A price increase is paying more money for more real value.
Inflation is paying of more money for the same real value.
In theory, when electricity becomes more valuable in the SA economy and it´s price is increased by 45%, then households would have to spend less on other items – all else being equal.
Thus, no increase or decrease in inflation.
Inflation comes about when business abuses the electricity price increase to increase the general price level instead of just the price of electricity.
A one percent increase in inflation – paying one per cent more for the same real value in general – is expected as a result of the electricity price increase.
A 45% price increase for three years in a row equals a 304% increase over that period.
Kindest regards,
Nicolaas Smith
Friday, 23 October 2009
Wednesday, 21 October 2009
Valuing monetary items during low inflation
Valuing monetary items during low inflation
Money and other monetary items can not be updated or indexed or inflation-adjusted or maintained during the current financial period under any accounting model under any economic mode that is not sustainable zero per cent annual inflation. Inflation destroys the real value of monetary items evenly throughout the SA monetary economy currently at 6.4% per annum (Aug 2009) or about R124 billion per annum. Monetary items only maintain their real values perfectly stable under sustainable zero per cent annual inflation. This has never been achieved before over an extended period of time.
The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. SARB
The SARB´s definition of price stability, in practice, is the destruction of the real value of the Rand at a rate of 6% or about R120 billion per annum because inflation normally increases to the top of the inflation targeting range. Real value is destroyed evenly in Rand bank notes and coins and other monetary items (loans, deposits, etc) throughout the SA monetary economy. Why destroying R120 billion per annum of the Rand´s real value in people’s pockets is supposedly good for the SA economy – supposedly good for economic growth and supposedly good for creating employment – is not well known in the SA economy.
SA accountants account monetary items at their original nominal values – at their historical cost – during the current financial period. It thus appears that it is correct when it is stated that “financial reporting simply reports on what took place”. That is dead wrong. Accountants value everything they account. There is no other way monetary items can be accounted and valued during the current financial period. It is an illusion that accountants only record what happened in the past: the “financial reporting simply reports on what took place” illusion as promoted by some SA accounting professors.
SA accountants value monetary items at their current depreciated generally lower real values by accounting them at their original nominal values during inflation. Their real values are destroyed by inflation over time. Being stated at their original nominal values by accountants during inflation means that monetary items are automatically being valued by the continuous economic process of inflation over time.
This obviously means that monetary items are always correctly valued during the current financial period in any current account: at the current real value as determined by the current rate of inflation. Money and other monetary items´ real values consequently generally decrease monthly to a lower real value in low inflationary economies.
SA accountants do not destroy the real value of monetary items in the SA monetary economy: inflation does that. SA accountants value and account monetary items correctly in the SA monetary economy by stating them at their original nominal values. They, however, fail to calculate and account the net monetary gains and losses from holding either net monetary liabilities or net monetary assets, as the case may be.
The only difference between accounting and valuing monetary items under the current real value destroying Historical Cost Accounting model and their accounting and valuation when measuring financial capital maintenance in real value maintaining units of constant purchasing power would be the calculation and accounting of net monetary gains and losses. These gains and losses are not calculated and accounted under the HCA model although it can be done. See Kapnick above. No-one does that under HCA. Net monetary gains and losses are constant real value non-monetary items (income statement gains and losses) once they are accounted and have to be inflation-adjusted thereafter under the Constant ITEM Purchasing Power Accounting model.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
Money and other monetary items can not be updated or indexed or inflation-adjusted or maintained during the current financial period under any accounting model under any economic mode that is not sustainable zero per cent annual inflation. Inflation destroys the real value of monetary items evenly throughout the SA monetary economy currently at 6.4% per annum (Aug 2009) or about R124 billion per annum. Monetary items only maintain their real values perfectly stable under sustainable zero per cent annual inflation. This has never been achieved before over an extended period of time.
The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis. SARB
The SARB´s definition of price stability, in practice, is the destruction of the real value of the Rand at a rate of 6% or about R120 billion per annum because inflation normally increases to the top of the inflation targeting range. Real value is destroyed evenly in Rand bank notes and coins and other monetary items (loans, deposits, etc) throughout the SA monetary economy. Why destroying R120 billion per annum of the Rand´s real value in people’s pockets is supposedly good for the SA economy – supposedly good for economic growth and supposedly good for creating employment – is not well known in the SA economy.
SA accountants account monetary items at their original nominal values – at their historical cost – during the current financial period. It thus appears that it is correct when it is stated that “financial reporting simply reports on what took place”. That is dead wrong. Accountants value everything they account. There is no other way monetary items can be accounted and valued during the current financial period. It is an illusion that accountants only record what happened in the past: the “financial reporting simply reports on what took place” illusion as promoted by some SA accounting professors.
SA accountants value monetary items at their current depreciated generally lower real values by accounting them at their original nominal values during inflation. Their real values are destroyed by inflation over time. Being stated at their original nominal values by accountants during inflation means that monetary items are automatically being valued by the continuous economic process of inflation over time.
This obviously means that monetary items are always correctly valued during the current financial period in any current account: at the current real value as determined by the current rate of inflation. Money and other monetary items´ real values consequently generally decrease monthly to a lower real value in low inflationary economies.
SA accountants do not destroy the real value of monetary items in the SA monetary economy: inflation does that. SA accountants value and account monetary items correctly in the SA monetary economy by stating them at their original nominal values. They, however, fail to calculate and account the net monetary gains and losses from holding either net monetary liabilities or net monetary assets, as the case may be.
The only difference between accounting and valuing monetary items under the current real value destroying Historical Cost Accounting model and their accounting and valuation when measuring financial capital maintenance in real value maintaining units of constant purchasing power would be the calculation and accounting of net monetary gains and losses. These gains and losses are not calculated and accounted under the HCA model although it can be done. See Kapnick above. No-one does that under HCA. Net monetary gains and losses are constant real value non-monetary items (income statement gains and losses) once they are accounted and have to be inflation-adjusted thereafter under the Constant ITEM Purchasing Power Accounting model.
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission
Accountants transform an illusion into a GAAP
Inflation destroys the assumption that money is stable which is the basis of classic accountancy. In such circumstances, historical values registered in accountancy books become heterogeneous amounts measured in different units. The use of such data under traditional accounting methods without previous correction makes no sense and leads to results that are void of meaning.
Massone, 1981a. p.6
Money’s third function is that it is the unit of account in the economy. It is a monetary standard of measure of the real value of economic items to facilitate exchange without barter in order to overcome the double coincidence of wants problem. Inflation destroys the real value of money and deflation increases the real value of money. Money has never been perfectly stable in real value over an extended period of time. However, money illusion makes people believe that money maintains its real value over the short to medium term. Money is the only standard unit of measure that is not a fundamentally stable or fixed unit of value. All other standards of measure are perfectly stable units.
Accountants transformed money illusion into an official generally accepted accounting principle with their stable measuring unit assumption, also called 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 reports.
Kindest regards,
Nicolaas Smith
Massone, 1981a. p.6
Money’s third function is that it is the unit of account in the economy. It is a monetary standard of measure of the real value of economic items to facilitate exchange without barter in order to overcome the double coincidence of wants problem. Inflation destroys the real value of money and deflation increases the real value of money. Money has never been perfectly stable in real value over an extended period of time. However, money illusion makes people believe that money maintains its real value over the short to medium term. Money is the only standard unit of measure that is not a fundamentally stable or fixed unit of value. All other standards of measure are perfectly stable units.
Accountants transformed money illusion into an official generally accepted accounting principle with their stable measuring unit assumption, also called 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 reports.
Kindest regards,
Nicolaas Smith
Tuesday, 20 October 2009
Inflation is the abuse of the Rand´s store of value function
Money is a store of value. Money is a depreciating store of value during inflation and an appreciating store of value during deflation.
Money has to maintain most of its value over time in order to be accepted as a medium of exchange. It would not solve barter’s double coincidence of wants problem if it could not be stored over time and still remain valuable in exchange.
The fact that inflation is destroying the real value of money means it is a store of depreciating real value during inflation. Money was a store of value right from the start. First types of money consisted of gold or silver coins. The metals from which the coins were made had an actual real value in themselves and these coins could be melted down and the metal could be sold in its bullion form when the bullion price was above the coin price. Next money was not made of precious metal coins but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating money simply represents depreciating real value since depreciating bank notes and bank coins have no intrinsic value. Although the store of value function and nominal values of depreciating bank notes and bank coins are legally defined, their depreciating real values are determined by the economic process of inflation.
The abuse of money’s store of value function led to inflation.
Money is very liquid; i.e. it is readily available as cash and it is normally easy to obtain on demand. A property, e.g. a well-located plot of land with a well-maintained and well-equipped building is also a store of value. It is however quite an illiquid store of value. The real value is not immediately available in easily transportable and divisible cash. Money’s high liquidity makes it more desirable as a store of value in comparison with other stores of value like gold, property, marketable securities, bonds, etc. Money is obviously not the best store of value in an inflationary economy where its real value is being destroyed by inflation. Money is normally available in convenient smaller denominations which facilitate everyday small purchases. As such, money is very user friendly. It is easily transportable especially with electronic transfer facilities.
Inflation actually manifests itself in money’s store of value function. Inflation does not manifest itself in money’s medium of exchange function or unit of account functions which vindicates the fact that inflation can only destroy the real value of money and monetary items; i.e. inflation has no effect on the real value of non-monetary items. Money is always a medium of exchange of equal real value at the moment of exchange. Free market prices are adjusted in the market in a price setting process that takes the decreasing real value of money into account (amongst many other factors) so that economic items (the product and the amount of money) of equal real value are exchanged at the moment of exchange.
Constant real value non-monetary items, e.g. salaries, wages, rents, etc which are measured in units of constant purchasing power (inflation-adjusted)
Depreciating money has a constantly decreasing real value. Depreciating “bank money” deposits have the same attributes of depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary values. The depreciating money represented by depreciating accounted bank money also has a depreciating store of value function.
A country’s money supply consists of banknotes and coins (currency) and bank money or demand deposits - the balances in savings and deposit accounts. Intangible bank money is usually a much larger part of the money supply than bank notes and coins.
SA monetary aggregates
According to the SARB the monetary aggregates in SA consist of the following:
M0
Deposits of banks and mutual banks with the SARB and notes and coins outside
the SARB and SA mint
M1A
Coins and banknotes in circulation outside the monetary sector, cheque and
transmission deposits with banking institutions and the post office savings
bank
M1
MIA plus other demand deposits with banking institutions
M2
M1 plus other short term deposits, and all medium term deposits (including
savings deposits) with the monetary banking institutions
M3
M2 plus all long term deposits with monetary banking institutions
In a low cash inflationary economy depreciating money is a store of decreasing real value but it is generally assumed to have a stable – as in fixed - real value. SA accountants officially assume that the Rand is perfectly stable when they value fixed balance sheet constant real value non-monetary items never maintained. They do not consider the destruction of the Rand´s real value (e.g. at 6.4% per annum and even up to more than 20% per annum, but not as high as 26% per annum for three years in a row) as sufficiently important for them to decide to measure constant items in units of constant purchasing power - as approved by the IASB twenty years ago - to stop the destruction of real value in fixed balance sheet constant items (issued share capital, retained profits, all other shareholders equity items, trade debtors, trade creditors, taxes payable, taxes receivable, etc) never maintained. SA accountants´ stable measuring unit assumption is very destructive and totally unacceptable. It always was and now still is fundamentally wrong and very costly to the SA economy. SA accountants unknowingly destroy about R200 billion in the real value of constant items never maintained in this manner – each and every year (all else being equal).
Kindest regards,
Nicolaas Smith
Money has to maintain most of its value over time in order to be accepted as a medium of exchange. It would not solve barter’s double coincidence of wants problem if it could not be stored over time and still remain valuable in exchange.
The fact that inflation is destroying the real value of money means it is a store of depreciating real value during inflation. Money was a store of value right from the start. First types of money consisted of gold or silver coins. The metals from which the coins were made had an actual real value in themselves and these coins could be melted down and the metal could be sold in its bullion form when the bullion price was above the coin price. Next money was not made of precious metal coins but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating money simply represents depreciating real value since depreciating bank notes and bank coins have no intrinsic value. Although the store of value function and nominal values of depreciating bank notes and bank coins are legally defined, their depreciating real values are determined by the economic process of inflation.
The abuse of money’s store of value function led to inflation.
Money is very liquid; i.e. it is readily available as cash and it is normally easy to obtain on demand. A property, e.g. a well-located plot of land with a well-maintained and well-equipped building is also a store of value. It is however quite an illiquid store of value. The real value is not immediately available in easily transportable and divisible cash. Money’s high liquidity makes it more desirable as a store of value in comparison with other stores of value like gold, property, marketable securities, bonds, etc. Money is obviously not the best store of value in an inflationary economy where its real value is being destroyed by inflation. Money is normally available in convenient smaller denominations which facilitate everyday small purchases. As such, money is very user friendly. It is easily transportable especially with electronic transfer facilities.
Inflation actually manifests itself in money’s store of value function. Inflation does not manifest itself in money’s medium of exchange function or unit of account functions which vindicates the fact that inflation can only destroy the real value of money and monetary items; i.e. inflation has no effect on the real value of non-monetary items. Money is always a medium of exchange of equal real value at the moment of exchange. Free market prices are adjusted in the market in a price setting process that takes the decreasing real value of money into account (amongst many other factors) so that economic items (the product and the amount of money) of equal real value are exchanged at the moment of exchange.
Constant real value non-monetary items, e.g. salaries, wages, rents, etc which are measured in units of constant purchasing power (inflation-adjusted)
Depreciating money has a constantly decreasing real value. Depreciating “bank money” deposits have the same attributes of depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary values. The depreciating money represented by depreciating accounted bank money also has a depreciating store of value function.
A country’s money supply consists of banknotes and coins (currency) and bank money or demand deposits - the balances in savings and deposit accounts. Intangible bank money is usually a much larger part of the money supply than bank notes and coins.
SA monetary aggregates
According to the SARB the monetary aggregates in SA consist of the following:
M0
Deposits of banks and mutual banks with the SARB and notes and coins outside
the SARB and SA mint
M1A
Coins and banknotes in circulation outside the monetary sector, cheque and
transmission deposits with banking institutions and the post office savings
bank
M1
MIA plus other demand deposits with banking institutions
M2
M1 plus other short term deposits, and all medium term deposits (including
savings deposits) with the monetary banking institutions
M3
M2 plus all long term deposits with monetary banking institutions
In a low cash inflationary economy depreciating money is a store of decreasing real value but it is generally assumed to have a stable – as in fixed - real value. SA accountants officially assume that the Rand is perfectly stable when they value fixed balance sheet constant real value non-monetary items never maintained. They do not consider the destruction of the Rand´s real value (e.g. at 6.4% per annum and even up to more than 20% per annum, but not as high as 26% per annum for three years in a row) as sufficiently important for them to decide to measure constant items in units of constant purchasing power - as approved by the IASB twenty years ago - to stop the destruction of real value in fixed balance sheet constant items (issued share capital, retained profits, all other shareholders equity items, trade debtors, trade creditors, taxes payable, taxes receivable, etc) never maintained. SA accountants´ stable measuring unit assumption is very destructive and totally unacceptable. It always was and now still is fundamentally wrong and very costly to the SA economy. SA accountants unknowingly destroy about R200 billion in the real value of constant items never maintained in this manner – each and every year (all else being equal).
Kindest regards,
Nicolaas Smith
Monday, 19 October 2009
Eskom: 1% Increase in inflation will cost SA an additional R53 billion per annum
Fin24.Com: Power price hikes fuel inflation
2009/10/18 11:45:00 AM Sake24.com reporter
"Johannesburg - Eskom's proposed electricity price hike will increase inflation by between a half and one percentage point.
Econometrix chief economist Dr Azar Jammine said South Africa will be fortunate if inflation falls to within the Reserve Bank's target range for the consumer price index of 3% to 6%.
"Inflation may fall below 6% in the second quarter of next year, but after that it will climb to 7% and stay there," Jammine told the annual congress of the South African Chamber of Commerce and Industry (SACCI) in Johannesburg on Friday."
A one percent increase in inflation will cost SA an additional R53 billion per year:
(1) Inflation will destroy an additional R20 billion in the real value of the Rand each and every year there after.
(2) SA accountants will unknowingly (?) destroy an additional about R33 billion in the real value of constant items never maintained in the SA real economy - e.g. in Retained Earnings - with their very destructive stable measuring unit assumption.
This will carry on for as long as the additional 1% increase stays in place and SA accountants keep on refusing to measure financial capital maintenance in units of constant purchasing power as they have been authorized to do by the International Accounting Standards Board in the Framework, Par. 104 (a) twenty years ago.
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. loans and bonds). However, inflation has no effect on the real value of variable real value non-monetary items (e.g. goods and commodities, like cars, gold, real estate, inventories, finished goods, foreign exchange, etc) and constant real value non-monetary items (e.g. issued share capital, retained profits, capital reserves, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc).
SA accountants choose to implement the stable measuring unit assumption during low inflation when they value constant items in fixed nominal monetary units. SA accountants´ choice of implementing the stable measuring unit assumption instead of measuring constant items´ real values in units of constant purchasing power results in the real values of these fixed constant real value non-monetary 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 measuring unit of account. Constant items are treated like monetary items when their real values are never maintained as a result of the implementation of the stable measuring unit assumption as part of the traditional Historical cost accounting model.
“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.”
At 7% inflation the total real value destroyed in the SA economy would be:
R140 billion per annum by inflation in the real value of the Rand in the monetary economy.
R233 billion (estimate) unknowingly (?) destroyed by SA accountants in the real value of constant items never maintained in the SA non-monetary or real economy.
Total: R373 billion per annum
When SA accountants freely decide to measure financial capital maintenance in units of constant purchasing power as per the IASB´s Framework, Par. 104 (a), then the total annual destruction will be reduced from R373 billion to only R140 billion real value destruction by inflation in the real value of the Rand.
PS: Do you know an accountant?
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
2009/10/18 11:45:00 AM Sake24.com reporter
"Johannesburg - Eskom's proposed electricity price hike will increase inflation by between a half and one percentage point.
Econometrix chief economist Dr Azar Jammine said South Africa will be fortunate if inflation falls to within the Reserve Bank's target range for the consumer price index of 3% to 6%.
"Inflation may fall below 6% in the second quarter of next year, but after that it will climb to 7% and stay there," Jammine told the annual congress of the South African Chamber of Commerce and Industry (SACCI) in Johannesburg on Friday."
A one percent increase in inflation will cost SA an additional R53 billion per year:
(1) Inflation will destroy an additional R20 billion in the real value of the Rand each and every year there after.
(2) SA accountants will unknowingly (?) destroy an additional about R33 billion in the real value of constant items never maintained in the SA real economy - e.g. in Retained Earnings - with their very destructive stable measuring unit assumption.
This will carry on for as long as the additional 1% increase stays in place and SA accountants keep on refusing to measure financial capital maintenance in units of constant purchasing power as they have been authorized to do by the International Accounting Standards Board in the Framework, Par. 104 (a) twenty years ago.
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. loans and bonds). However, inflation has no effect on the real value of variable real value non-monetary items (e.g. goods and commodities, like cars, gold, real estate, inventories, finished goods, foreign exchange, etc) and constant real value non-monetary items (e.g. issued share capital, retained profits, capital reserves, salaries, wages, rentals, pensions, trade debtors, trade creditors, taxes payable, taxes receivable, deferred tax assets, deferred tax liabilities, etc).
SA accountants choose to implement the stable measuring unit assumption during low inflation when they value constant items in fixed nominal monetary units. SA accountants´ choice of implementing the stable measuring unit assumption instead of measuring constant items´ real values in units of constant purchasing power results in the real values of these fixed constant real value non-monetary 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 measuring unit of account. Constant items are treated like monetary items when their real values are never maintained as a result of the implementation of the stable measuring unit assumption as part of the traditional Historical cost accounting model.
“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.”
At 7% inflation the total real value destroyed in the SA economy would be:
R140 billion per annum by inflation in the real value of the Rand in the monetary economy.
R233 billion (estimate) unknowingly (?) destroyed by SA accountants in the real value of constant items never maintained in the SA non-monetary or real economy.
Total: R373 billion per annum
When SA accountants freely decide to measure financial capital maintenance in units of constant purchasing power as per the IASB´s Framework, Par. 104 (a), then the total annual destruction will be reduced from R373 billion to only R140 billion real value destruction by inflation in the real value of the Rand.
PS: Do you know an accountant?
© 2005-2010 by Nicolaas J Smith. All rights reserved
No reproduction without permission.
Sunday, 18 October 2009
Medium of Exchange
Money performs the following three functions:
1. Medium of exchange
2. Store of value
3. Unit of account
1. Medium of Exchange
Money has the basic function that it is a medium of exchange of equivalent real values at the moment of exchange. It overcomes the inconveniences of a barter economy where there must be a coincidence of wants before a trade can take place. For a trade to take place in a barter economy one person must want exactly what the other person has to offer, at the exact time and place where it is offered.
In a monetary economy the real value of goods and services are measured in terms of money, the monetary medium of exchange, which is generally accepted to buy any other good or service. Without this function or attribute the invention cannot be money.
We use payment with money instead of barter to exchange real values in our economies in the transactions we enter into when we buy and sell goods, services, ideas, rights and any kind of property whether physical, virtual or intellectual. Money is the lifeblood of an economy even though it is continuously changing in real value. Without money the creation and exchange of real value in an economy would be severely restricted, as it would become a barter economy.
Kindest regards,
Nicolaas Smith
1. Medium of exchange
2. Store of value
3. Unit of account
1. Medium of Exchange
Money has the basic function that it is a medium of exchange of equivalent real values at the moment of exchange. It overcomes the inconveniences of a barter economy where there must be a coincidence of wants before a trade can take place. For a trade to take place in a barter economy one person must want exactly what the other person has to offer, at the exact time and place where it is offered.
In a monetary economy the real value of goods and services are measured in terms of money, the monetary medium of exchange, which is generally accepted to buy any other good or service. Without this function or attribute the invention cannot be money.
We use payment with money instead of barter to exchange real values in our economies in the transactions we enter into when we buy and sell goods, services, ideas, rights and any kind of property whether physical, virtual or intellectual. Money is the lifeblood of an economy even though it is continuously changing in real value. Without money the creation and exchange of real value in an economy would be severely restricted, as it would become a barter economy.
Kindest regards,
Nicolaas Smith
Friday, 16 October 2009
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.
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.
Thursday, 15 October 2009
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
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
Tuesday, 13 October 2009
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.
Monday, 12 October 2009
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
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
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
Friday, 9 October 2009
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
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
Thursday, 8 October 2009
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.
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.
Wednesday, 7 October 2009
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
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
Tuesday, 6 October 2009
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.
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.
Monday, 5 October 2009
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
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
Saturday, 3 October 2009
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
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
Friday, 2 October 2009
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 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
Thursday, 1 October 2009
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
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
Wednesday, 30 September 2009
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.
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.
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