Sunday, 12 January 2014

Is implementing IFRS a gateway to get rid of inflation, for example, in Iran?

Is implementing IFRS a gateway to get rid of inflation, for example, in Iran?

The scientific fact is that you cannot get rid of actual inflation with accounting concepts (IFRS). You can, however, get rid of THE EFFECT OF inflation (destruction of real value ONLY in monetary items) and THE EFFECT OF the stable measuring unit assumption (destruction of real value under Historical Cost Accounting) in constant real value non-monetary items with accounting concepts (IFRS). I do agree that this may also be seen as "getting rid of inflation" in the case of only monetary items. Inflation has no effect on the real value of non-monetary items: the stable measuring unit assumption (not inflation) destroys the real value of constant real value non-monetary items never maintained constant during inflation. So, it may appear that it may be right to say that IFRS is a gateway to get rid of inflation as far as monetary items are concerned, but it is important to understand the exact workings of this process as it happens and happened, for example, in Brazil in the past. This is not something new. 

Currently more than USD 3 trillion of local currency money (local currency monetary items) are being maintained constant in real value DAILY during low, high and hyperinflation in many - mostly low inflation - countries world wide in government capital inflation-indexed bonds. These sovereign bonds are inflation-indexed DAILY in terms of specific DAILY CPIs in all these countries. They are doing what is suggested in the title: they are "getting rid of" THE EFFECT of inflation (not ACTUAL inflation) in this USD 3 trillion worldwide DURING low inflation, high inflation and hyperinflation (hyperinflation in the case of Venezuela - I was informed that Venezuela also issued local currency government capital inflation-indexed bonds). See the list of some of these countries HERE. Argentina with 10% official inflation (high inflation) and 20% real (actual) inflation (approaching hyperinflation) also has government capital inflation-linked bonds. Argentina´s government obviously inflation-indexes these Argentinian bonds in terms of their "official" (lower) government-manipulated inflation rate. 

So we can see: in the case of the above USD 3 trillion, the people who own these bonds (lent local currency to these governments) "get rid of" the EFFECT OF low inflation, high inflation and hyperinflation, in these monetary items today and every day while they have that money in those bonds. But, at the same time, their Central Banks are still creating low inflation, high inflation and hyperinflation in all these countries. So, there are still low inflation, high inflation and hyperinflation in all these countries (no-one got rid of it yet) but there is no EFFECT OF low inflation, high inflation and hyperinflation in the USD 3 trillion in government capital inflation-indexed bonds today - because they are inflation-indexed DAILY. A Daily Index would thus be needed in Iran, i.e., a Daily CPI or the USD daily parallel rate if no CPI data are available.

Chile currently has 3% inflation (according to Trading Economics), but, all 90 day deposits in all their banks are inflation-indexed daily: their Central Bank informed me on my request. 25% + of their entire money supply is inflation-indexed DAILY. So, they "get rid of" the EFFECT OF 3% annual inflation in 25% + of their money supply, BUT they still have 3% annual inflation. They do not get rid of the actual inflation - only THE EFFECT OF the inflation in the monetary items they inflation-index DAILY.

As long as the Iranian Government and Central Bank create 30 to 35% too many rials (as long as they budget to do it for their next year which is year 1393 from Mar 2014 to Feb 2015 ) Iran WILL have 30 to 35% inflation per annum (hyperinflation). There is nothing anyone besides Iran´s Government and Central Bank can do about that. Iran´s Government and Central Bank have to be shown the way to bring that inflation down to 2% per annum via Daily inflation-indexing: first of the complete constant real value non-monetary item economy (the accounting - IFRS - solution) and then the entire money supply (the monetary  solution). The second part (DAILY inflation-indexing of 100% of the money supply) has never been done before. We are only sure of the 25% + currently in Chile. I do not know what percentage of the money supply was inflation-indexed daily in Brazil in the past. This is, of course, all part of the country solution for Iran. The individual company solution is similar but obviously easier to achieve than the country solution. 

However, it is possible to "get rid of"  (1) the destructive EFFECT of hyperinflation (created by Iran´s Government and Central Bank) on the real value of rial monetary items never inflation-indexed daily and (2) the destructive EFFECT on constant real value non-monetary items never maintained constant by the implementation of the stable measuring unit assumption (HCA) by Iran´s accountants during hyperinflation by: 

(1) Measuring all constant real value non-monetary items, e.g. salaries, wages, rents, taxes, trade debtors, trade creditors, all non-monetary payables, all non-monetary receivables, issued share capital, retained earning, capital reserves, all other items in shareholders equity, provisions, etc. in units of constant purchasing power in terms of a DAILY INDEX (the IFRS solution) like it was done in Brazil during the 30 years from 1964 to 1994. Brazil had high and hyperinflation of up to 2000 percent per annum, but they had a relatively stable constant real value non-monetary economy with positive real GDP growth - during hyperinflation. This is the accounting (IFRS) solution for stabilising the constant real value non-monetary item economy in Iran: to remove the effect of implementing the stable measuring unit assumption during hyperinflation, and

(2) DAILY inflation-indexing all monetary items (rial loans/bank deposits) - the monetary policy solution.

Chile inflation-indexes 25% + of its money supply DAILY in terms of their Unidad de Fomento Daily Index. I am saying: make that 100% of the money supply - BUT, that is a very, very big step to take: not so easy - to be done after first the accounting (IFRS) step.

The above explanation should be clear enough to see that IFRS or accounting concepts can not actually get rid of actual inflation, but only the effect of inflation - which may be seen as the same thing, while it is not. 

There are a number of big surprises about IFRS. The first and most important surprise is the fact that IAS 29 Financial Reporting In Hyperinflationary Economies - which Iran would have to implement in the whole of Iran when they decide to converge their accounting standards with IFRS, had absolutely no positive effect during the 8 years it was implemented in Zimbabwe´s hyperinflationary economy. It is a fact. Most accountants and economists know that Zimbabwe´s economy imploded in November 2008 with the full implementation of IAS 29 during the last 8 years of their hyperinflation.

Don´t get a fright when I point out this fact. I know why it happened: it is because Zimbabwean accountants used the monthly published CPI during hyperinflation of billions and billions of percent per annum: millions of percent per month. Brazil used a DAILY INDEX: the Unidade Real de Valor. You can only maintain constant real value non-monetary items and monetary items constant with a DAILY INDEX: all the above 3 USD trillion of inflation-indexed bonds are maintained constant DAILY with DAILY CPI´s. Brazil used a Daily Index, the Unidade Real de Valor.

So, the problem is solved: Iran would have to use a DAILY INDEX: their Daily CPI. If the Iranian government issues capital inflation-indexed bonds then they already have an Iranian Daily CPI: we just have to find it. 

If Iran does not have government capital inflation-indexed bonds, then it is also not a problem: the formula to construct a DAILY CPI is quite simple and freely available on many sites on the internet. Nobel prize winner Robert Shiller had done a lot of work on it. It is quite easy to set up. 

So, there will be surprises if Iran were to start implementing IFRS, but they can all be overcome. Otherwise I would not be so confident in my advice. I have already done this in a company in Angola in 1996 during hyperinflation of 3200 percent per annum.

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.