Daily Index Plan removes country risk from exchange rate

Daily Index Plan removes country risk from exchange rate

The 17 countries in the European Monetary Union are, in practice, “Dollarized” in terms of the Euro. They have stable monetary economies (one third of their economies: the non-monetary economy being made up of the constant and variable item economies), but their central banks have no independent monetary policy capability. The European Central Bank is not a federal central bank: in principle, it is the German Bundesbank in disguise. The Euro is a monetary policy straight-jacket for 16 EMU countries, not for Germany. As long as the 17 balance (or get close to balancing) their government spending with receipts, the Euro is stable and first level Euro countries like Germany and Holland can grow, while – at the exact same time - countries like Greece and Portugal are in recession to the great detriment (maybe for the next 10 to 15 years) of the populations of these countries as a result of no federal political system in the European Union which most probably will never come about (e.g., Portugal and Greece are not East Germany who received 100 billion Euros per annum in development funds for years). The Euro is good for Germany in all respects, not for Portugal and Greece in expansionary monetary policy capability which is zero under the current EMU set up. The Euro is simply the Deutche Mark in European colours.

The central banks of Portugal, Greece and Ireland cannot implement the very successful US and Japanese policy of unlimited credit (what Portugal and Greece actually need now) during an economic crisis or monetary easing like the US does or create 6 percent inflation (the upper inflation target in a growing economy like South Africa, for example) via simply, sovereignly creating new money on a temporary basis (to be removed later on from the money supply: see US quantitative easing) in their monetary economies. Portugal and Greece would be able to do that if we were to first adopt the Daily Index Plan and then leave the European Monetary Union while remaining in the European Union like the United Kingdom.

In exactly the same way as Belgium can have no government for two years (completely secure with a completely open economy in the heart of the Europe Union), so can Portugal and Greece leave the Euro Monetary Union after first implementing the Daily Index Plan while staying in the European Union. The IMF is always there in the background as a backstop to avoid sovereign default. The ECB and the European Commission are not critical for this purpose: see the mission of the IMF.

The individual EMU country risk has thus been removed from the Euro exchange rate by “Dollarizing” EMU countries in terms of the relatively stable Euro. The individual country risk is now reflected in the individual country´s government bond interest rate: the new country risk paradigm.

The same would happen under the Daily Index Plan in any economy with a Daily CPI fully reflecting a currency´s foreign exchange exposure during low inflation or the US Dollar daily free-market exchange rate being used as the actual Daily Index during high and hyperinflation. With daily indexing the entire constant item economy and daily inflation-indexing of the entire monetary economy, the monetary economy and constant item economies would be “Dollarized” in terms of a constant (not nominal) local currency unit always being exactly equal to the US Dollar when the USD free-market exchange rate is used as the Daily Index during high and hyperinflation, but the local Central Bank would have completely autonomous monetary policy capability.

Whenever the foreign exchange rate (USD parallel rate during hyperinflation) would change it would immediately be fully reflected in the entire economy by all constant items and all monetary items automatically being indexed to the new foreign exchange value via the Daily CPI or the actual US Dollar daily exchange rate being used as the Daily Index (as Brazil did for 30 years with their daily indices). It would make no difference to stability in the local economy: all constant items and monetary items would be automatically indexed on a daily basis: in principle, what Brazil did for 30 years in their constant item economy and part of their monetary economy (Brazil did not inflation-adjust their entire money supply during the referred period) from 1964 to 1994 during very high inflation and hyperinflation.

This would remove the country risk from the exchange rate: the constant and monetary economies would be “Dollarized” in terms of a constant (indexed) local currency unit, with a Central Bank with full monetary policy capability. The country risk would be reflected in the government bond interest rate as it is now (2012) happening in Greece, Portugal and Ireland in the EMU.

Two countries (or monetary regions) both implementing the Daily Index Plan would have an almost permanently fixed foreign exchange rate between the two countries with their individual country risks being reflected in each government´s bond interest rate.

The Daily Index Plan would thus generally lead to very low inflation immediately after its introduction – all else being equal - in hyperinflationary countries because of the use of the daily US Dollar free-market exchange rate as the Daily Index in the entire economy (as it happened, in principle, in 1994 in Brazil with the Real Plan).

(The EU part of this article is obviously influenced by my Portuguese self-interest.)

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Zero Erosion Economy

Zero Erosion Economy

 

The Daily Index Plan would result in zero erosion of real value in:

 

1. Constant items in the constant item economy, e.g. salaries, wages, rentals, capital, trade debtors, trade creditors, taxes payable, etc. since all these items would be indexed daily in terms of the Daily CPI or USD daily parallel rate. They would automatically always have constant real values over time since the stable measuring unit assumption is never implemented under capital maintenance in units of constant purchasing power.

 

2. Real price increases and decreases in the variable item economy (e.g. property, plant, equipment, inventories, foreign exchange, etc.) generally determined in free markets with these prices updated daily in terms of the Daily CPI or daily USD parallel rate when they are not determined in the free market on a daily basis in terms of IFRS excluding the stable measuring unit assumption under capital maintenance in units of constant purchasing power.

 

3. Zero erosion in monetary items in the monetary economy - excluding bank notes and coins outside the banking system - since all monetary items, as qualified, would be inflation-indexed on a daily basis in terms of the Daily CPI or daily USD parallel rate. All monetary items in the banking system would be inflation-indexed on a daily basis resulting in zero erosion of real value in monetary items in the banking system.

 

Definition

 

Monetary items are local currency units held and items with an underlying monetary nature being substitutes of the former.

 

Examples of monetary items that are not local currency units held are money loans, consumer loans, home loans, car loans, student loans, the capital amounts of bonds, the capital amounts of money market and capital market instruments, notes payable, notes receivable, etc. when these items are not in the form of local currency units held.

 

The Daily Index Plan constitutes

 

(A) capital maintenance in units of constant purchasing power as authorized in IFRS and

 

(B) daily inflation-indexing of the entire money supply, both in terms of the Daily CPI or daily USD parallel rate.

 

The Daily Index Plan would result in zero erosion of real value in (1) constant items as a result of measuring all constant items in units of constant purchasing power and (2) constant real value monetary items as a result of daily inflation-indexing the entire money supply excluding bank notes and coins outside the banking system with both (1) and (2) in terms of a Daily CPI or daily USD parallel rate.

 

In practice it would result in a Zero Erosion Economy (ZEE) at whatever rate of inflation or deflation. Inflation would generally fall to very low levels under the Daily Index Plan since the monetary effect (nature) of money is completely compensated for in a fully inflation-indexed money supply economy under IFRS-authorized capital maintenance in units of constant purchasing power in terms of a Daily Index with complete co-ordination.

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Hidden and unknow cost of Dollarization (gain to the US)

Hidden and unknow cost of Dollarization (gain to the US)

Dollarization and the Dail Index Plan stop hyperinflation overnight. The Daily Index Plan implements the principles used under Dollarization, but with constant real value local currency monetary items and constant real value local currency non-monetary items implemented via daily indexation as was done with the Brazilian Real Plan in 1994.

Dollarization is a very costly, historically proven, but currently obsolete, irrelevant and unneccessary monetary policy option during high inflation and hyperinflation. Dollarization comes at a huge cost with some of this cost hidden and unknown.

Cost of Dollarization

1. The entire monetary base (money supply) has to be substituted with US Dollars.
2. The Central Bank cannot implement any independent monetary policies once the economy is Dollarized.
3. The hidden and generally unknown cost: The people of the Dollarized country continuously loses the sovereign windfall profit of seigniorage when Dollarization starts and every time new US Dollar bank notes are required as the Dollarized local economy grows. This real profit continuously accrues to the people of the United States of America (plus its multiplier effect) at apparently no cost to them.

Only the Central Bank has the authority to print new money, precisely to allow this windfall profit or seigniorage to accrue for the benefit of the entire population of the country where the money is created (the United States of America, in the case of Dollarization in US Dollars).

Example of the cost of Dollarization

(i) Monetary base in Iran (for example): USD 245 billion = cost of Dollarization in Iran.

(ii) Central Bank Monetary policies given up:

1. Monetary easing used very successfully in the US, UK and Japan, but refused by Germany for Greece, Ireland and Portugal. These countries are, in priciple, dollarized in Euros. 
2. Interest rate policies
3. The ability of the Central Bank to be responsible for labour policies very similar to “full employment” policies in the country, like the Federal Reserve Bank´s very successful labour policy responsibilities in the US economy.
4. The complete range of other normal Central Bank discretionary monetary policies.

(iii) Loss of Seigniorage - the hidden cost, hardly understood by anyone.

What is seigniorage?

Definition

Seigniorage is the profit the Central Bank (country) makes from the difference between the real value of fiat money bank notes and coins when they are added to the money supply and the cost of printing them.

Only about 8 percent of the money supply is made up of actual bank notes and coins in an advanced economy (based on the US money supply).

Fiat money has a decreasing real value during inflation: 7 billion plus people use generally decreasing real value fiat money each and every day to buy and sell almost everything in the world economy. When too much fiat money is created, this erosion of real value is reflected by the rate of inflation over time. Consumer Price Indices indicate the change in the real value of fiat money in the world economy within their particular local economies. Countries that issue government capital inflation-indexed bonds already have a Daily CPI that indicates the daily change in the real value of their local currency within their local economy.

Example: The economy grows in terms of GDP at 2 percent per annum. The monetary base needs to be increased. The Central Bank  – in the normal course of its activities - orders new fiat money bank notes with a nominal value of USD 4 billion at a cost of USD 100 000 from the bank note supplier, De la Rue, in the UK, for example.

Real value       USD 4 000 000 000

Printing cost                     100 000

Seigniorage            3 999  900 000

The Central Bank (country) is free to do whatever it wants with the newly printed fiat money bank notes and coins in terms of its articles of association. For example, lend it to commercial banks in terms of monetary policy in order to create more fiat money (this time not printing new bank notes and coins) in the economy via fractional reserve banking, buy new computers, new office blocks, new cars, etc. The Central Bank can also pay the newly printed money as a dividend to the Government who can do anything it wants with the newly printed money – in terms of the constitution, e.g., pay civil service, army, police, health services, military, education salaries, buy or develop / maintain nuclear weapons, if it were a member of the official Nuclear Club (Russia, China, US, Israel, UK, France, India, Pakistan, others ?), etc.

Countries like Zimbabwe, Panama, Ecuador, (Argentina, in the recent past) and other Dollarized countries as well as the increase in the use of the US Dollar outside the US economy continuously contribute in this way to the increase in the short and long term welfare and security of the people of the United States of America at no apparent cost to the people of the United States of America for an indefinite period of time - to the possible detriment of the people of these Dollarized countries. It would be a detriment if these countries were able to do better for their people by not being Dollarized as compared to the stability that Dollarization brings compared to its huge costs as indicated above.

This avoidance of Dollarization is now possible in terms of the Daily Index Plan, i.e., capital maintenance in units of constant purchasing power as authorized in IFRS twenty three years ago plus daily inflation-indexing of the entire money supply, both in terms of a Daily Consumer Price Index (the USD daily parallel rate during hyperinflation). The Daily Index Plan results (guaranteed) in the local economy being “Dollarized” in terms of constant local currency monetary and non-monetary items instead of actual United States Dollars. It results in the local economy operating with monetary and non-monetary items of completely stable real value: i.e., constant (not nominal) real value local currency monetary and non-monetary items of perfectly stable real value.

If Iran were to Dollarize her economy, the people of Iran would continuously contribute to the short and long term welfare and security of the people of the United States of America for an indefinite period of time (forever) at apparently no cost to the people of the United States of America but at a cost (e.g., continuous loss of seigniorage, etc.) to the people of Iran, if Iran were to stay Dollarized for an indefinite period of time – possibly to the overall short and long-term detriment of the people of Iran. This aspect needs credible, specific value, verifiable and peer-reviewed research to determine its real economic implications.

Seignoreige is a windfall profit which only comes about as a result of the double-entry accounting model in the same way as capital, as we know it, comes about. It is the initial accounting of a real value that exists or is newly created in the economy: in the case of capital, as a result of laws (company, commercial and other laws) and the existing real value of net assets. In the case of seigniorage, as a result of the sovereign law of legal tender giving rise to newly created real value in the economy (newly printed fiat money bank notes and coins) and the accumulated economic value of all the underlying value systems in the economy, e.g., sound governance, sound economic policies, sound political policies, sound monetary policies (e.g., no oversupply of the money base as indicated by inflation and hyperinflation), sound accounting policies, sound educational policies, sound health policies, sound international relations, sound legal system, sound defence system, etc.

Nothing of the above was or is specifically “engineered” by the government of the United States of America or any entity in the US. All of it came about as a result of specific historical economic circumstances that resulted in Dollarization in the past. Dollarization in the past was a direct reflection of the level of undestanding or lack of understanding of, e.g. the effect of the stable measuring unit assumption (Historical Cost Accounting) in the economy, daily inflation-indexing of the entire money supply, etc.

The US Dollar is almost always used for Dollarization. It is estimated that 50% of US Dollars is used outside the US economy because of the extraordinary success of the US economy and Federal Reserve Bank over the last at least 100 years: because of the faith people in general have in the US Dollar as a relatively stable currency and unit of account. 

Chile, Angola, Turkey and especially the large Brazilian economy beat hyperinflation without resorting to Dollarization. The Brazilian Real Plan in 1994 signalled the end of official Dollarization as a remedy during hyperinflation. The Real Plan very successfully used the principles implemented under Dollarization without using actual Dollarization in US Dollars to the great and indefinite advantage of the people of Brazil.

Zimbabwe´s spontaneous Dollarization in 2008 occured outside the realm of official monetary policy implementation: the povo (people) decided what to do, not the government of Zimbabwe (Robert Mugabe) or the Central Bank (Gideon Gono) as the agent of the government. Zimbabwe is a very open economy (on the consumer level) surrounded by stable economies, especially the large South African economy which could be up to 100 times larger than the Zimbabwean economy.

As Nelson Mandela stated: (Economic collapse in) Zimbabwe was a case of failure of leadership: clearly true as far as monetary policy, amongst many policies, was concerned.

There is absolutely no necessity for Iran now - or any other country in the future - to Dollarize, except possibly in the case of spontaneous Dollarization by the people of a relatively small economy in total economic chaos like Zimbabwe in 2008. Spontaneous Dollarization cannot be controlled under a total lack of official monetary policy initiatives in a very open economy. It is a matter of survival for the people of the country and they take matters into their own hands like they did in Zimbabwe in 2008 when the government is incapable of looking after their economic well being.

Dollarization is not necessary at present (2012). All Dollarized economies can successfully end Dollarization by implementing IFRS authorised capital maintenance in units of constant purchasing power and daily inflation-indexing of the entire money supply, both in terms of a Daily CPI. The correct implementation of the Daily Index Plan is guaranteed (by proven economic, mathematical and IFRS authorized accounting principles) to result in an economy operating in constant real value local currency monetary and non-monetary items.

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

The US Dollar is the substitute for a global unit of real value

The US Dollar is the substitute for a global unit of real value.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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Global seigniorage profits to the US of America

Global seigniorage profits to the US of America

What is seigniorage?

Investopedia explains 'Seigniorage'

"Seigniorage may be counted as revenue for a government when the money that is created is worth more than it costs to produce it. This revenue is often used by governments to finance a portion of their expenditures without having to collect taxes."
Explanation:

Seigniorage is simply the difference between the total nominal value of new bank notes introduced into the economy and the cost to print them.

It is a complete windfall profit to the Central Bank, i.e., to the country or the welfare of the people of the country where the new bank notes are introduced into the economy.

This windfall profit "without having to collect taxes" accrues to the welfare of the people of the  United States of America from the eonomies of countries that are Dollarized, for example Zimbabwe, Panama, Ecuador and from all dollarization outside the US economy for an indefinite period of time while these countries are Dollarized and from all Dollarization outside the US economy.

Nicolaas Smith


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Capital maitenance in units of constant purchasing power is halal

Capital maintenance in units of constant purchasing power is halal and Sharia-based since it only operates in real values.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Most destructive assumption ever made by mankind

Most destructive assumption ever made by mankind

The stable measuring unit assumption. Assuming, in practice, that money is perfectly stable during inflation and deflation.

The Historical Cost Accounting model is based on the stable measuring unit assumption. Ban Historical Cost Accounting (i.e., the stable measuring unit assumption) and you stop the effects of inflation and deflation.

Nicolaas Smith

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Dollarization with total local monetary policy autonomy

Dollarization with total local monetary policy autonomy

The Daily Index Plan, namely, capital maintenance in units of constant purchasing power as authorized in IFRS twenty three years ago as an option to HCA plus daily inflation-indexing the entire money supply under complete co-ordination, both in terms of the daily US Dollar free-market rate would result in a constant (real value) local currency always being exactly equal to the US Dollar (used during hyperinflation).

The local hyperinflationary economy would in practice in the economy be Dollarized in terms of the constant (real value) local currency - not in terms of actual, physical US Dollars. Monetary and constant items would be constant in real value and their constant real values would remain constant in US Dollar terms too (exactly the same as).

The fundamental difference with actual Dollarization is that the local Central Bank would have complete monetary autonomy. That is what is completely lost / given up under Dollarization.

A Daily indexed local currency monetary item and a Daily indexed local currency constant real value non-monetary item are constant real value local currency items. They would always be exactly equal in real value to their  respective foreign currency equivalents when the daily free-market foreign currency exchange rate is used as the index during hyperinflation. The Daily CPI is used during low inflation and deflation.

Eg.: US Dollar : Iranian Rial exchange rate = 1 :35 000

The indexed local currency would be:

Local currency value divided by USD rate:

35 000 rials/35 000 = 1 which is the amount of US Dollars.

Thus: a constant real value local currency (monetary or constant real value non-monetary) item is always exactly equal to its US Dollar equivalent when the US Dollar exchange rate is used as the index during hyperinflation.

When the entire monetary and constant item economies are indexed daily in terms of the daily US Dollar rate, then they are Dollarized in constant (real value) local currency units, not in physical US Dollars.

It is a fact that official Dollarization or a Currency Board stops hyperinflation overnight at a huge cost in US Dollars, but with no local monetary policy autonomy. Dollarization or a Currency Board is a monetary policy straight-jacket and is very costly.

Anyone - not only Prof. Steve Hanke - can stop hyperinflation overnight with Dollarization or a Currency Board. It´s no big deal. No-one would use it now that the Daily Index Plan - based on the Brazilian Real Plan - is available as an IFRS at no cost.

The Daily Index Plan, i.e., capital maintenance in units of constant purchasing power plus daily inflation-indexing the entire money supply, both in terms of the daily US Dollar parallel rate, stops hyperinflation overnight at no cost and maintains total local monetary policy autonomy.

The official or unofficial Dollarization and a currency board solutions are thus made obsolete and irrelevant by the Daily Index Plan.

The Daily Index Plan equals Dollarization in constant real value local currency values: no US Dollars required.

The daily US Dollar rate is simply used as a relatively stable unit of account in the absence of a Daily Consumer Price Index. This is similar to pre-monetary economies which used units of account without money being available in the economy (Shiller). An economy could use the US Dollar parallel exchange rate as a relatively stable unit of account without a single US Dollar being exchanged in the economy.

The US Dollar is thus being used as subsitute for a universal unit of real value.

Any relatively stable foreign currency, e.g., the Euro or the Yuan, can be used instead of the US Dollar.

The US Dollar is used in this way during hyperinflation when reliable Daily CPI data are not avaliable. 

The Daily CPI is used as the Daily Index during low inflation, high inflation and deflation. All countries with government capital inflation-indexed bonds, including Venezuela in hyperinflation, already have a Daily CPI.

Nicolaas Smith

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Global unit of real value

Global unit of real value

 

The consumer basket is the global unit of real value.

Nicolaas Smith

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The Daily Index Plan: A monetary and accounting plan

The Daily Index Plan: A monetary and accounting plan

The plan is called the Daily Index Plan because the daily index is the common factor in maintaining both the monetary and constant item economies constant. It is different from (better than) the Unidade Real de Valor daily index as well as from the Real Plan monetary reform implemented by Brazil in 1994.

The Daily Index Plan is not simply a daily index like the URV was and it is also not exactly the same as the Real Plan. It is a combination of principles and concepts which were used in both the URV daily index and in the Real Plan monetary reform. But it is neither simply the one nor simply the other and it is also not a simple combination of the two.

The Daily Index Plan is a combination of principles and concepts used in the URV and Real Plan plus capital maintenance in units of constant purchasing power in terms of a Daily Index.

The principles and workings of the Daily Index Plan are so mathematically correct and logical in real value that I am now completely confindent in stating that it can be used to stop the total effect of hyperinflation – not actual hyperinflation in bank notes and coins (their nominal values are still permanently printed on them) – in the monetary economy as well as the very destructive effect of the stable measuring unit assumption in the constant item economy overnight at no cost when the plan is implemented correctly with complete coordination.

The crucial factor is the fact that the US Dollar daily rate is used as the index. Then, logically (mathematically), a constant local currency is always exactly equal to the US Dollar. So, you are effectively running your economy in US Dollars (Dollarization) when you daily index your complete local currency money supply and all constant items in your economy to the daily US Dollar rate. We all know Dollarization stops hyperinflation overnight, but at the cost of having sufficient US Dollars available overnight.

Because you use a constant local currency you can still have hyperinflation when someone injects too many nominal local currency units into the economy, but the Daily Index Plan would always remove the total cost of hyperinflation as well as the total cost of the stable measuring unit assumption from the economy under complete co-ordination.

With the Real Plan in 1994 (which was only a monetary reform plan – Brazil actually went back to Historical Cost Accounting – a step backwards, but that is another story) the actual URV index was changed into a new currency - the Real currency. The previous currency was withdrawn from circulation, but the URV index was almost 100 percent constructed with (made up of) the official (not a parallel) Daily US Dollar rate in Brazil and the population was already used to (for 30 years) working with daily indexing with the URV and other government-supplied daily indices. This was all done by the Brazilian Government via the Central Bank of Brazil. Well, the Central Bank was completely independent because the head of state was not involved (not interested) in the workings of the Central Bank at all.

It is thus possible to stop the total effect of low inflation, high inflation, hyperinflation and deflation and the stable measuring unit assumption overnight at no cost in any economy. The accounting part was the important part that  was missing (the weakness) in the Real Plan. The Daily Index Plan is thus the complete economic plan: a better plan than the Real Plan. The Real Plan was only a monetary reform. The Daily Index Plan is a monetary and a fundamental accounting – an economic – reform plan.

 

Nicolaas Smith

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The Generally Accepted Definition of Hyperinflation

The Generally Accepted Definition of Hyperinflation

The International Accounting Standard Board´s definition of hyperinflation is the generally accepted definition in the world economy since April 1989, the date IAS 29 was authorized.

The IASB defines hyperinflation in IAS 29 Financial Reporting in Hyperinflationary Economies, Par. 3 (e) as follows:

"the cumulative inflation rate over three years is approaching, or exceeds, 100%."

 

The IASB´s definition if followed by millions of accountants and all countries implementing International Financial Reporting Standards since April 1989.

 

In 1956, Phillip Cagan wrote The Monetary Dynamics of Hyperinflation, generally regarded as the first serious study of hyperinflation and its effects. In it, he defined a hyperinflationary episode as starting in the month that the monthly inflation rate exceeds 50%, and it ending when the monthly inflation rate drops below 50% and stays that way for at least a year.^[4] Economists usually follow Cagan’s description.

 

No country in the world follows Cagan´s definition for any purpose or is required to follow Cagan´s definition.

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Fourth advantage of daily inflation-indexing the entire money supply

Another (the fourth) very important benefit of daily inflation-indexing the entire money supply at all levels of inflation and deflation under complete co-ordination (which is the rejection of the stable measuring unit assumption in the monetary economy) would be that it would logically compliment the rejection of the stable measuring unit assumption in the constant item economy (the non-monetary or real economy being made up of the constant and variable item economies) under financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index as already authorised in IFRS.

Financial capital maintenance in units of constant purchasing power as authorised in IFRS would automatically maintain the constant purchasing power of equity (capital) 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.

This means the constant real value of the entire capital investment base in an economy would automatically be maintained constant for an indefinite period of time as qualified above, i.e., in all entities that at least break even in real value, all else being equal under financial capital maintenance in units of constant purchasing power.

Nicolaas Smith

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Daily inflation-indexing the entire money supply an inevitable future step

Daily inflation-indexing the entire money supply an inevitable future step

 

Daily inflation-indexing of the entire money supply in terms of already existing Daily CPIs is an inevitable future step in the world economy.

(i)The first known inflation–indexed bond was issued by the Massachusetts Bay Company in 1780.

(ii) The British government began issuing inflation–linked Gilts in 1981. The market for inflation–linked bonds has grown rapidly since then - with the use of Daily CPI´s.

(iii) The IASB originally authorised financial capital maintenance in units of constant purchasing power in the original Framework in 1989.

(iv) Non-monetary items were then split in variable real value non-monetary items (property, plant, equipment, inventories, etc.) and constant real value non-monetary items (issued share capital, all items in shareholders´equity, salaries, wages, rents, trade debtors, trade creditors) in 2005 making the development of an accounting model based on financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index possible.

(v) The draft IFRS 'X' CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER in terms of a Daily CPI or other daily index was submitted to the IASB in January 2012. An IFRS based on IFRS 'X' should be authorised in 6 to 8 years´ time.

(vi) Some years´ after that countries could start inflation-indexing their entire money supplies.

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Benefits of daily inflation-indexing the entire money supply

Benefits of daily inflation-indexing the entire money supply

 

The benefits of daily inflation-indexing the entire money supply at all levels of inflation and deflation under complete co-ordination (everyone doing it) would be:

1. It would remove only the entire cost of or gain from inflation and deflation from only (except from actual bank notes and coins) the entire monetary economy - inflation has no effect on the real value of non-monetary items - under complete co-ordination at all levels of inflation and deflation. It would do nothing to actual inflation or deflation. The monetary economy, however, would operate as if there is no inflation or deflation - at whatever level of inflation and deflation. Monetary items (excluding bank notes and coins) would have constant real values over time.

 

2. As far as comparing its benefits to the benefits of a currency board or dollarization to stop hyperinflation is concerned: it would remove the entire cost of hyperinflation from the entire monetary economy (excluding bank notes and coins) while an economy using a currency board or dollarizaton to stop hyperinflation would still be subject to the cost of and gain from inflation or deflation of the currency board currency or dollarization currency as well as the cost of or gain from the stable measuring unit assumption in the currency board currency or dollarization currency.

 

3. There would be no currency board currency (foreign exchange) needed.

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Running an economy in constant values

Iran is currently in hyperinflation.

 

When the whole money supply is inflation-adjusted or hyperinflation-adjusted on a daily basis under complete co-ordination (everyone doing it) in terms of a Daily CPI or daily black market rate there would still be inflation and hyperinflation in only the monetary economy, but no cost of /gain from inflation or hyperinflation. Monetary items, excluding bank notes and coins, would have constant real values. It would be as if there is no inflation or deflation or hyperinflation in the economy.

Inflation and deflation obviously have no effect on the real value of non-monetary items. The stable measuring unit assumption as implemented under traditional Historical Cost Accounting is destroying Iran´s non-monetary economy. It is impossible for hyperinflation to destroy Iran´s non-monetary economy.

Under hyperinflation daily inflation-adjustment of the entire money supply is possible by means of the daily black market rate. Under low inflation, high inflation and deflation this is possible by means of the Daily CPI that exists in all countries issuing government inflation-indexed bonds (95+ per cent of the world economy). These bonds trade daily and are priced daily in terms of a Daily CPI which is normally a one or two month lagged daily interpolation of the monthly published CPI. TIPS are priced like that daily.

Chile currently inflation-adjusts 25 percent of its broad M3 money supply on a daily basis in terms of their Unidad de Fomento. At least USD 3.5 trillion is inflation-adjusted daily in the global sovereign inflation-indexed bond market.

Whereas daily inflation-adjustment of the complete money supply would remove the cost/gain from inflation / deflation, including hyperinflation (not inflation/deflation or hyperinflation), from only the monetary economy (excluding from actual bank notes and coins), financial capital maintenance in units of constant purchasing power, the IASB´s alternative to Historical Cost Accounting, authorized in IFRS in 1989, in terms of a daily CPI or daily black market rate would remove the total cost of the stable measuring unit assumption from the entire economy; i.e., abandoning the HCA model.

It is thus currently possible to run an entire economy with constant real value monetary items (excluding bank notes and coins) and constant real value non-monetary items. The split of non-monetary items in variable real value non-monetary items and constant real value non-monetary items is inferred in IFRS.

I could explain this to Iran, but then the US government would be very upset with me. I have no intention of explaining this to Iran. They may read it on my blog though.

I am trying (quite unsuccessfully so far) to get Venezuela, which is in hyperinflation in terms of the IASB´s definition, to abandon traditional HCA and to change over to IFRS-authorized financial capital maintenance in units of constant purchasing power in terms of their Daily CPI. Venezuela issues government inflation-indexed bonds and this Daily CPI is available in the country.

 

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Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.

DEFINITION OF FINANCIAL CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

DEFINITION OF FINANCIAL CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

Financial capital maintenance in units of constant purchasing power is the automatic maintenance of the real value (constant purchasing power) of capital (equity), based on the principle that the real value (constant purchasing power) of equity is always equal to the real value of net assets 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 hyperinflation as authorised in current IFRS in The Conceptual Framework (2010), Par. 4.59 (a) in terms of a Daily Consumer Price Index or other daily index.

STABLE MEASURING UNIT ASSUMPTION NEVER IMPLEMENTED

The stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power.

Financial capital maintenance in units of constant purchasing power is not Constant Purchasing Power Accounting, i.e., it is not the restatement of non-monetary items in Historical Cost or Current Cost financial statements during hyperinflation.

Financial capital maintenance in units of constant purchasing power is the same as to CONSTANT ITEM PURCHASING POWER ACCOUNTING as described in the Kindle e-book CONSTANT ITEM PURCHASING POWER ACCOUNTING per IFRS.  You can download a free Kindle Reading Application here.

VALUE DATE

The value date under financial capital maintenance in units of constant purchasing power is always the current date, i.e., today, namely today´s Daily CPI or today´s market price or other daily index. All items are always stated, viewed, accessed, printed, published and presented at today´s real value. Tomorrow all the prices are different. They are valued of updated daily.

The Daily CPI is normally a one or two month lagged, daily interpolation of the monthly published CPI used in all countries issuing government capital inflation-indexed bonds to price these bonds on a daily basis.

Buy the Kindle ebook at Amazon.com for $2.99 or £1.53 or €2.68

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.