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Monday, 16 November 2009

Inflation has no effect on the real value on non-monetary items

A house is a variable real value non-monetary item. Let us assume a house in Port Elizabeth is fairly valued in the PE market at say R 2 million on 1st January in year one. With no change in the market a year later but with inflation at 6% in SA, the seller would increase his or her price to R2.12 million - all else being equal. The house’s real value remained the same. The depreciating monetary price for the house expressed in the depreciating Rand medium of exchange – all else being equal - was inflation-adjusted to compensate for the destruction of the real value of the depreciating Rand in the internal SA market by 6% annual inflation. It is clear that inflation does not affect the house’s variable non-monetary real value – all else being equal.

However much inflation rises, it can only make the Rand more worthless at a higher rate and over a shorter period of time. Heaven forbid that what happened in Zimbabwe recently would ever happen in SA. As inflation rises the price of the house would rise to keep pace with inflation or value destruction in the real value of the Rand – all else being equal. The real value of the property will be updated as long as the house is valued as a variable real value non-monetary item at its market price, a measurement base dictated by IFRS and also practiced in all open markets.

When a property was valued at Historical Cost in the not so distant past in a company’s balance sheet it may have stayed at its original HC of, for example, R 100 000 for 28 years since January, 1981 in the company’s balance sheet. When it is eventually sold today for R 1.4 million we can see that inflation did not destroy the property’s variable real non-monetary value – all else being equal. Inflation only destroyed the real value of the depreciating Rand, the depreciating monetary medium of exchange, over the 28 year period - all else being equal. This was taken into account by the buyer and seller at the time of the sale. The selling price in Rand was increased to compensate for the destruction of the real value of the Rand by inflation. R1.4 million today (2009) is the same as R100 000 in January, 1981 – all else being equal.

As the two lady academics from Turkey state: Purchasing power of non monetary items does not change in spite of variation in national currency value.

Kindest regards,

Nicolaas Smith