it - in very short terms - to me as follows in an email message:

“It was essential, in the Brazilian case, and this may be a general case, that the URV was defined as part of the monetary system. It has a lot to do with jurisprudence regarding monetary correction; URV denominated obligation had to be treated as if they were obligations subject to monetary correction. In the URV law it was defined that the URV would be issued, in the form of notes, and when this would happen, the URV would have its name changed to Real, and the other currency, the old, the Cruzeiro, was demonetised.”

That was the Real Plan. I am not proposing a Real Plan for Venezuela. Only the Venezuelan government together with the Central Bank of Venezuela can do that. The Real Plan was used after daily indexing had already been used in Brazil for 30 years and specifically the last daily index, the URV which was a monetised daily indexed unit of account. The Brazilian NON-MONETARY economy was already stabilised before the Real Plan with the use of different daily indices formulated by different governments over those 30 years. The Real Plan simply stopped hyperinflation overnight with the introduction of the new currency as explained by Dr. Franco. It stopped hyperinflation in an already stabilised non-monetary economy.

I am only proposing the use of the Venezuelan Daily CPI to stabilise the Venezuelan non-monetary economy via an update in IAS 29 Financial Reporting in Hyperinflationary Economies to REQUIRE DAILY INDEXATION in terms of the DAILY CPI. The URV or Unidade Real de Valor was a daily index supplied by the Brazilian goverment based almost entirely on the official - not parallel - daily US Dollar exchange rate with the Brazilian currency. As you can see above it was defined as part of the monetary system. It was a monetised daily indexed unit of account. I am not suggesting the equivalent for Venezuela. I am suggesting a daily index being the Daily CPI since a URV-based daily index would not currently be possible in Venezuela because the US Dollar exchange rate is not an official exchange rate: it is currently still a parallel or black market rate.

Seignoirage is the profit the Venezuelan government makes on increasing the Bolivar money supply. The Venezuelan government would still make large seignoirage profits under daily indexation if they were to continue creating hyperinflation with an excessive increase in the money supply. However, the real value of that profit will decrease as the governemnt´s payees would demand more nominal Bolivars to get paid the correct real value.

Daily inflation is known in advance with the Daily CPI. There are no surprises for anyone. The Daily CPI is a lagged, daily interpolation of the monthly published CPI.

Only when hyperinflation is reduced to low inflation, would the profit from seignoirage be drastically reduced.

“What actions do you think they could take to counter this loss?”

If they were to keep hyperinflation at the current level they would thus receive less seignoirage, but not drastically less.

People in power will always be in a good position to exploit whatever possibilities the new model provides: while they control the money supply increases, they will make seignoirage profits, but at a lower real value level.

In Zimbabwe the same people who destroyed Zimbabwe´s MONETARY economy with hyperinflation are still there after spontaneous Dollarization. The Zimbabwean NON-MONETAR ECONOMY was destroyed by the implementation of IAS 29 in terms of the MONTHLY CPI. IAS 29 had absolutely no positive effect in Zimbabwe. The Zimbabwean economy would never have imploded on 20 November 2008 if IAS 29 were REQUIRED to be implemented in terms of a DAILY INDEX - more correctly an index that recognises ALL changes in the general price level because it can change more than once a day from about 3000% inflation per annum. That was what happened in Angola and obviously much more often in Zimbabwe´s case.

“Even if these people decided not to fight it and instead help stabilize the system, the economy then effectively becomes dollarized which brings a whole branch of other ramifications,”

No, that is not correct. An economy is ony dollarized when the local currency is demonitised and a relatively stable foreign currency - normally the US Dollar - is used in the economy as the functional currency. Implementing daily indexing in Venezuela would be done with the Bolivar continuing being the functional fiat currency.

I think what you mean is that the NON-MONETARY economy would be stabilised AS IF it is dollarized. That is correct.

Real dollarization does have severe ramifications: (1) you have no autonomous monetary policy: your central bank cannot stimulate your economy with quantitative easing like the US Fed is currently doing in the US. Portugal and 15 other European Monetary Union countries are dollarized in terms of the Euro. (2) The US gains the seignoirage from the increase in US Dollar money supply to accomodate the Venezuelan economy. This is not orchastrated by the US: countries decide on their own to dollarize or dollarize spontaneously. The US has nothing to do - directly - with the reasons for dollarization.

ramifications, including salaries going down…”
That is not correct. Salaries, wages, rents, taxes, trade debtors, trade creditors, etc. would maintain their constant purchasing power (real value) over time.
“I hear what you are saying about Brazil, but that is not the only way to bring down inflation”

As I stated before: daily indexation of NON-MONETARY items is not about bringing down inflation in the MONETARY ECONOMY. Daily indexation of NON-MONETARY ITEMS implements financial capital maintenance in units of constant purchasing power in terms of the Daily CPI.

“Contrast your suggestion against distributing all income from oil directly, daily, and equally to all citizens.”

The wealth of a country can be in many forms: oil, minerals as well as the general wealth created by the population in a diversified economy. The government taxes this wealth and uses these taxes to provide education, health services, security, infrastructure, etc. to the population on a daily basis. Daily indexation of the non-monetary economy greatly improves the above model at any level of inflation and deflation.

The oil wealth of a country would play its proper role in the above model.

Distributing all income from oil directly, daily, and equally to all citizens per se does not guarantee the sustainable development of the economy. State of the art education, equal opportunity, free competition and abundant availability of investment capital (e.g., via quantitative easing) in the above model I described do a good job of generating sustainable developement in an economy.

“while not excluding the non earners, as your suggestion seems to do”

The non earner part of you comments is the most difficult part for me to grasp. Please explain how you see that daily indexing resulting in a stable non-monetary economy including constant purchasing power social grants to non earners as well as the taxes on which they are based being maintained constant in real value, exclude non earners.

Thank you very much for your comments. I really appreciate them. Please ask me any question regarding the subject.

Nicolaas Smith

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