Monday, 24 January 2011

Inflation only has a monetary component

I stated the following in a Letter to the Editor published in the Financial Mail in South Africa:

Financial Mail 09 May 2008

Accounting for inflation

Nicolaas Smith, Lisbon

DA deputy finance spokesman Dion George states: "Reserve Bank governor Tito Mboweni recently hiked interest rates, despite real concern over the impact this will have on sustainable economic growth" (Letters April 25).

SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.

There is an option that would make this destruction of the SA real economy by inflation or hyperinflation impossible - if we so choose.

We have to remember that inflation is the destruction of value in monetary and constant items over time.

Inflation has two components: a monetary component - inflation - and a non monetary component - historical cost accounting inflation. We can stop the second component completely, which will stop the destruction of real value in the real economy completely.

The 10,6% (March) inflation was caused by excessive (21%) money supply growth in SA. What causes excessive money supply is a complex economic process that should be dominated by Mboweni and the Bank as it is dominated by central banks elsewhere.

Historical cost accounting inflation is caused by the combination of 10,6% inflation and SA accountants' implementation of the stable measuring unit assumption (a historical cost accounting practice) throughout the SA economy.

The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.

We will still have 10,6% inflation in the monetary economy - all else being equal - but we will have 0% inflation in the real economy with an (as for now unknown) increase in GDP and sustainable economic growth in SA.

Inflation would then have only a monetary component, namely, inflation.

No-one stops us from revoking the stable measuring unit assumption.

The historical cost accounting model is not required by SA law, or by Generally Accepted Accounting Practice or the International Accounting Standards Board.”

The full understanding of the difference between the generally accepted accounting practice whereby accountants unnecessarily, unknowingly and unintentionally erode the real values of only existing constant real value non-monetary items never maintained constant only in the constant item economy with their free choice of implementing their very erosive stable measuring unit assumption during low inflation as authorized by the IASB when it approved the very popular accounting fallacy of financial capital maintenance in nominal monetary units per se during low inflation in the Framework, Par 104 (a) in 1989 and the erosion by the economic process of inflation of the real value of only money and other monetary items only in the monetary economy is an ongoing process. It has become clear to me, since September 2008, that inflation and hyperinflation only erode the real value of money and other monetary items. Inflation and hyperinflation only have one – a monetary – component. It is clear to me now that it is not inflation or hyperinflation that is causing the erosion of the real value of existing constant real value non-monetary items never maintained in the real economy. It is clear to me now that inflation does not have a non-monetary component and that inflation has no effect on the real value of non-monetary items.

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

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