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Wednesday, 27 April 2011

Real estate and a mortgage are not one and the same thing

Real estate is a variable real value non-monetary item. Inflation has no effect on the real value of non-monetary items, never had in the past and never will in the future. The same is true for deflation and hyperinflation. As Milton Friedman so correctly stated: inflation is always and everywhere a monetary phenomenon. That is also true for deflation and hyperinflation.

A buyer normally negotiates a mortgage with a bank or other credit institution. The mortgage is not the same as the real estate. The real estate is one thing: a variable real value non-monetary item. The mortgage is a completely different thing/item: another item/thing. It is a monetary item, not a non-monetary item. It is not the same as the real estate. You can live in a house. You cannot live in a mortgage. A mortgage is normally a contract written on paper. Real estate is normally a house or an apartment or other physical property. The contract is also written on physical paper. That does not make the real estate and the mortgage the same thing.

Only the capital amount of a mortgage is a monetary item. The real value of the capital amount of a mortgage is eroded by inflation and hyperinflation and increased by deflation.

The interest paid and received on a mortgage are constant real value non-monetary items once accounted in the income statement.
Interest paid and received on a mortgage are generally immediately claimed or paid by banks - claimed from or paid into bank accounts which are monetary items. The entries in the bank accounts are part of the monetary item balances of the bank accounts.

A bank balance is one thing/item: a monetary item. Interest is another thing/item: a constant real value non-monetary item once payable or receivable or accounted in the income statement.

The money in the bank accounts is the monetary medium of exchange by which the constant real value non-monetary items interest paid and interest received are mutually agreed to be settled.

The interest paid and interest received entries in the bank accounts are simply the descriptions of what the money paid or received relates to, the same as the entries for deposits and withdrawals or bank charges, for example.

Interest payable or receivable (not yet paid or received) are constant real value non-monetary items and have to measured in units of constant purchasing power, i.e. updated over time under the constant item purchasing power paradigm, i.e. financial capital maintenance in units of constant purchasing power as authorized in IFRS.

Under the Historical Cost paradigm, i.e. financial capital maintenance in units of nominal monetary units - also authorized in IFRS in the same statement that authorized financial capital maintenance in units of constant purchasing power, interest paid, received, payable and receivable are all treated as if they are monetary items.

Real estate is a non-monetary item and a mortgage is a monetary item under both paradigms authorized in IFRS.

Inflation only affects the real value of the capital amount of the mortgage. Inflation has no effect, never had in the past and will never in the future have an effect on the real value of the real estate.

Nicolaas Smith

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