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Wednesday 13 June 2012

Measurement during low inflation

Measurement during low inflation


Monetary items are normally not inflation–adjusted daily under HCA during low inflation although Chile inflation-adjusts between 20 and 25 per cent of its broad M3 money supply daily (2011) and most countries issue government inflation-indexed bonds which totalled about USD 2.9 trillion at the end of 2009. Inflation thus erodes the real value of most money and other monetary items evenly throughout the world´s monetary economy under the HC paradigm. Money and other monetary items would only maintain their real values perfectly stable, excluding complete daily indexation of the total money supply, under permanently sustainable zero per cent annual inflation. This has never been achieved on a sustainable basis over an extended period of time.



The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.



SARB



The SARB´s definition of price stability results in the erosion of the real value of the Rand at a rate of three to six per cent per annum. That is the erosion of about R66 to R132 billion in real value in the SA monetary economy per annum (March 2012). Real value is eroded evenly in Rand bank notes and coins and other monetary items (loans, deposits, consumer credit, mortgage credit, monetary investments, car loans, nominal government bonds, etc.) throughout the SA monetary economy. Inflation has no effect on any non–monetary item in the SA or any other economy.



Monetary items not inflation-indexed daily are valued at their current depreciated generally lower real values by being accounted during the current accounting period at their original nominal HC values during inflation. Monetary items´ real values are eroded by inflation over time. Being valued at their original nominal values during inflation means that monetary items are automatically being valued by the continuous economic process of inflation over time. Monetary items´ real values thus change daily in the internal economy as indicated by the Daily CPI or a monetized daily indexed unit of account, but their nominal values stay the same over time under HCA. Under HCA this change in real value is not calculated and not accounted. The net monetary loss or gain is not calculated and accounted during low inflation.



This obviously means that monetary items are always correctly valued during the current financial period in any current account: at its current real value as determined by the Daily CPI or monetized daily indexed unit of account. Money and other monetary items´ real values consequently generally decrease to a lower real value daily as indicated by the Daily CPI in low inflationary economies. Their nominal values stay the same under HCA when they are not inflation-adjusted daily.



There are net monetary losses and gains whenever the entire or any part of the money supply is not inflation–indexed on a daily basis. It is however a Generally Accepted Accounting Practice compliant with IFRS not to calculate net monetary losses and gains under HCA except during hyperinflation as required by IAS 29.  By implementing the stable measuring unit assumption it is considered that changes in the purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low and high inflation and deflation. It is thus generally assumed under HCA that money is, in practice, perfectly stable for the purpose of valuing current period monetary items during low inflation in the accounting records. Daily infltion-indexed monetary items are valued and accounted at the values as determined in the contracts under which they are being inflation-adjusted daily, i.e. their nominal values increase daily while their real values stay the same during inflation.



There is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power (CIPPA). All monetary items (the whole money supply) would be inflation–indexed on a daily basis in terms of the Daily CPI with complete coordination in a perfect implementation of financial capital maintenance in units of constant purchasing power which is highly unlikely in the near future (2012). It would be the best solution, but it is doubtful that any country would have an accounting authority and a central bank with the necessary understanding of the implementation and benefits of financial capital maintenance in units of constant purchasing power in terms of a Daily CPI to implement the best solution right from the start.  This would remove the entire cost of inflation (not actual inflation in money and other monetary items) from the economy.



The concept of net monetary losses and gains would be extinct under inflation-adjusting the entire money supply and complete coordination.



Chile is the country closest to achieving this, still implementing the HCA model. Chile inflation-indexes 20 to 25 per cent of its broad M3 money supply (2011) on a daily basis by means of the Unidad de Fomento. The rest of Chile´s money supply is subject to the erosion of the real value monetary items by inflation. All constant items in Chile´s constant item economy economy never maintained constant are also still subject to the erosion of their real values by the implementation of the stable measuring unit assumption.



The stable measuring unit assumption does not erode the about R132 billion (March 2012) in real value of the Rand and other monetary items in the SA monetary economy: six per cent annual inflation does that.


Net monetary gains and losses are constant real value non–monetary items (income statement gains and losses) once they are accounted and have to be inflation–adjusted – measured in units of constant purchasing power – thereafter under 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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