The post-Historical Cost economy

The post-Historical Cost economy

The post-HC economy would be an economy in which the stable measuring unit assumption would be replaced with the Units of Constant Purchasing Power (UCPP) paradigm. The HC paradigm would be abandoned and no-one would ever assume money is perfectly stable during low and high inflation and deflation for the purpose of valuing some (not all) items in the economy as all economists, accountants and business people do during non-hyperinflationary periods in the current HC era. 

HCA would be replaced with the Capital Maintenance in Units of Constant Purchasing Power (CMUCPP) in terms of the Daily CPI model in the post-HC economy.

CMUCPP was authorized in IFRS as an alternative to HCA during all levels of inflation and deflation in the original Framework (1989), Par. 104 (a) which stated: 

"Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power."

The above wording is maintained intact in International Financial Reporting Standards in the current Conceptual Framework (2010), Par. 4.59 (a).

The accounting model for the post-HC economy was thus authorized in 1989 in IFRS. It was also authorized in US GAAP and other national accounting standards during that time.

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Hayek: Stability in value would prove to be the decisive factor

On 11 August I blogged: Is Bitcoin fatally flawed? in which I stated:

"The fact that bitcoin has a fixed supply limit - 21 million - may mean it may be fatally flawed in its attempt to be money (a monetary item possessing the three attributes of money) because the limit in supply may result in it never being able to be relatively stable in real value: an essential requirement for money."

Friedrich Hayek had the same view regarding the fact that a relatively stable real value is essential for an item to be accepted as money.

"Hayek stated that “Stability in Value” would prove to be the decisive factor in assessing the level of acceptance" (of a currency).

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The value of money

Money is only a monetary item within an economy or monetary union.

The real value of money is determined by all underlying value systems in an economy or monetary union. 

For example, sound monetary policies, sound governance, sound education, sound health policies, sound industrial policies, sound defence policies, sound judiciary, sound legal system, sound commercial policies, sound international relations, sound sustainable development, sound political system, etc, etc, etc. 

The real value of money within an economy is indicated by the nominal interest rate less the inflation/hyperinflation or deflation rate.

Is Bitcoin fatally flawed?

The fact that bitcoin has a fixed supply limit - 21 million - may mean it may be fatally flawed in its attempt to be money (a monetary item possessing the three attributes of money) because the limit in supply may result in it never being able to be relatively stable in real value: an essential requirement for money. 

Bitcoin may thus never be able to be used as a relatively stable unit of measure for accounting purposes. Bitcoin may thus never be able to replace fiat money. 

However, bitcoin may come to dominate the market for a cheap, digital medium of exchange if its exchange technology could be improved to make it a very cheap, instantaneous, peer-to-peer, digital medium of exchange. 

See: Hayek: Stability in value would prove to be the decisive factor

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Is bitcoin closing in on usurping the sovereign power of creating money?

Bitcoin is a very exciting and innovative technology.

Bitcoin has for the first time ever made all of us realize that anyone - not just sovereign states - can invent a monetized money-like crypto-medium-of-exchange that could become very popular very quickly and may result in improving the world in a very positive way.

The power to create money is a sovereign power. Sovereign powers (for example, to be a state, with a constitution, print fiat money, etc.) are the second highest level of power. Only judicial power is higher: the supreme court judges can remove the president.

The fact that bitcoin is almost (not actually yet) usurping a sovereign power - the power to create money to be used on a national and global scale (private money was created on a national scale in the past) - is an historic event. At the moment bitcoin is still not yet money: it is a monetized money-like crypto payment platform with a relatively unstable non-monetary real value , but it is getting closer to being money.

If bitcoin were ever to actually become money, i.e., a monetary item with a relatively stable real value that accountants can assume to be perfectly stable like they assume all fiat currencies are perfectly stable in real value during low and high inflation and deflation under the historical cost paradigm when they implement the traditional Historical Cost Accounting model, then it would create a legal storm because I think all countries´ legal systems state that only the sovereign state can create money: a monetary item which is subject to inflation and deflation when a central bank is involved. 

The reason bitcoin is not banned outright globally is the fact that it is not money: it is a property (as ruled by the US, China and other countries): a variable real value non-monetary item. Sovereign states generally have no problems with newly invented assets/properties.

Sovereign states, however, guard their unique power to create money very jealously. The status quo may come under attack in the future depending on whether bitcoin - or maybe its successor - can actually be real money, i.e., a medium of exchange, a relatively stable store of real value and consequently a relatively stable unit of measure for accounting purposes.

I very much doubt that sovereign states would let the money supply be controlled by unknown people in a decentralized manner.  The money supply is a matter of national importance for every nation. 

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Money can be a monetary or a non-monetary item

Fiat money can be either a nominal monetary item or a variable real value non-monetary item depending on where it is being used: inside the economy where it was created or outside.

Fiat money is a monetary item only within the economy where it is created. In this case, fiat money´s real value is eroded by inflation (low, high and hyperinflation) and increased by deflation within the local economy. 

The net monetary loss or gain in the real value of monetary items is not calculated and accounted under the historical cost paradigm during low and high inflation and deflation. It is calculated and accounted under the constant purchasing power paradigm required under IFRS in IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation. 

Fiat money as a monetary item is generally never perfectly stable in real value over time during inflation and deflation. However, fiat money as a monetary item within the economy where it is created is assumed to be perfectly stable in real value by accountants, economists, business people and people in general for the measurement of many (not all) economic items under the historical cost paradigm, i.e., implementing the Historical Cost Accounting model during low and high inflation and deflation. 

When a country´s currency is used outside the economy where it was created, i.e., when it is used as a foreign currency in another economy, then it is a variable real value non-monetary item. The real value of fiat money used as foreign currency is determined in terms of other currencies in the multitude of foreign exchange markets around the world. A foreign currency´s real value in terms of other currencies is not determined just by the inflation rate in the economy where it was created, although this is an important factor taken into account by buyers and sellers in the forex market. Many other factors besides inflation or deflation are taken into account by buyers and sellers of currencies in foreign exchange markets when they determine the exchange rate of a foreign currency in terms of their own currency.

An entity with its head-office in a particular economy values the local fiat currency as monetary items under the historical cost paradigm during low and high inflation and deflation. Local currencies are always assumed to be perfectly stable in real value over time under the historical cost paradigm.  

An entity generally values foreign fiat currencies it holds as variable real value non-monetary items in terms of the constantly changing forex rates in the forex market. 

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

All digital fiat currencies (92% of the global money supply) are digitally created in decentralized commercial banks

Ecuador will be the last (latest), not the first, country to create its own digital national currency. Ecuador does not currently have its own digital national currency because it currently does not have its own national currency. It is a dollarized economy. Ecuador uses the mainly digital US Dollar as mainly digital medium of exchange in the country. 92% of the US Dollar money supply inside the Ecuadorian economy is exchanged in a digital USD format daily. 

All countries issuing fiat money have digital currencies for a long time already. 92% of the world´s money supply is in the form of digital fiat currencies. These digital fiat currencies were/are created in decentralized commercial banks via decentralized digital fractional reserve banking. 

Sweden´s central bank does not require Swedish commercial banks to keep reserves with the Riksbank. It is the oldest central bank in the world. 

Fiat digital currencies (all currencies in the world) are not centrally created. They are digitally created in a decentralized way in the various national commercial banks via decentralized digital fractional reserve banking.

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Ecuador cryptocurrency

Ecuador has banned bitcoin and announced that it is going to create its own cryptocurrency to be used alongside the US Dollar in the country.

Ecuador and all other countries have fiat virtual currencies. All countries transact their fiat virtual currencies 24/7, 365 days a year via the 70-year-old (or older) global fiat virtual currency very secure fiat virtual banking system. 92% of all the fiat money in the world is only transacted virtually. I think it most probably is done with values being sent encrypted. Thus 92% of all real money is transacted virtually and encrypted. The fiat virtual currencies are not virtual cryptocommodities (like bitcoin) created via blockchain technology: they are virtual representations of physical fiat currency banknotes and coins.

For Ecuador to create its own cryptocurrency it has to create a virtual currency fundamentally very different from the virtual cryptocommodity called bitcoin.

Ecuador does not have its own national fiat currency. It is a dollarized economy. It uses the US Dollar as its national currency for the sake of relative monetary stability. Thus, Ecuador is subject to inflation (erosion of the real value) in the USD as experienced in the US.

Ecuador is attempting something very unique. It has to create a cryptocurrency that is actually a monetary item or real money like the USD inside the US economy. Monetary items are all items in a country´s money supply. If an item appears on the list of items (cash, notes, coins, loans, bonds, etc.) in the central bank´s list of items that make up the money supply, then it is a monetary item. If not, it is a non-monetary item, like bitcoin. Monetary items are fiat money and subject to inflation and deflation. Money, i.e., a monetary item, is relatively stable in real value like the USD, Euro, Yuan, etc. Accountants actually assume money (all fiat currencies) is perfectly stable in real value for the valuation of many items in a business under the traditional Historical Cost Accounting model during low and high inflation and deflation. The items that accountants value in nominal assumed-to-be perfectly stable fiat value, include, but are not limited to capital, retained income, all profits, all losses, salaries, wages, rent, taxes, all expenses, trade debtors, trade creditors, all revenue, all income, all items in the income statement, cash, bank balances, money loan balances, etc.

Ecuador thus has to create a cryptocurrency with an assumed to be perfectly stable in real value per unit of cryptocurrency. That is not the case with bitcoin. Accountants in Ecuador are going to assume this new cryptocurrency (if they actually manage to create it) is perfectly stable in real value for the valuing/measurement of the above stated items in balance sheets and income statements of businesses in Ecuador. That is not the case with the crypto commodity bitcoin which is a variable real value non-monetary item, the real value of which changes minute by minute on the various bitcoin exchanges around the world. That is also the case with fiat currency when the fiat currency is transacted as foreign exchange, that is, outside the economy where the fiat currency is created. Inside the economy where the fiat currency is created, the fiat currency notes and coins maintain their nominal values fixed, but their real value is determined by the rate of inflation or deflation.

Bitcoin will never be assumed to be perfectly stable in real value (like all fiat currencies) for accounting purposes because it is not a monetary item.

Thus Ecuador is really trying something very special. Ecuador is going to try and do what bitcoin should have been, i.e., a monetary item or money. Bitcoin is a virtual cryptocommodity with a constantly changing real value.

I wish Ecuador good luck. If they succeed it will be something very special and may be a fundamental breakthrough that will have a fundamental impact on the bitcoin phenomenon.

Update: Ecuador´s (possibly [hyper]inflationary?) virtual IOU´s

Nicolaas Smith Copyright (c) 2005-2014 Nicolaas J Smith. All rights reserved. No reproduction without permission.