Friday, 30 April 2010

Japan and South Africa have the same enemy

Perfect policies are easy to implement in perfect markets

It is now clear that the US Dollar gains a lot from the fact that the US market is much closer to “perfect” than the EU market. Opinion states it well:

“StratFor raised an important aspect when they pointed out that the US was able to respond quickly to its banking crisis because it had to go through relatively few layers of regulators and law makers before the funds were made available.

Greece (and potentially Italy, Portugal and Spain) are being sunk because they cannot respond quickly enough and bring all the parties on board.”

Another example of an imperfect market is deflation in Japan:

Japan is at war with deflation for the last 15 years or more. Japan´s accountants implement the 700 year old generally accepted traditional Historical Cost Accounting model: like the rest of the world - supposedly excluding Venezuela which is in hyperinflation. However nothing can be further from the truth in Venezuela.

Back to Japan´s deflation: CNN is running a story today of a social website that allows Japanese housewives to almost always buy the lowest price groceries in their area thus driving down prices even more and increasing the deflationary pressure.

Where is the imperfection in the market and what would the perfect market solution in Japan be?

The imperfection in the market is the Historical Cost Accounting model: the Japanese Yen is in deflation. Thus, accounting non-monetary items at their historical costs, i.e. implementing the stable measuring unit assumption meaning Japanese accountants assume there is no deflation in Japan – instead of lowering all non-monetary item values to reflect the increase in the real value of the Yen, creates the deflation the Bank of Japan is unable to stop.

Deflation creates more real value in money, the Yen, in Japan – because of the monetary nature of money. (Don´t laugh at the expression: it is correct.) :-)

When Japanese accountants stop measuring financial capital maintenance in nominal monetary units, i.e. when they abandon the traditional Historical Cost Accounting model and with it the dreaded stable measuring unit assumption, they will adjust all constant items´ values with deflation: they will automatically lower the nominal values of salaries, but, the real value of the salaries will remain the same because of deflation in the Yen: it is increasing in real value all the time.

That means that Japanese consumers would stop to gain from delaying their consumption while they wait for deflation to automatically increase the real value of their salaries. The Japanese real or non-monetary economy would stabilise as all non-monetary items would see their values adjusted downwards evenly in the non-monetary or real economy. That would stop deflation.

I´m sending this off to the Bank of Japan if I can find a user friendly email address on their website.

In South Africa we have exactly the opposite situation: SA accountants implement the stable measuring unit assumption as part of Historical Cost Accounting and unknowingly destroy the real value of SA banks´ and SA companies´ shareholder equity never maintained constant as a result of insufficient revaluable fixed assets.

The enemy in Japan and South Africa is exactly the same: the stable measuring unit assumption, that is traditional Historical Cost Accounting.

Luckily the International Accounting Standards Board has authorized killing off the Historical Cost Accounting model 21 years ago in their Framework, Par 104 (a) in 1989 which states:

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

Aren´t we lucky we have such clever people at the IASB!

Kindest regards

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith

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