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Saturday, 12 April 2008

Cash economy and real economy

Monetary economy = everything that is actually money and monetary values. Monetary values are accounted monetary items, eg, bank balances, bank loans made and given, financial instruments (not shares), debt instruments, bonds, treasury bonds, home loans, etc.

Very simply stated: money

Real economy or non-monetary economy = everything else in the economy: everything that is not money.

Eg. Property, plant, equipment, shares, stocks in the warehouse, finished goods. Also items like retained income, companies´issued share capital, reserves and provisions on balance sheets, trade debtors, trade creditors, etc.


These non-monetary items are divided in two sub-groups:

1. Variable real value non-monetary items. Eg: Property, plant, equipment, shares, stocks in the warehouse, finished goods, all items for sale, etc.

These items are adequately valued in terms of International Accounting Standards, eg. at fair value, market value, the lower of cost or net realisable value, present value or recoverable value.

There is thus no value destroyed by the accounting or vauluation method. They are adequately valued. No value is destroyed.

2. Constant real value non-monetary items.

Examples: Retained income, issued share capital values, capital reserves, trade debtors, trade creditors, all expenses and all income items in the profit and loss account.

Constant real value non-monetary items came about when the double entry accounting model was introduced in 1300.

Without the double entry accounting model there are no constant real value non-monetary items.

Accountants understand that there is an economic process called inflation and that inflation destroys the real value of money and that money is not stable in real value in inflationary economies.

Money is an historical cost item that you cannot update. Thus, inflation destroys its real value all the time.

Accountants unfortunately, at the same time, ASSUME that money is PERFECTLY stable (no inflation) ONLY for the purpose of valuing CONSTANT real value non-monetary items, eg. retained income.

They thus do NOT update CONSTANT real value non-monetary items, eg. retained income.

Thus, the real value of constant real value non-monetary items never updated, eg. retained income, is also destroyed, just like money, at the rate of inflation.

Under Real Value Accounting this silly and illogical assumption that money is perfectly stable ONLY for the purpose of valuing constant real value non-monetary items is ignored.

All constant real value non-monetary items are updated every time the Consumer Price Index changes under Real Value Accounting in non-hyperinflationary economies. In hyperinflationary economies this is done every time the parallel rate or a daily index rate changes.

This results in 0% inflation ONLY in all CONSTANT real value non-monetary items in the real economy: that is, no value destruction ONLY in that part of the real economy.