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Sunday, 31 December 2017

Shocking mistake in IFRS 1 since 2010

Economic concepts the IASB should re-evaluate

1. Severe hyperinflation

2. Zero effect of hyperinflation, low inflation, high inflation and deflation automatically resulting from Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI. 

Severe hyperinflation

The IASB defines Severe Hyperinflation as follows in IFRS 1, D27:

"The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:

(a) a reliable general price index is not available to all entities with transactions and balances in the currency.

(b) exchangeability between the currency and a relatively stable foreign currency does not exist."

Fact: When "exchangeability between the currency and a relatively stable foreign currency does not exist" then there is no currency. The currency has zero value, thus it does not exist as a currency when it cannot be quoted in terms of another currency. No currency means no inflation or deflation at any level. Thus, it also means no severe hyperinflation. 

When there is no exchangeability there is no currency. No exchangeability defines the moment a currency dies. Unfortunately, the IASB defines it as "severe hyperinflation." 

The people at the Reserve Bank of Zimbabwe will find it very strange. They know what no exchangeability means. It happened to them. So they know better than anyone else in the world that no exchangeability means zero value for a currency and consequently zero inflation, forget about severe hyperinflation. I will ask them to contact the IASB about the definition of severe hyperinflation in IFRS 1, D 27. 

See Comment Letter CL6 Exposure draft Severe Hyperinflation - Second Submission (September 2010)

European Financial Reporting Advisory Group: re-publication of Severe Hyperinflation Comment Letter CL1 blog post. First submission (substituted).

I explained very clearly in my two comment letters to the IASB regarding this matter (see copies directly above) that no exchangeability means the end of the real value of the currency, that it dies with that and that severe hyperinflation after that point is impossible. 

This is what I stated in my second and final comment letter:

"I disagree with the IASB´s definition of severe hyperinflation. Severe hyperinflation is impossible when there is no exchangeability."

The IASB, however, came up with exactly the opposite statement in IFRS 1, D 27  - as an actual definition of "Severe Hyperinflation" : The currency of a hyperinflationary economy is subject to severe hyperinflation if exchangeability between the currency and a relatively stable foreign currency does not exist."

It is true that hyperinflation and the economic concepts during hyperinflation and at the end of hyperinflation are very difficult to understand for people who have spent their whole lives in low inflationary economies and have absolutely no experience of hyperinflation in any form whatsoever. The same is true for deflation and the economic concepts involved during deflation.

Where I worked in Luanda I helped the company to overcome the fear of hyperinflation in Angola after 15 months by the end of 1996 by means of Daily US Dollar indexing our accounting and all our daily operations in terms of the Daily US Dollar parallel rate. Then I spent the next 21 years researching the theoretical basis for achieving zero effect of hyperinflation by means of Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI. 

Gideon Gono, the then Governor of the Reserve Bank of Zimbabwe, understood very well that the only way to end the ZimDollar was to ensure that there is no exchangeability with any foreign currency. Although there was no US Dollar exchange rate for the ZimDollar right at the end of hyperinflation, there was still the OMIR, the Old Mutual Implied Rate, at which Old Mutual shares were being traded on the Zimbabwe Stock Exchange. So, there was still implied exchangeability with the British Pound. Gono understood that. The only way he could stop the OMIR was to shut down the entire Zimbabwe Stock Exchange. That is exactly what he did. That was the only way to finally end the ZimDollar, to have no exchangeability, also not implied exchangeability.

No exchangeability meant no ZimDollar, which meant zero value for the ZimDollar, which meant no hyperinflation, which meant no severe hyperinflation too. The Zimbabwe economy Dollarized spontaneously. 

IASB board members totally disagree. To them, no exchangeability means "severe hyperinflation." How can you have any hyperinflation, severe or not, when the ZimDollar has zero value because there is no exchangeability? How can zero value be "severe hyperinflation"? According to the IASB it is exactly that: "The currency of a hyperinflationary economy is subject to severe hyperinflation if exchangeability between the currency and a relatively stable foreign currency does not exist." IFRS 1, D27

The IASB has to re-evaluate their definition of severe hyperinflation. The current version is all over Big Four websites and all over the internet. The IASB has defined "severe hyperinflation." It has to be correct - everybody thinks. (It appears only the European Financial Reporting Advisory Group and I think for ourselves.) 

The IASB's definition of "severe hyperinflation" needs to be corrected. 

Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist.

 “Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” p 9-10  

 There was severe hyperinflation in Zimbabwe while there was exchangeability with at least one relatively stable foreign currency – the British Pound in this case as made possible via the OMIR. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and severe hyperinflation stopped: no exchangeability means no severe hyperinflation.

, Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation,Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), p. 353-64 Available athttp://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf

The European Financial Reporting Advisory Group re-published my first comment letter regarding severe hyperinflation while the IASB unfortunately disregarded my first and second comment letters about the matter. 

Nicolaas Smith Copyright (c) 2005-2017 Nicolaas J Smith. All rights reserved. No reproduction without permission.