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Tuesday, 20 October 2009

Inflation is the abuse of the Rand´s store of value function

Money is a store of value. Money is a depreciating store of value during inflation and an appreciating store of value during deflation.

Money has to maintain most of its value over time in order to be accepted as a medium of exchange. It would not solve barter’s double coincidence of wants problem if it could not be stored over time and still remain valuable in exchange.

The fact that inflation is destroying the real value of money means it is a store of depreciating real value during inflation. Money was a store of value right from the start. First types of money consisted of gold or silver coins. The metals from which the coins were made had an actual real value in themselves and these coins could be melted down and the metal could be sold in its bullion form when the bullion price was above the coin price. Next money was not made of precious metal coins but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating money simply represents depreciating real value since depreciating bank notes and bank coins have no intrinsic value. Although the store of value function and nominal values of depreciating bank notes and bank coins are legally defined, their depreciating real values are determined by the economic process of inflation.

The abuse of money’s store of value function led to inflation.

Money is very liquid; i.e. it is readily available as cash and it is normally easy to obtain on demand. A property, e.g. a well-located plot of land with a well-maintained and well-equipped building is also a store of value. It is however quite an illiquid store of value. The real value is not immediately available in easily transportable and divisible cash. Money’s high liquidity makes it more desirable as a store of value in comparison with other stores of value like gold, property, marketable securities, bonds, etc. Money is obviously not the best store of value in an inflationary economy where its real value is being destroyed by inflation. Money is normally available in convenient smaller denominations which facilitate everyday small purchases. As such, money is very user friendly. It is easily transportable especially with electronic transfer facilities.

Inflation actually manifests itself in money’s store of value function. Inflation does not manifest itself in money’s medium of exchange function or unit of account functions which vindicates the fact that inflation can only destroy the real value of money and monetary items; i.e. inflation has no effect on the real value of non-monetary items. Money is always a medium of exchange of equal real value at the moment of exchange. Free market prices are adjusted in the market in a price setting process that takes the decreasing real value of money into account (amongst many other factors) so that economic items (the product and the amount of money) of equal real value are exchanged at the moment of exchange.

Constant real value non-monetary items, e.g. salaries, wages, rents, etc which are measured in units of constant purchasing power (inflation-adjusted)

Depreciating money has a constantly decreasing real value. Depreciating “bank money” deposits have the same attributes of depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary values. The depreciating money represented by depreciating accounted bank money also has a depreciating store of value function.

A country’s money supply consists of banknotes and coins (currency) and bank money or demand deposits - the balances in savings and deposit accounts. Intangible bank money is usually a much larger part of the money supply than bank notes and coins.

SA monetary aggregates

According to the SARB the monetary aggregates in SA consist of the following:

M0

Deposits of banks and mutual banks with the SARB and notes and coins outside
the SARB and SA mint

M1A

Coins and banknotes in circulation outside the monetary sector, cheque and
transmission deposits with banking institutions and the post office savings
bank

M1

MIA plus other demand deposits with banking institutions

M2

M1 plus other short term deposits, and all medium term deposits (including
savings deposits) with the monetary banking institutions

M3

M2 plus all long term deposits with monetary banking institutions


In a low cash inflationary economy depreciating money is a store of decreasing real value but it is generally assumed to have a stable – as in fixed - real value. SA accountants officially assume that the Rand is perfectly stable when they value fixed balance sheet constant real value non-monetary items never maintained. They do not consider the destruction of the Rand´s real value (e.g. at 6.4% per annum and even up to more than 20% per annum, but not as high as 26% per annum for three years in a row) as sufficiently important for them to decide to measure constant items in units of constant purchasing power - as approved by the IASB twenty years ago - to stop the destruction of real value in fixed balance sheet constant items (issued share capital, retained profits, all other shareholders equity items, trade debtors, trade creditors, taxes payable, taxes receivable, etc) never maintained. SA accountants´ stable measuring unit assumption is very destructive and totally unacceptable. It always was and now still is fundamentally wrong and very costly to the SA economy. SA accountants unknowingly destroy about R200 billion in the real value of constant items never maintained in this manner – each and every year (all else being equal).

Kindest regards,

Nicolaas Smith