Capital
maintenance in units of constant purchasing power would
(a)
- with never implementing the stable
measuring unit assumption – automatically
maintain the real value of constant real value non-monetary items constant for
an indefinite period of time in all entities that at least break even in real value – all else being equal – at
all levels of inflation and deflation, including during high inflation and
hyper inflation, whether they own any revaluable fixed assets or not
and
(b)
– with daily inflation-indexing the
entire money supply - compensate 100 percent for the effect of inflation and deflation (including high inflation and hyperinflation) on
the real value of only monetary items.
It
does exactly what its name states: it automatically maintains the constant
purchasing power of capital (equity) constant for an indefinite period of time,
but, only in entities that at
least break even in real value – all
else being equal – at all levels of inflation and deflation, whether they own
any revaluable fixed assets or not: i.e., the constant purchasing power (real
value) of capital is equal to the real value
of net assets under this model - in conformity with FAS 33, Par. 24:
‘It is
essential to the credibility of financial reporting to recognize that the recovery
of the real cost of investment is not earnings – there can be no earnings unless
and until the purchasing power
of capital is maintained.’
FAS 33,
Par. 24
Daily
inflation-indexing the entire money supply does not mean low inflation, high
inflation, hyperinflation or deflation would stop, because these economic
processes are determined by a number of factors, a very important one being the
level of increase or decrease of the money supply. It would, however, always compensate for the effect: it would
always be as if there were no
low inflation, high inflation, hyperinflation or deflation during low inflation, high inflation, hyperinflation or
deflation. It would always result in zero erosion of the real value of monetary
items, not zero inflation because using the Daily Consumer Price Index (or
daily US Dollar parallel – free market – rate during hyperinflation) would
automatically result in eliminating the effect of low inflation, high
inflation, hyperinflation or deflation.
(a)
Daily inflation-indexing the entire money supply plus (b) capital maintenance
in units of constant purchasing power in terms of a daily index means the local currency is used as a constant
(not nominal) unit of account: in effect, the constant item and monetary
economies would be “dollarized” in terms a constant (not nominal) local
currency.
The
stabilizing effect of adopting capital maintenance in units of constant
purchasing power on real values in the constant item and monetary economies of
previously high inflationary and hyperinflationary economies would generally
lead to low inflation after adoption of the new accounting model – all else
being equal – as it happened after the adoption of the Real Plan in 1994 in Brazil.
Capital
maintenance in units of constant purchasing power in terms of a daily index is
very similar to Dollarization of a previously high inflationary or
hyperinflationary economy. However, under official Dollarization the local
Central Bank (1) has no autonomous monetary policy capability and (2)
seignorage (the practically 100 percent profit Central Banks / countries make
on printing new bank notes and coins as required by their growing economies)
continuously accrues to the US economy (a foreign economy) – the Fed prints the
new US Dollars required - while under capital maintenance in units of constant
purchasing power the local economy (i) gains economic stability similar to
being Dollarized, but (ii) the local Central Bank maintains its independent
monetary policy capacity and (iii) the local economy continuously benefits from
the entire profit from seignorage.
The
previous paragraph explains the use of capital maintenance in units of constant
purchasing power in terms of a daily index – a freely available IFRS – to stop
hyperinflation overnight at no cost instead of with very costly Dollarization
or an equally costly currency board, the solutions of Prof. Steve Hanke, the
eminent US economics professor who had already been personally involved in
stopping 10 hyperinflations in this fashion. Official Dollarization and a
currency board both require vast sums of US Dollars to replace the local
currency money supply, often a prohibiting factor for a country in hyperinflation.
The
very successful Real
Plan used by Brazil in 1994 to stop their hyperinflation
overnight at no cost was, in essence, capital maintenance in units of constant
purchasing power in terms of a daily index although they did not understand it
as such at the time.
The
option to use a freely available IFRS to stop hyperinflation overnight at no
cost obviously makes the Dollarization and currency board solutions obsolete
and irrelevant. No country in hyperinflation or high inflation needs to use
these solutions any more. (A capital maintenance in units of constant
purchasing power IFRS – IFRS ´X` - would thus be of great value to high
inflationary and hyperinflationary countries although it obviously can already
be done in terms of IFRS authorization in the Conceptual Framework, Par. 4.59
(a).)
Summary
Capital
maintenance in units of constant purchasing power would automatically maintain
the constant item and monetary economies stable resulting in a stable overall
economy at all levels of inflation and deflation (including during high
inflation and hyperinflation), which is the basis for real economic growth and
increased employment and would result in sustainable economic development.
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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