Consumer Price Index

“The consumer price index was first used in 1707. In 1925 it became institutionalized when the Second International Conference of Labour Statisticians, convened by the International Labour Organization, promulgated the first international standards of measurement.”

Agrekon, Vol 43, No 2 (June 2004), Vink, Kirsten and Woermann.

The CPI is a non-monetary index number measuring changes in the weighted average of prices quoted in the functional currency of a typical basket of consumer goods and services. The per cent change in the CPI is used to measure inflation. It is a price index determined by measuring the price of a standard group of goods and services representing a typical market basket of a typical urban consumer. It measures the change in average price for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation). It can be used to measure changes in the cost of living. It is a measure estimating the average price of consumer goods and services purchased by a typical urban household.

We use the change in the CPI as a measure to calculate the destruction of real value in monetary items (which cannot be indexed) and constant items never maintained (thus being treated as monetary items) over time in an inflationary economy implementing the HCA model. We also use the change in the CPI as a measure to calculate the creation of real value in monetary items (never indexed) and constant items never maintained (never decreased) over time in a deflationary economy. The CPI can be used to measure financial capital maintenance in units of constant purchasing power and thus index (adjust nominal values for inflation’s destruction of the real value of money which is the monetary unit of account) wages, salaries, pensions, all income statement items, issued share capital, retained profits, capital reserves, other shareholders´ equity items, trade debtors, trade creditors, taxes payable, taxes receivable and all other balance sheet constant items.

There is no CPI in a barter economy as there is no money in such an economy. The CPI is essential to maintain the real value of constant items in the economy with measurement of financial capital maintenance in units of constant purchasing power being used as the fundamental model of accounting. The CPI is used to calculate the destruction of real value in constant items never maintained in low inflationary economies using HCA as the fundamental model of accounting.

The real value of money is automatically updated by inflation and deflation. Whereas the price of a constant item should change inversely with the change in the real value of money, the real value of money changes inversely with the change in the level of the CPI.

The CPI is the sine qua non in an inflationary and deflationary economy for correcting the problem created by the fact that money is the only universal unit of account that is not a stable unit of measure. It would be impossible to measure inflation and deflation without the CPI. Consequently it would also have been impossible to stop the destruction of the real value in constant real value non-monetary items never maintained (generally retained profits and issued share capital of companies using HCA during inflation with no fixed assets or not sufficient fixed assets to maintain equity´s real value).

This massive destruction of the real value of SA companies´ and banks´ retained profits never maintained, unknowingly perpetrated by SA accountants implementing their very destructive stable measuring unit assumption during low inflation would have been impossible to stop without the CPI. The CPI makes it easy to fix the problem and to stop our accountants destroying about R200 billion each and every year in the SA real economy.

When our accountants freely start measuring financial capital maintenance in units of constant purchasing power as the IASB authorized them to do 20 years ago in the Framework, Par. 104 (a), then they will maintain all constant items in the SA economy for an unlimited period of time by updating them in terms of the change in the CPI instead of destroying their real values at a rate equal to the inflation rate as they are unknowingly doing right now. They would do that even in companies with no fixed assets at all. The "equivalent fixed assets requirement" is only applicable with the stable measuring unit assumption.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Money has no intrinsic value

Our money today has no intrinsic value in itself. It is fiat money that is created by government fiat or decree. The government declares fiat money to be legal tender. In the past monetary coins were made of, for example, silver or gold which were valuable in themselves. The actual metal of which the coin was made had a real or intrinsic value supposedly equivalent to the nominal value inscribed on the coin. Today fiat money is a government decreed and legally recognized medium of exchange, a unit of account and a store of value in our economy.

Our money today has no intrinsic value, as it is the natural product of the development of the monetary unit through time. In the beginning stages it was a full value metal coin. Later it was not a full value metal coin but it was the next best thing as far as economic agents were concerned: it was 100 per cent backed by gold. Today it has no intrinsic value and it is not backed by gold but is “backed” by the combined macroeconomic real value of all the underlying value systems in our economies. This includes, but is not limited to, the economic system, the manufacturing system, the industrial system, the monetary system, the political system, the social system, the educational system, the defence system, the health system, the security system, the legal system, the accounting system, and so on, to name but a few.

Money´s lack of intrinsic value is one of the reasons why gold is the best long-term hedge against economic and political meltdown.

Kindest regards,

Nicolaas Smith

SA accountants simply assume there is no inflation

SA accountants simply assume there is no such thing as inflation and never ever was before either.

Inflation is a rise in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation destroys the real value (purchasing power) of money.

The effect of inflation is distributed evenly in money and monetary items and as a consequence there are hidden costs to some and hidden benefits to others from this destruction in purchasing power in items that are assets to some while a the same time liabilities to others. For example, with inflation lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers will benefit. Individuals and institutions with net monetary assets will experience a net monetary loss (less real value owned/more real value – real assets – destroyed) while individuals and institutions with net monetary liabilities will experience a net monetary gain (less real value owed/more real liabilities destroyed) during inflation.

Increases in the price level (inflation) destroy the real value of money (the functional currency) and other monetary items with an underlying monetary nature (e.g. bonds and loans). However, inflation has no effect on the real value of variable real value non-monetary items (e.g. property, plant, equipment like cars, gold, inventories, finished goods, foreign exchange, etc) and constant real value non-monetary items (e.g. issued share capital, retained profits, capital reserves, other shareholder equity items, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc).

Inflation destroys the real value of money. Inflation has no effect on the real value of non-monetary items. Fixed constant real value non-monetary items never maintained are effectively treated like monetary items under traditional Historical Cost Accounting. Their real values are destroyed at a rate equal to the rate of inflation because they are measured in nominal monetary units and inflation destroys the real value of money which is the monetary unit of account.

SA accountants choose to implement the stable measuring unit assumption during low inflation when they value constant items in fixed nominal monetary units. Accountants´ choice of implementing the stable measuring unit assumption instead of measuring constant items´ real values in units of constant purchasing power, as they are authorized to do in the Framework, Par. 104 (a), results in the real values of these fixed constant items being destroyed at a rate equal to the rate of inflation when they are never maintained during low inflation because inflation destroys the real value of money which is the monetary unit of account. Fixed constant items never maintained are effectively monetary items under HCA. Their real values are destroyed at a rate equal to the rate of inflation because they are measured in nominal monetary units and inflation destroys the real value of money which is the monetary unit of account.

This costs the SA real economy about R200 billion per annum in unknowing real value destruction by SA accountants implementing their very destructive stable measuring unit assumption. They can freely stop this by measuring financial capital maintenance in units of constant purchasing power as they have been authorized to do by the IASB in 1989 in the Framework, Par. 104 (a) which states:

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

They refuse to do that.
The extremely rapid destruction of the real value of the monetary unit of account is compensated for during hyperinflation by the rejection of the stable measuring unit assumption in International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies. IAS 29, which has to be implemented during hyperinflation, requires all non-monetary items (variable items and constant items) to be measured in units of constant purchasing power.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Net monetary gains and losses

Hi,

Net monetary gains and losses are calculated and accounted during hyperinflation as required by IAS 29 Financial Reporting in Hyperinflationary Economies and with the measurement of financial capital maintenance in units of constant purchasing power in terms of the IASB´s Framework, Par. 104 (a) during low inflation. Net monetary gains and losses are not required to be computed under the traditional Historical Cost Accounting model although it has been stated that it can be done.

Computing the gains or losses from holding monetary items can be done and the information disclosed when the books are maintained on a historical-cost basis.

Harvey Kapnick, Chairman of Arthur Anderson & Company, Value based accounting: Evolution or revolution, Saxe Lecture, 1976, Page 6.

http://newman.baruch.cuny.edu/DIGITAL/saxe/saxe_1975/kapnick_76.htm

This omission to compute the gains and losses from holding monetary items is a consequence of the stable measuring unit assumption.

The Measuring Unit principle: The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.

Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc. Page 429.

Kindest regards,

Nicolaas Smith

Money versus real value

In practice, money has a specific real value for a month at a time in an internal economy during low inflation. It changes every time the CPI changes. A monetary note or monetary coin has its nominal value permanently printed on it. Its nominal value does not and now cannot change.

Today monetary units are mostly created in economies subject to inflation. The Japanese economy is regularly in a state of deflation.

Money refers to a monetary unit used within the economy or monetary union in which it is created. This does not refer to the foreign exchange value of a monetary unit. The foreign exchange value of a monetary unit refers to its exchange value in relation to another monetary unit normally the monetary unit of another country or monetary region.

The real value of money would remain the same over time only at sustainable zero per cent annual inflation. Money would thus be the same as real value only at sustainable zero per cent annual inflation. This has never happened on a permanent basis in any economy. Now and then countries achieve zero inflation for a month or two at a time. But never for a sustainable period of a year or more.

Real value is the most important fundamental economic concept although it is the lesser studied and understood compared to the study of money. Money and real value are, unfortunately, not one and the same thing during inflation and deflation. Money and monetary items always have lower real values during inflation and higher real values during deflation under any accounting model.

Money is an invention. We can terminate its existence while real value is a fundamental economic concept, which exists, while we exist. Economies have already functioned without money. Barter economies operated without a medium of exchange. Cuba in the past bought oil from Venezuela and paid part in money and part by the provision of the services of sports coaches and medical doctors. Corn farmers in Argentina stored their corn in silos and paid for new pick-up trucks and other expensive mechanized farm implements with quantities of corn - the unit of real value Adam Smith described more than 220 years ago as a very stable unit of real value.

There will always be real value while the human race exists. The need for a medium of exchange, which is money’s first and basic function, is equally true. Money is one of the greatest human inventions of all time. It ranks on par with the invention of the wheel and the Gutenberg press in terms of importance to human development. Without money modern human development would have been very slow indeed.

Monetary items have the exact same attributes as money with the single exception that they are not actual bank notes and bank coins.

Non-monetary items are all items that are not monetary items.

Kindest regards,

Nicolaas Smith

Money illusion

Definition: Money illusion is the mistaken belief that money is stable – as in fixed – in real value over time.

Money illusion is primarily evident in low inflation countries. In hyperinflationary countries there is absolutely no money illusion as far as the hyperinflationary national currency is concerned. Everyone knows as a fact that the local hyperinflationary currency loses value day by day. In low inflationary countries people are vaguely aware that money loses value over a long period of time. Over the short term, however, low inflation money is used as if its real value is completely stable – as in fixed.

Money illusion is evident everywhere in low inflationary economies. TV channels reporting on historical events regularly quote historical values as the most natural thing to do. “Marble Arch was built for 10 000 Pounds” the TV reporter states with sincere knowledge that his audience is being well entertained with correct facts and figures. It is a figure very difficult to instantaneously value today. 10 000 British Pounds was the original cost in historical terms but we live today and absolutely no-one can immediately imagine what the construction cost of Marble Arch was in current terms. It is the same as saying that 300 years ago something cost one Pound. It is impossible to immediately value it now. We live now and not 300 years in the past. We don’t know what some-one could have bought for a Pound 300 years ago. People in the United Kingdom know what a person can buy for one Pound now – and that value changes month after month.

Companies report an unending stream of information about their performance and results. Sales increased by 5 per cent over last year’s figures, for example. Are these historical cost comparisons or real value comparisons? It is more never than hardly ever stated.

Money illusion is very, very common in our low inflationary economies. An example: The BBC recently ran a program about the fantastic E-Type Jag. It was stated that one of the many reasons why the E-type Jag - the best car ever, according to the presenter - was such a success was its original nominal price of 2 500 Pounds at the time of its first introduction into the market. Towards the end of the program it is then stated that a number of years later these same original E-Type Jags sold at a nominal price at that time of 25 000 Pounds. It is thus implied to be 10 times more than the original price of 2 500 Pounds. In nominal terms, yes. We all agree. Certainly not in real terms and we are interested in real values. We are real people. We live real lives in a real world. Nominal profits - however fantastic they may look - are misleading the longer the time period and the higher the rate of inflation or hyperinflation in the transaction currency during the time period involved.

In this example we are all led to believe that the E-Type Jag was sold at a real value 10 times its original real value. It is the notorious money illusion at work. The real value in a sale like that certainly would not be 10 times the original real value once the original nominal price is adjusted for inflation in the British Pound over the years in question.

Money illusion in Historical Cost values

(The following is adapted from a live-event on CNN. Any resemblance to a living person is purely coincidental ;-)

Let us assume a highly respected 75-year-old grandfather tries to encourage his grandson to accept a low starting salary in a very good company as a good starting point for the youngster’s career. The grandfather may mention that when he started work he earned 25 Dollars per week - meaning that he also started with a low salary and worked his way up. Stating his starting salary at its original historical cost value of maybe more than 50 odd years ago completely distorted the example he was trying to give. He was trying to say - and he certainly did, incorrectly (unintentional though it may have been) create the impression - that he started work at a low salary and had to work his way up. When the original historical cost value of 25 US Dollars of the grandfather’s first weekly pay packet is inflation-adjusted for inflation - in the medium of exchange - during the fifty or more years of his working life till the date of his comments on CNN, we find that he started work at a monthly salary of about 5 000 US Dollars current at the date of his comments. So, at 60 000 US Dollar per year the grandfather had a very good starting salary - which is exactly the opposite of what he was trying to say to his grandson.

That is money illusion at work. Money illusion is so pervasive in our low inflation societies that we do not even notice it any more. It is a complete state of mind - a way of thinking.

We have to stop thinking in money terms and start thinking in real value terms. As long as there is positive inflation in an economy, the national currency created and used in that inflationary economy is not a store of stable real value. It is a store of decreasing real value. Money is losing real value all the time when an economy is in a state of inflation. All current notes and coins will actually be worthless sometime in the future when an economy remains in an inflationary mode for a long enough period of time.

Money developed upon the mistaken belief that it is stable – as in fixed – in real value in the short to medium term in economies with low inflation. The term stable money is seen as meaning that money’s real value stays intact over the short to medium term in low inflationary economies. Money illusion is still very evident today in most economies in money, monetary items and constant items that are mistakenly considered to be monetary items, for example, trade debtors and trade creditors.

Kindest regards,

Nicolaas Smith

International Financial Reporting Standards

Constant Item Purchasing Power Accounting is authorized by the IASB during low inflation

The statement that financial capital maintenance can be measured in either constant purchasing power units or in nominal monetary units in the IASB´s Framework, means that CIPPA has been authorized by the IASB since 1989 as an alternative to the traditional HCA model during periods of low inflation.

This means that the international accounting profession has been in agreement regarding the use of CIPPA for financial capital maintenance in units of constant purchasing power during low inflation since 1989. The standards thus reject the stable measuring unit in this option and in IAS29 Financial Reporting in Hyperinflationary Economies.

Income statement constant real value non-monetary items like salaries, wages, rentals, utilities, transport fees, etc are normally valued by accountants in terms of units of constant purchasing power during low inflation in most economies including South Africa.

Payments in money for these items are normally inflation-adjusted by means of the CPI to compensate for the destruction of the real value of the unstable monetary medium of exchange by inflation. Inflation is always and everywhere a monetary phenomenon and can only destroy the real value of money (the functional currency inside an economy) and other monetary items. Inflation can not and does not destroy the real value of non-monetary items.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission.

Real value destruction in the South African economy

There are two processes of economy wide real value destruction operating in the SA economy. The one overall real value destruction process is well known and generally accepted. It is inflation. Inflation is the enemy in the monetary economy and the Governor of the Reserve Bank is the enemy of inflation. Everybody knows that inflation is destroying the real value of their Rands and all other monetary items at the rate of 6.4% per annum, at the moment. Value date: August 2009 CPI 108.5

The second process of economy wide real value destruction is the unknowing, unintentional and completely unnecessary destruction by SA accountants of the real value of constant items never maintained in the SA constant item economy. This is the result of their implementation of the very destructive stable measuring unit assumption during low inflation as part of the real value destroying traditional Historical Cost Accounting model used by most SA companies. The enemy is SA accountants´ stable measuring unit assumption. In principle, they assume the unit of measure, the Rand, is perfectly stable during inflation; that is, they assume that changes in its general purchasing power are not sufficiently important to require the inflation-adjustment of the nominal values of all constant items in the SA economy in order to maintain their real values constant. In so doing, they unknowingly destroy the real values of constant items never maintained during inflation.

SA accountants´ stable measuring unit assumption is a stealth enemy: hardly anyone understands that when accountants implement it they are unknowingly and unintentionally responsible for the destruction of the real values of constant items not maintained under HCA during inflation.

Table 1: Real value destruction: Historical Cost Paradigm

Monetary aggregate: M3 R1 952.799 billion SARB: Value date: August 2009
Estimated value of constant items not maintained in SA economy: R 3 333 billion

Table 2: Real value destruction: Const. ITEM Purch. Power Accounting

Table 1 above gives us a close estimate of the state of real value destruction in the SA economy at the moment: In the 12 month period ending in August, 2009, inflation actually destroyed R1 952.799 billion x 0.064 = R124.9 billion in the real value of the Rand in the SA monetary economy. At the same time SA accountants unknowingly, unintentionally and completely unnecessarily destroyed about R200 billion in the real value of constant items never maintained in the SA constant item economy. About R324 billion in real value was thus destroyed in the SA economy in the 12 months to August, 2009 by inflation and by SA accountants implementing their very destructive stable measuring unit assumption.

If inflation stays at 6.4% for the next five years and SA accountants keep on unknowingly destroying the real values of constant items not maintained with their very destructive stable measuring unit assumption then a cumulative total of R1 620 billion in real value would be destroyed in the SA economy – all else being equal. The cumulative totals of real value destruction under these circumstances for 10, 20 and 30 years would be R3 240 billion, R6 480 billion and R9 720 billion respectively – ceteris paribus. These are huge values of real value destruction in the SA economy of which the part for which SA accountants are unknowingly responsible, is completely unnecessary and can easily be prevented.

We can see from Table 2 what the difference would be when SA accountants freely decide to measure financial capital maintenance in units of constant purchasing power as the IASB authorized them to do 20 years ago in the Framework, Par. 104 (a).

The destruction of real value in constant items would stop completely. There would only be real value destruction in the real value of the Rand because of inflation. At 6.4% annual inflation only R124 billion in real value would be destroyed in the economy as a whole instead of the current about R324 billion over a period of 12 months. Over five years the cumulative total of real value destruction would drop from R1 620 billion to R 624 billion, over 10 years from R3 240 billion to R1 249 billion, over 20 years from R6 480 billion to R2 498 billion and over 30 years from R9 720 billion to R3 747 billion.

SA accountants unknowingly destroy existing real values in existing constant items with their very destructive stable measuring unit assumption. When they stop their stable measuring unit assumption they would knowingly maintain about R200 billion in existing constant item real values during every period of 12 months in the SA real economy amounting to R1 000 billion over 5 years, R 2 000 billion over 10 years, R4 000 over 20 years and R6 000 billion over 30 years. Boosting the real economy with these real values would make a very big difference to the SA economy as a whole, to growth and to employment in the economy over that period.

Obviously a further reduction of inflation to an annual average of 3% would improve the SA economy even more. Over 30 years it would boost the economy by a further R2 000 billion on top of the R6 000 to be gained when SA accountants freely switch over to financial capital maintenance in units of constant purchasing power.

Kindest regards,

Nicolaas Smith

Capital illusion

Capital illusion is the mistaken belief by accountants, economists, analysts, investors and business people that the real value of companies´ capital and retained profits are always adequately maintained during low inflation under the Historical Cost paradigm.

Capital illusion is aided and abetted by the International Accounting Standards Board’s unqualified statement in the Framework, Par. 104 (a) that financial capital maintenance can be measured in nominal monetary units.

It is impossible to maintain the real value of financial capital in nominal monetary units – per se – during inflation.

100% of the inflation-adjusted original real values of all contributions to Shareholders´ Equity have to be invested during inflation in revaluable variable item fixed assets with an equivalent updated fair value (revalued or with unrecorded hidden holding gains) in order not to destroy Shareholders Equity’s original real value at a rate equal to the rate of inflation under the traditional Historical Cost Accounting model implemented by most companies in South Africa.

Very few companies in SA abide by the 100% of equity invested in fixed assets rule.

There is neither capital illusion nor massive unnecessary capital destruction when financial capital maintenance is measured in units of constant purchasing power as authorized by the IASB in the Framework, Par. 104 (a) in 1989: the real value of Shareholders´ Equity is maintained even without fixed assets in companies that break even.

Kindest regards,

Nicolaas Smith

Summary: Capital illusion is the mistake everyone makes in thinking that the real value of companies´ equity (capital and retained profits) is always backed by their fixed assets - either revalued or with unaccounted holding gains. Inflation-adjusting all constant items will maintain the real value of your equity forever as long as you break even - even if you have no fixed assets at all - instead of destroying the unbacked part at the rate of inflation as accountants are unknowingly doing at the moment, unnecessarily decapitalizing SA companies and banks by about R200 billion per year.

Mboweni´s R120 billion annual gift to South Africa

Money illusion is still very evident today in most economies in money, monetary items and constant items that are mistakenly considered to be monetary items, for example, trade debtors and trade creditors.

The incorrect treatment of trade debtors and trade creditors as monetary items is mainly due to the incorrect definition of monetary items in IFRS. IAS 29, Par. 12 defines monetary items incorrectly as follows:

Monetary items are money held and items to be received or paid in money.

Not all items to be received or paid in money are monetary items – per se. Money is simply used as the generally accepted medium of exchange to transfer monetary items as well as most non-monetary items from one economic entity to another. Most non-monetary items are transferred from one entity to another by generally accepted mutual agreement to use money as the medium of exchange.

Money has the legal backing of being legal tender. Legal tender is an offered payment that, by law, cannot be refused in settlement of a debt. Legal tender is anything which, when offered, extinguishes the debt. Credit cards, debit cards, personal cheques and similar non-cash methods of payment are not usually legal tender. The law does not relieve the debt until payment is accepted which explains the practice in some economies of making out receipts for most payments. Bank notes and coins are usually defined as legal tender.

Monetary items are incorrectly defined in IAS 21, Par. 8 too:

Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency.

Not all assets and liabilities to be received or paid in a fixed or determinable number of units of currency are monetary items – per se.

The correct definition of monetary items:

Monetary items are money held and items with an underlying monetary nature.

Money illusion is the mistaken belief by people in general that money’s real value is maintained in the short to medium term in low inflationary economies. Central bank governors aid and abet money illusion by regularly stating in their monetary policy statements that they are “achieving and maintaining price stability.”

“The MPC remains fully committed to its mandate of achieving and maintaining price stability.”

TT Mboweni, Governor. 2009-06-25: Statement of the Monetary Policy Committee, SARB.

It is not always pointed out by governors of central banks that the “price stability” they mention, refers to their definition of “price stability”. Jean-Claude Trichet, the President of the European Central Bank, is a central bank governor who regularly mentions that 2% inflation is their definition of price stability. Absolute price stability is a year-on-year increase in the Consumer Price Index of zero per cent. The SARB´s definition of “price stability” “is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”

The SARB would aid in reducing money illusion by stating:

The MPC remains fully committed to its mandate of achieving and maintaining the SARB´s chosen level of price stability which is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. Absolute price stability is a year-on-year increase in the CPI of zero per cent. Current 6.4% annual inflation destroyed about R124 billion of the real value of the Rand over the past 12 months to the end of August, 2009. A one per cent decrease in inflation would maintain about R19 billion per annum of real value in the SA monetary economy.

Tito Mboweni, the highly respected outgoing Governor of the SARB, has achieved the remarkable distinction of reducing the average annual destruction of the real value of the Rand by inflation by 50% during his 10 year tenure at the helm of South Africa’s central bank. In the 18 years before his arrival, average annual destruction of the real value of the Rand by inflation was 12 % or R240 billion per annum in August, 2009 CPI value terms – ceteris paribus. This means that Mr Mboweni and his excellent team at the SARB managed to maintain, on average, an extra R120 billion per annum in the SA monetary economy over the last 10 years. This annual R120 billion benefit to the SA economy will remain in place as long as average annual inflation stays at 6% or lower – all else being equal.

A further reduction of average annual inflation to 3% - the bottom level of the SA´s inflation target range – would maintain an additional R60 billion per annum in the SA monetary economy. That would bring the total real value maintained to R180 billion per annum compared to the R240 billion real value destroyed per annum during the last 18 years before Mr Mboweni´s arrival at the SARB.

Kindest regards,

Nicolaas Smith

Money makes the world go round

Hi,

Monetary items are money held and items with an underlying monetary nature.

Money is the greatest economic invention of all time. Money did not exist and was not discovered. It was invented over a long period of time. Money is a monetary item which is used as a medium of exchange and serves at the same time as a store of value and as the monetary unit of account for the accounting of economic activity in a country or a monetary region like the Rand Common Monetary Area which includes South Africa, Namibia, Swaziland and Lesotho.

Money is a medium of exchange which is its main function. Without that function it can never be money. Money is the functional currency in an economy, i.e. the currency of the primary economic environment in which an economic entity operates. The historical development of money led it also to be used as the fundamental unit of measure to account the value of economic items. Money is the only universal unit of measure that is not a stable value. All other universal units of measure are fundamentally stable units of measure, e.g. inch, centimetre, ounce, gram, kilogram, pound, etc.

Historically money developed on the mistaken belief by people in general that it is stable – as in fixed – in real economic value in the short to medium term in economies with low cash inflation. Stable in this instance was seen as meaning that money kept its real value intact over the short to medium term in low inflationary economies. Money illusion is still very evident today in most economies in money, monetary items and constant items that are mistakenly considered to be monetary items, for example, trade debtors and trade creditors. There is no money illusion in hyperinflationary economies. People know that hyperinflation destroys the real value of money very quickly.

It is not what it appears to be

When we discuss, write about, talk about or analyze this monetary item described above, we call it money and describe it using the term money with the implicit assumption that this money we are dealing with is stable - as in fixed - in real economic value in our low inflationary economies. We thus assume at the same time that prices are more or less stable in low inflationary economies.

The term stable is normally accepted by the public at large to indicate a permanently fixed situation or position or state or price or value. A stable – as in fixed - price over time would be drawn as a horizontal line on a chart. A slowly increasing price over time would be drawn as a slightly rising line on a chart. A slowly decreasing value over time would be drawn as a slightly declining line on a chart. When we say production of a commodity is stable we accept that the absolute number of items being produced is not fluctuating but is at the same level all the time.

The term stable as used by economists, however, does not mean a fixed price or level, even though that is what the public in general thinks it means. The term stable in economics these days means slowly increasing or slowly decreasing – depending on what it is being applied to. The term price stability as used by economists today does not mean that prices in general stay the same, but that prices in general are rising slowly – which is, as we are all taught, the popular definition of inflation.

The term stable money as used by economists equally does not mean that the real value of national monetary units they are talking about stays the same in the economy – even though that is what the public in general thinks it means. What they mean with stable money is that the real value of a national monetary unit is slowly decreasing over time – which is, as we shall see, a much better – but not yet the best – definition of inflation.

When a central bank governor says that the central bank’s primary task or objective is price stability what she or he means is that the central bank would be fulfilling its primary task, in an economy with low levels of inflation, when prices in general are slowly rising over time (that well known definition of inflation again). The flip side of that statement is that the real value of national monetary units is slowly being destroyed by inflation over time – the best definition of inflation.

A central bank’s primary task being price stability is the same as saying a central bank’s main responsibility is ensuring that inflation is maintained at a very low level. This low level is now generally accepted in first world economies to be up to 2 percent per annum. We know that inflation is always and everywhere the destruction of real value in money and other monetary items over time. We also know that inflation has no effect on the real value of non-monetary items.

The maintenance of price stability thus means that the primary task of a central bank is to limit the destruction of real value in money and other monetary items by inflation to a maximum of 2 percent per annum within an economy or common monetary area. Two percent continuous inflation destroys the following percentages of real value over the time periods indicated:

Years....%
5.......10
10......18
16......28
20......33
30......45
35......51

We also know that accountants unknowingly destroy the real value of constant items never or not fully updated during inflation when they implement the very destructive stable measuring unit assumption as part of the real value destroying traditional Historical Cost Accounting model. Historical Cost accountants thus unknowingly destroy the same percentages stated above in the real value of constant items never updated during continuous “price stability” of 2% inflation per annum in low inflation first world economies.

Kindest regards,

Nicolaas Smith

Deloitte ignores capital

Deloitte, one of the Big Four accounting and auditing multi-nationals, also ignores the paragraphs in the Framework that deal with the concepts of capital, capital maintenance and the determination of profit or loss in their presentation of the Framework on their site IAS Plus as at 02/10/2009. Deloitte do not even mention one word in their presentation of the Framework about the fact that companies can measure financial capital maintenance in units of constant purchasing power.



This appears to be another example of the lack of understanding by accountants in general that an essential function of accounting is to maintain the real value of constant items at all levels of inflation and deflation which can only be achieved with the IASB approved CIPPA model in the Framework, Par. 104 (a) during low inflation and IAS 29 during hyperinflation.

http://www.iasplus.com/standard/framewk.htm

Similarly the paragraphs in the Framework dealing with the concepts of capital, the concepts of financial capital maintenance and units of constant purchasing power were also omitted from presentation of the Framework in the Wikipedia article on IFRS till they were added very recently. The whole of the Framework was summarized in the Wikipedia article, except those paragraphs.

The concept of financial capital maintenance in units of constant purchasing power during low inflation seems to have been correctly treated by the IASC Board twenty years ago – and then simply just ignored by everyone.

Kindest regards,

Nicolaas Smith

This is not inflation accounting

Constant ITEM Purchasing Power Accounting, despite being approved by the IASB in the Framework twenty years ago, is completely ignored by accountants in non-hyperinflationary economies even though it would maintain instead of destroy the real values of not only all income statement constant items but also all balance sheet constant real value non-monetary items for an unlimited period of time during low inflation and deflation. CIPPA would stop SA accountants unknowingly destroying about R200 billion in the real value of constant items in the SA real economy each and every year. CIPPA would result in SA accountants knowingly boosting the SA real economy by at least R200 billion per annum for an unlimited period – ceteris paribus.

The reason accountants ignore CIPPA is because any price-level accounting model is generally viewed by almost all accountants and accounting authorities as a 1970-style failed and discredited inflation accounting model that requires all non-monetary items - variable real value non-monetary items and constant real value non-monetary items - to be inflation-adjusted by means of the CPI.

SA accountants forego the opportunity to implement the substantial real value maintaining benefits of measuring financial capital maintenance in units of constant purchasing power in SA companies and the economy in general. This results in the unknowing and unintentional destruction by SA accountants of billions of Rand in real value in the SA real economy – in most companies´ Retained Earnings (to name just one item unknowingly destroyed by SA accountants like this) - year in year out because they choose to measure financial capital maintenance in nominal monetary units and implement the very destructive stable measuring unit assumption as part of the real value destroying HCA model in SA when they maintain the stable measuring unit assumption for an unlimited period of time during indefinite inflation.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission

Salaries and wages are normally inflation-adjusted

Salaries, wages, rentals, etc are normally inflation-adjusted in South Africa and generally too in most economies in the world.
Inflation-adjusted income statement constant real value non-monetary items, for example, salaries and wages, are – right this very moment - a blessing to users in SA – and all around the world - because they maintain the real value or purchasing power of salaries and wages during inflation as long as the inflation-adjustment is at least equal to inflation over the period in question. Millions of SA workers, their trade unions, the SA government, SA accountants and South Africans in general would agree that the practice of inflation-adjusting accounts in a low inflation environment is a blessing to users and does not insult them.
Inflation-adjusted balance sheet constant real value non-monetary items, e.g. Issued Share capital, Retained Earnings, etc in SA´s low inflation environment would be a blessing to everyone in SA when our accountants simply choose to change from their current implementation of the real value destroying traditional HCA model and freely choose to implement the real value maintaining Constant ITEM Purchasing Power Accounting model as approved in the IASB´s Framework, Par. 104 (a) twenty years ago. They would maintain - instead of currently destroy as they also did last year and all the years before - at least R200 billion annually in constant item real value in the SA real economy for an unlimited period – all else being equal – and as they will do next year if they carry on with their very destructive stable measuring unit assumption.


© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.

1970-style CPP inflation accounting was a failed inflation accounting model.

1970-style CPP inflation accounting was a failed inflation accounting model.

The difference between constant real value non-monetary items and variable real value non-monetary items is not generally known yet.
SA accountants freely destroy real value in the real economy with their assumption that the rand is perfectly stable only for the purpose of accounting constant value items, and have absolutely no concern about the negative impact this has on sustainable economic growth.

The destruction of real value in the real economy by SA accountants will stop when they stop their assumption that the rand is perfectly stable only for the purpose of accounting constant items never or not fully updated.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission

Inflation August, 2009

A slightly diffirent presentation of inflation facts for South Afrca. It would
be quite interesting to calculate the amount of real value destroyed over the
last 5, 10, 15, 20, 25 years, etc.

Annual inflation 6.4%


Annual destruction in real value of Rand by inflation R128 billion aprox


Annual constant item real value destruction by the implementation of the
stable measuring unit assumption by SA accountants R200 billion aprox


Cumulative inflation since Jan 1981 1 386.3%


Cumulative inflation since Apr 1994 167.2%


Real value unknowingly destroyed by SA accountants in Shareholders´ Equity items having remained in SA companies from Jan 1981 to Aug 2009 without an equivalent investment in fixed assets with the same fair value (revalued or with undisclosed holding gains) as a result of Historical Cost Accounting. 93.3%


The equivalent value from Apr 1994 to Aug 2009. 62.6%


Kindest regards,

Who destroy more real value: Inflation or SA Accountants?

100% of the inflation-adjusted original real values of all contributions to Shareholders´ Equity have to be invested in revaluable variable item fixed assets with an equivalent updated fair value (revalued or with unrecorded hidden holding gains) in order not to destroy Equity’s original real value under the traditional Historical Cost Accounting model implemented by all companies in South Africa.

The current real value of the nominal portion not invested as such will be destroyed at a rate equal to the rate of inflation when the constant item Equity is measured in nominal monetary units, i.e. implementing the stable measuring unit assumption as done by all SA accountants.

Most companies do not meet the 100% requirement. In practice this means that the real value of Retained Profits of all SA companies and banks are unknowingly and unintentionally being destroyed at a rate equal to the rate of inflation by SA accountants implementing the real value destroying traditional Historical Cost Accounting model.

Implementing the IASB approved alternative, namely, financial capital maintenance in units of constant purchasing power as authorized in 1989 in the Framework, Par. 104 (a), would stop this destruction forever under all levels of inflation and deflation whether a company has fixed assets or has no fixed assets at all.

SA accountants would maintain instead of currently destroy about R200 billion per annum in constant item real value in the SA real economy when they reject the stable measuring unit assumption as approved in Par. 104 (a).

One percent inflation destroys about R20 billion per annum in the real value of the Rand in SA.

6.4% inflation thus destroys about R128 billion per annum in the real value of the Rand.

SA accountants unknowingly and unintentionally destroy about R200 billion per annum in the real value of constant items not fully or never updated because they implement the stable measuring unit assumption.

Kindest regards

Nicolaas Smith

Summary: The only way you can prevent your accountant from destroying the real value of your capital and retained profits at the rate of inflation with traditional Historical Cost Accounting is to invest 100% of your capital and retained profits in fixed assets. Hardly any company does that. It means that most companies´ and banks´ retained profits are unknowingly being destroyed by their accountants.

Under the alternative units of constant purchasing power accounting during low inflation your accountant would maintain the real value of your capital and retained profits forever no matter what the rate of inflation and even if you have no fixed assets - as long as you break even.

SA accountants are unknowingly terrible destroyers with their stable measuring unit assumption.

Sir David Tweedie´s perfect solution

Accountants are players in the business game because of their specialized knowledge in the monetary game and variable item game which they play together with other management team players. Accountants are always scorekeepers by training in all the games too.

Accountants do not have the assistance of other management team players in the constant item game they play against the stable measuring unit assumption enemy. In the selected income statement constant item game accountants are unbeatable world champions against the stable measuring unit assumption enemy. They inflation adjust salaries, wages, rentals, etc during low inflation and score all the time. The stable measuring unit assumption enemy never scores as long as accountants measure these items in units of constant purchasing power during low inflation.

Now comes the End Game.

The purpose of this game is to maintain the real value of the other income statement and all balance sheet constant items.

The game is played at Ellis Park.

Sir David Tweedie, Chairman of the International Accounting Standards Board leads a delegation from the Board at the game. The IASB has a magnificent exhibition inside the Ellis Park grounds where they demonstrate their indestructible Measurement in Units of Constant Purchasing Power Missile Attack System. This missile kills the stable measuring unit assumption enemy instantaneously whenever this missile is used for an indefinite period of time.

It is very strange that all the Boards of Directors of especially JSE listed companies stream past Sir David´s exhibition without anyone even stopping to look at the deadly weapon. When I ask one of the Board of Directors why that is, they say the exhibition has been there since 1989 and no-one has ever stopped to look at it.

SA accounting professors are Historical Cost gurus. They advised them that accountants are actually only scorekeepers and should not even be on the field playing against the stable measuring unit assumption enemy. They state that there is absolutely no substance in the claim that Sir David´s Measurement in Units of Constant Purchasing Power system can be used during low inflation. They all love the stable measuring unit assumption. They feel that they have proved themselves after their long Historical Cost teaching careers and that anyone who opposes them must be nuts.

I pointed out to them that Sir David has a big poster up saying: FOR USE DURING LOW INFLATION!! The Board of Directors say they don´t understand it especially after the professors´ specific instructions that accountants are only scorekeepers and never players. They seem to be very confused.

The End Game begins.

There are only accountants on the field against the massive stable measuring unit assumption enemy who uses the Historical Cost method. The accountants kick off at the start of the financial year. Then something extraordinary happens. All the accountants get a glazy look in their eyes as if they cannot see the stable measuring unit assumption enemy. They all turn around and meekly go and sit behind the try-line.

The stable measuring unit assumption enemy gathers the ball and trots through unopposed to score under the poles and converts the try. The next kick-off is by the ABSA accountants. After the kick-off they do the same. They quietly run back and sit down behind the try-line. The stable measuring unit assumption picks up the ball, scores under the poles and converts thus destroying about R3.4 billion in the real value of ABSA´s Retained Profits during 2009.

At the end of the game the stable measuring unit assumption enemy has destroyed R200 billion in the real value of SA constant items never updated. The game is over for the year. The accountants being well trained scorekeepers keep score during and after the game.

In this game they are only scorekeepers which prove the professors right – but, only for this mainly balance sheet constant item game. Not for any of the other games. This proves that when accountants are only scorekeepers in Historical Cost nominal monetary values for constant items never updated, real value is destroyed on a massive scale in the SA real economy.

Next year´s game will be exactly the same unless Sir David can get SA Boards of Directors to accept his free offer. He is a very patient man. He has been trying for the last 20 years with not a single free give-away in SA – or anywhere else in the low inflation world. Apparently a rogue SA accountant living in Portugal accepted his offer. Well, at least he managed one free give-away in twenty years.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission

All hell breaks lose in final game

All hell breaks lose in final game


We have seen up to now that accountants are always scorekeepers because of their specialized training and knowledge in the two accounting games looked at so far: the monetary item game and the variable item game.

But, they are always also important players in these two games. They are never just scorekeepers as SA accounting professors so eloquently claim. They and all their supporters in this aspect of accounting are dead wrong.

A very interesting point is that in the monetary item and variable item games accountants join all the other members of their management teams to play the business game. As players they all score when they make profits, are part of the profit making process or simply mangage to maintain the real values of economic items.

In the monetary item game they are up against the inflation enemy. There are no apparent enemies in the variable item game as the efficient market mechanism kills all enemies to the equilibrium of supply and demand. We must admit that it was actually a variable item enemy, bad mortgage credit, which caused the current international financial crisis.

The constant item game is a very different type of game. There is only one person who can play this game: the accountant. No-one else in the management team or any worker in the business game can play this game.

We find the second economic enemy in this game: the stable measuring unit assumption. Only accountants can fight against the stable measuring unit assumption.

This economic enemy is a remarkable enemy. It is a stealth enemy. No-one really knows that it is destroying the economy. Those who know, like Market Monkey, say it does not really make any difference. He and they are dead wrong.

The board of directors can acquire a deadly weapon for the accountant to kill the stable measuring unit assumption instantaneously. All boards of directors inexplicably refuse to do anything about it.


Accountants managed to break the constant item game up into two games: a selected income statement constant item game and a mainly balance sheet constant item game.

In the selected income statement constant item game accountants completely crush the stable measuring unit assumption enemy. They inflation adjust salaries, wages, rentals, etc and the stable measuring unit assumption enemy never ever scores as long as accountants value these items in units of constant purchasing power.

Accountants are world champions in this selected income statement constant item game. They never lose and the stable measuring unit assumption enemy never scores one single point against them.

Accountants are obviously also scorekeepers in this game. They are the only players on the field but they get invaluable help from trade unions off the field.

In the next post all hell brakes loose in the final game. You will never ever believe what happens.

© 2005-2010 by Nicolaas J Smith. All rights reserved

No reproduction without permission

Inflation accounting

As a result of the lack of appreciating the destructive nature of their implementation of the very destructive stable measuring unit assumption, 1970-style CPP inflation accounting was also not an accounting system implemented by accountants to correct or eliminate the destruction of the real value of constant items by the use of the stable measuring unit assumption, but, a failed attempt to simply make financial reports more understandable and more comparable with previous year statements during periods of high inflation by inflation-adjusting all non-monetary items equally in terms of the CPI.

Accountants simply do not appreciate that they unknowingly destroy real value on a massive scale in all constant real value non-monetary items never or not fully updated when they choose to implement the very destructive stable measuring unit assumption for an unlimited period of time during indefinite inflation. They also do not appreciate that they make that choice. Neither do they appreciate that they will stop that destruction by freely choosing to measure financial capital maintenance in units of constant purchasing power, as approved in the IASB Framework, Par. 104 (a) in 1989.

Geoffrey Whittington in his definitive work on inflation accounting in the beginning of the 1980´s, Inflation Accounting - An Introduction to the Debate, published in 1983, clearly indicated that with 1970-style CPP inflation accounting all non-monetary accounts (with no distinction being made between variable and constant real value non-monetary item accounts) were updated by means of the CPI.

He stated that Constant Purchasing Power inflation accounting (CPP) was a method of inflation-adjusting all non-monetary accounts consistently by means of the Consumer Price Index which reflected changes in money’s purchasing power. 1970-style CPP inflation accounting tried to deal with the problem of inflation in the popularly understood sense, as a decrease in the real value of money. According to Whittington, CPP inflation accounting tried to solve this problem by inflation-adjusting all non-monetary items at the reporting date by means of the CPI.

Kindest regards,

Nicolaas Smith