Saturday, 21 September 2013

Daily Indexing is free, 2% better than Dollarization and autonomous monetary policy control is maintained

Thank you for your kind reply.

I wish to express my respect for your direct, honest and good faith analysis of my very technical accounting replies. You already have an excellent understanding of recently identified accounting concepts that are currently not even understood at the International Accounting Standards Board (IASB) which is of course a great disadvantage for Venezuela which has been in hyperinflation since 2009. Daily Indexing or daily monetary correction has only very recently been identified as actually being financial capital maintenance in units of constant purchasing power in terms of a Daily Index as authorized at all levels of inflation and deflation in International Financial Reporting Standards (IFRS) since 1989 and authorised in US GAAP since 1985.

You write about the simplicity of Daily Indexing. It is a very straightforward process: there is no stable measuring unit assumption - implemented via an IFRS: the government has nothing to do with the process. That´s it. So, EVERYTHING has to be indexed DAILY. In fact, not only daily, but every time the price level changes. When Venezuela gets to about 3000% inflation per annum you will have some days during the year when the price level would change more than once a day.

Daily Indexing is simply (1) measuring non-monetary items in units of constant purchasing power in terms of a Daily Index (you cannot inflation-adjust them because they are not monetary items) and (2) inflation-adjusting monetary items in terms of a Daily Index - both (1) and (2)  during whatever rate of inflation or hyperinflation in Venezuela. There would still be hyperinflation as long as your Central Bank prints too many Bolivars, but there would be no REAL VALUE erosion in non-monetary items measured in units of constant purchasing power in terms of a Daily Index and there would be no inflation effect (REAL VALUE erosion) in monetary items inflation-indexed Daily.

The REAL EFFECT would be the same as zero inflation, but there would still be hyperinflation. It would be AS IF there were no hyperinflation - the same as in Brazil in the past.

The real effect of perfect Daily Indexing would be 2% better than dollarization (the US Dollar has a 2% inflation target), except you would still have full monetary policy control over your local currency which you would lose under actual Dollarization. Daily Indexation is the same as “dollarization” in a constant purchasing power Bolivar unit of account while you would maintain full autonomous monetary control.

Daily Indexing is free. Official or unofficial Dollarization requires US Dollars to the value of whatever is required to replace Venezuela´s money supply. Spontaneous dollarization (Zimbabwe´s case) sorts out the money supply problem spontaneously.

Daily Indexing is simply a totally different paradigm: the constant item constant purchasing power paradigm (no stable measuring unit assumption) instead of the traditional, 3000-year-old nominal Historical Cost paradigm (implementing the stable measuring unit assumption).

Your statement:

From the perspective of wage earners, this proposal would adjust their income daily such that inflation ceases to be a concern of theirs, at least as far as their income’s value”

echos Alan Greenspan´s definition of price stability:

"Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making."

The real value (constant purchasing power) of their wages would remain constant over time at whatever rate of hyperinflation. The nominal values would be indexed daily - similar to all taxes, profits, losses, reserves, capital, rents, debtors, creditors and all other non-monetary items as well as normally a substantial part of the monetary economy. No-one would ever assume money were perfectly stable for any item under Daily Indexation: it is a totally different paradigm.

You stated:

“From the perspective of non earners, earners of the informal economy, and anyone whose income is not processed through an accounting system, the price of everything around them increases more quickly and in a worse manner than before.”

Once the whole economy adopts Daily Indexing it would be used in the informal economy too. Their wages would be increased at the exact same rate as the price of everything around them too.

‘By the way, I have to bring up again the salaries going down issue. Yes, they “would maintain their constant purchasing power (real value) over time”, but their numerical value would go down if the currency starts becoming stronger with respect to the dollar.’

The official US Dollar exchange rate in terms of the local currency and the daily US Dollar parallel rates normally unify at the parallel rate over time. Under Daily Indexing the nominal value of their salaries would increase during all that time with the real value staying constant. Yes, after unification of the two rates at the parallel rate, IF (ONLY a theoretical IF) Venezuela were to get so lucky that the Bolivar (Venezuelan economy) would become STRONGER than the US Dollar (the US economy), then the nominal value of their salaries would go down, but the real value would always remain constant under Daily Indexing. Workers would be happy under any scenario with Daily Indexing.

While the Bolivar official rate for the US Dollar is below the parallel rate and it is getting closer and closer to the parallel rate, the Bolivar would NEVER during that time be STRONGER THAN the US Dollar: the rate by which its real value would be eroded (it would ALWAYS be in a state of erosion compared to the USD till it gets to the parallel rate) would be LOWER till there is no erosion when it maintains its par value with the USD. Disinflation is simply LOWER - but still positive - inflation. Disinflation is STILL inflation (erosion of real value), but at a LOWER rate than before.

Disinflation (lower INCREASE in the CPI - lower inflation) is to be expected as the economy stabilises under Daily Indexing. The Bolivar actually getting “stronger than” the USD is a different story altogether: I think it is only a theoretical case. I think the Venezuelan economy - like the Portuguese economy - would never be stronger than the US economy under currently foreseeable circumstances.

You stated:

“There is no such thing as a free lunch.”

I totally disagree with you with reference to what has been happening and is happening in Venezuela. See Miguel Octavio´s latest article. I think I would call Venezuela The Free Lunch Self-Destructing Economy.

First of all: seigniorage is a free lunch to the state normally applied to the benefit of the population in countries with good governance. The new banknotes have to be put into circulation. Another example: The US has a free lunch from increasing the USD money supply to accommodate countries that dollarize using the USD. This is not orchestrated by the US. Countries decide to dollarize (officially or unofficially) or dollarize spontaneously.

The Venezuelan economy is being destroyed by the free lunches obtained by Venezuelans who illegally arbitrage between the official and parallel rate: Miguel´s article. The Venezuelan economy is being destroyed by the unnecessary extra free lunch the state gets from creating hyperinflation when they do not apply it in sustainable development, for example via Daily Indexing.

You stated:

“The greater the sum of differences in income from daily indexation, the greater the loss for those profiting from seigniorage, unless they make up for it with greater printing, which only worsens the situation for the poor.”

Unless they make up for it with greater printing: that is classical increase in hyperinflation. Zimbabwe was the perfect example. That was how they got to 89 700 000 000 000 000 000 000 percent (Hanke 2008) hyperinflation in 2008.

“which only worsens the situation for the poor”: not under Daily Indexing. The poor would see their wages, pensions, social subsidies, etc. indexed daily. DI implements a daily measurement in units of constant purchasing paradigm applied to all items.

You stated:

“Without an accompanying belt tightening by the government (e.g., reducing government expenses, attracting foreign investment, increasing reserves), this idea worsens inequality. Would you agree with this, or am I missing something?”

That is a very broad political statement (out of the blue) now bringing in “inequality”. Daily Indexing, i.e., financial capital maintenance in units of constant purchasing power in terms of a Daily Index, would simply be a technical accounting matter that CAN be implemented via IAS 29 without the involvement of the Venezuelan government which would stabilise the Venezuelan non-monetary economy over a short period of time.

Yes, “an accompanying belt tightening by the government (e.g., reducing government expenses, attracting foreign investment, increasing reserves)” is part of the broad macroeconomic solution.

Daily Indexing “worsens inequality” between the rich and the poor?

Common sense would indicate that Daily Indexing would reduce inequality at the time of its adoption since the poor are normally abused at all levels (as currently required/supported by the IASB under IAS 29 in terms of the monthly published CPI), e.g., with fixed nominal salaries and benefits during hyperinflation. Daily Indexation would stop that. Daily Indexing can be expected to reduce inequality over the medium and long term as first a stable non-monetary economy and then a relatively stable monetary economy (with low inflation) would play a great part in normalising the economy which would increase the rate of the poor moving up to middle class via education and higher constant wages. This happened and is happening very successfully in post-apartheid South Africa with an inflation target of 3 to 6 percent even under Historical Cost Accounting. Six percent inflation under HCA is not EXACTLY, but "almost like", 94% Daily Indexing.

Your criteria:

1) high chance of winning votes over from the chavista side;”

Daily Indexing is a technical accounting standards matter dealing with the basic measurement paradigm in the economy outside government control: everyone will have to do it and everyone will gain and see and experience that they are gaining, both chavistas and opposition.

You stated:

“It would be difficult to explain to those who would benefit from it.”

In Angola street vendors, some of whom had never been to school, understood daily indexing in terms of the US Dollar parallel rate instinctively. Street traders in all hyperinflationary economies are one of the first groups to understand it. Normally the local population understands the concept very quickly. Foreigners from low inflation countries who did not get used to it slowly over time, but suddenly encounters it, take longer to understand the concept.

160 Million Brazilians used it for 30 years from 1964 till 1994. Millions of other Latin Americans too, for many years.

The Argentinian Accounting Federation in their 2010 proposal to the IASB regarding Financial Reporting in High Inflationary Economies also pointed out to the IASB that South American countries have a long experience of indexation.

I think you may be wrong in this case. The invisible hand of self-interest would normally ensure quick acceptance.

“and difficult to swallow for those who would suffer worse for it, which makes it easy for chavismo to counter through misiones adjustment promises, economic stabilization be damned.”
Daily Indexation would be implemented via an IFRS. It would be a technical accounting matter outside political control.
Everyone agrees that dollarization in the US Dollar would stabilise the monetary and non-monetary economies with loss of autonomous monetary policy control. Daily Indexing is “dollarization” of the non-monetary economy and inflation-indexed monetary economy in terms of an indexed local currency unit AND you would still have full control over local monetary policy.
You stated:
“As opposed to Daily Indexing (DI), UCT reduces inequality.”
I explained above that Daily Indexing would reduce inequality.
You stated:
“it seems that DI could in fact make citizens more supplicants than ever.”
Instead of suppliantly enduring the tyranny of the implementation of the stable measuring unit assumption during hyperinflation, citizens would be able to avail themselves of the unfailing availability of the Daily Indexing of all items under the Constant Item Constant Purchasing Power paradigm.
You stated:
‘I disagree with stating that UCT “does not guarantee the sustainable development of the economy” since DI does not either’
Maintaining the constant purchasing power of constant items constant in a stabilised non-monetary economy implementing Daily Indexing would be the cornerstone of the sustainable development of the economy.
You stated:
“UCT at least forces the government to have the incentive of increasing its taxation income,”
Daily Indexing of all taxes, taxes payable and taxes receivable (they are all constant real value non-monetary items under Daily Indexing) would always increase the real value of the above items during inflation/hyperinflation compared to treating them as traditional fixed nominal monetary items.

Nicolaas Smith

Copyright (c) 2005-2013 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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