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Friday, 8 July 2011

CIPPA equals automatic zero erosion in constant item economy

CIPPA equals automatic zero erosion in constant item economy


We do not have stable – as in fixed real value – money. The real value of money is generally accepted by the public at large to be stable – as in fixed – in low inflation economies, but this is not true. The belief that we have stable – as in fixed real value – money is an illusion, namely the notorious money illusion.

Central banks and monetary authorities have monetary policies that often create the impression that money is stable in real economic value. They implement monetary policies that include the tolerance of low inflation limits of up to two per cent per annum. Then they assure everybody that “price stability” is guaranteed and assured. The public at large mistakenly assume that this means stable – as in fixed – prices. We regularly read in inflation reports that low inflation targets have been met and that “price stability” is assured.

In a low inflationary economy this appears to be true. But in reality it is not true. Yes, money illusion makes us believe that our depreciating money maintains its real value stable, while it actually halves in real value over 35 years with constant two per cent per annum inflation – the generally accepted level of “price stability.” All currently existing bank notes and coins will eventually arrive at a point of being almost completely worthless in real value during indefinite inflation. How quickly depends on the level of inflation.
In Zimbabwe hyperinflation reached such high levels that the real value of the country’s entire money supply was wiped out when the ZimDollar had no exchangeability with any foreign currency in November 2008. Towards the end of the hyperinflationary spiral the real value of the ZimDollar halved every 24.7 hours according to Steve Hanke from Cato Institute.

There is no money illusion in hyperinflationary economies. People know that hyperinflation erodes the real value of their money very quickly.

Central bank governors aid and abet money illusion by regularly stating in their monetary policy statements that they are “achieving and maintaining price stability.”

“The MPC remains fully committed to its mandate of achieving and maintaining price stability.”

TT Mboweni, Governor. 2009–06–25: Statement of the Monetary Policy Committee, SARB.

It is not always pointed out by governors of central banks that the “price stability” they mention, refers to their definition of “price stability”. Jean–Claude Trichet, the President of the European Central Bank, is a central bank governor who regularly mentions that 2% inflation is their definition of price stability. Absolute price stability is a year–on–year increase in the Consumer Price Index of zero per cent. The SARB´s definition of “price stability” “is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”

The SARB would aid in reducing money illusion in the SA economy by stating:

The MPC remains fully committed to its mandate of achieving and maintaining the SARB´s chosen level of price stability which is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. Absolute price stability is a year–on–year increase in the CPI of zero per cent. Current 4.6 % annual inflation eroded about R100 billion of the real value of the Rand over the past 12 months to the end of May, 2011. The stable measuring unit assumption as applied as part of the traditional Historical Cost Accounting model used by SA companies unnecessarily eroded about R200 billion of the real value of constant real value non-monetary items never maintained constant in SA companies at a rate equal to the current 4.6% annual inflation rate.

A one per cent decrease in inflation (disinflation) maintains about R20 billion per annum of real value only in the SA monetary economy as a result of the decrease in the level of inflation. At the same time, about R33 billion is maintained in the non–monetary economy as a result of the reduction in the level of unknowing, unintentional and unnecessary erosion by the traditional HCA model in the real value of constant real value non–monetary items never maintained constant in consequence of the implementation of the very erosive stable measuring unit assumption; i.e. financial capital maintenance in nominal monetary units during low inflation as authorized in IFRS in the original Framework (1989), Par 104 (a).

All that has to be done is to freely change over to IFRS compliant IASB–approved financial capital maintenance in units of constant purchasing power during low inflation (CIPPA) and the SA real economy will automatically be boosted by about R200 billion per annum forever in all entities that at least break even - ceteris paribus as long as the SARB maintains its chosen level of “price stability” between 3 and 6% inflation per annum.

As the Deutsche Bundesbank stated:

“The benefits of price stability, on the other hand, can scarcely be overestimated, especially as these are, in principle, unlimited in duration and accrue year after year.”

Deutsche Bundesbank, 1996 Annual Report, P 83.

All SA companies changing over to CIPPA means automatic zero erosion of constant items´ real values forever in the SA economy in all entities that at least break even during inflation and deflation – ceteris paribus. The same principle applies to all other economies.

Gill Marcus, the current governor of the SARB, will have to bring inflation down to zero per cent per annum on a permanent basis to have the same effect in the real economy. CIPPA does this automatically at any level of inflation or deflation. Zero per cent inflation is not currently advisable in the monetary economy because governments and central banks still do not know how to run an economy at sustainable zero per cent annual inflation. It is very easy to automatically run the constant item economy in any country or monetary union at sustainable zero percent erosion in constant items forever: just choose the other option: real value maintaining CIPPA. It is compliant with IFRS and has been authorized by the IASB in 1989.

CIPPA is a basic accounting model approved in 1989 that results in the automatic maintenance – without additional capital contributions or extra retained profits – of the real value of constant real value non–monetary items in the constant item economy for an unlimited period of time in all companies that at least break even during inflation and deflation – ceteris paribus. The principle applies when any economy - currently implementing the very erosive stable measuring unit assumption as part of the traditional HCA model – changes over to CIPPA.


Nicolaas Smith

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