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.
South African Reserve Bank
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 completely worthless in real value during
indefinite inflation. How quickly depends on the level of inflation.
Real Value Table
Per cent of Today’s Real Value
Eroded
Hyperinflation*
Annual
Inflation 2% 6% 10% 26%
Years %
% % %
5 10 27 41 78
10 18 46 65 95
16 28 63 84 99
20 33 71 88
30 45 84 96
35 51 89 98
44 59
93 99
75 78 99
114 90
228 99
*Cumulative inflation over three years equals or is more than 100 per
cent: for example, inflation at 26 per cent per annum for three years in a row.
In Zimbabwe
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.’
(Mboweni, 2009)
It is not regularly pointed out by governors
of central banks that the ‘price stability’ they mention, refers to their particular
definition of ‘price stability’. Jean–Claude Trichet, the ex-President of the
European Central Bank, was a central bank governor who regularly mentioned that
two per cent inflation was 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 per annum on
a continuous basis. Absolute price stability is a year–on–year increase in the
CPI of zero per cent. Current 6 per cent annual inflation eroded 6 per cent of
the real value of every Rand and in total about R132 billion of the real value
of the Rand money supply over the past 12
months to the end of March, 2012.
It has to be remembered that the stable measuring unit assumption (not
inflation) as implemented as part of the traditional Historical Cost Accounting
model used by South African companies unnecessarily eroded an additional about
Rand 100 billion of the real value of constant items never maintained constant
in SA companies at a rate equal to the 6 per cent (March, 2012) annual
inflation rate.
A one per cent decrease in inflation (disinflation) would maintain about
R22 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, an additional R20 billion
would be maintained in the SA constant item economy as a result of the
reduction in the level of erosion by the traditional HCA model in the real
value of constant items never maintained constant in consequence of the
implementation of the stable measuring unit assumption; i.e. financial capital
maintenance in nominal monetary units during low inflation in South Africa.
All that has to be done to completely stop this erosion of constant
items by the stable measuring unit assumption is for all entities to freely
change over to IFRS–approved financial capital maintenance in units of constant
purchasing power during low inflation (CIPPA) in terms of a Daily CPI and the
SA real economy would automatically be boosted by about R100 billion per annum
for an indefinite period of time as long as the SARB maintains its chosen level
of price stability at 6 per cent inflation per annum. This would require
complete co-ordination although any individual company can start any time it
wants since it was authorized in IFRS in 1989.
The SA economy would continue to suffer the erosion of R132 billion of
the real value of the Rand money supply per annum – ceteris paribus – but would be boosted by the maintenance of about
R100 billion per annum in the constant item economy for an indefinite period of
time at continuous 6 per cent inflation when everybody is SA change over to
financial capital maintenance in units of constant purchasing power (CIPPA).
The SA economy would be boosted by a further R132 billion per annum for
an indefinite period of time at continuous 6 per cent inflation when SA
inflation-adjusts the entire money supply.
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)
All SA entities changing over to CIPPA would mean automatic zero
erosion of constant items´ real values for an indefinite period of time 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 (2012) governor of the SARB, would have to
bring inflation down to zero per cent per annum on a permanent basis to have
the same effect in the constant item economy. Financial capital maintenance in
units of constant purchasing power (CIPPA) in terms of a Daily CPI would do
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 relatively easy to
automatically run the constant item economy in any country or monetary union at
sustainable zero per cent erosion in constant items for an indefinite period of
time: just choose the other option: real value maintaining financial
capital maintenance in units of constant purchasing power (CIPPA). It is
compliant with IFRS and has been authorized by the IASB in 1989.
Financial capital
maintenance in units of constant purchasing power (CIPPA) is a basic accounting
model 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 in real value during inflation and deflation – ceteris paribus. The principle applies
when any economy changes over to financial capital maintenance in units of constant
purchasing power (CIPPA).
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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