Four accounting models authorized under IFRS

A: Financial capital maintenance in nominal monetary units during low inflation and deflation: traditional Historical Cost Accounting (see the Framework, Par 104 (a))


B: Financial capital maintenance in units of constant purchasing power; i.e. Constant ITEM Purchasing Power Accounting (CIPPA) under which ONLY constant real value non-monetary items (NOT variable items) are inflation-adjusted during low inflation and deflation. This is NOT Constant Purchasing Power Accounting which is an inflation-accounting model required ONLY during hyperinflation under which ALL non-monetary items – BOTH variable and constant items – are inflation-adjusted. (see the Framework, Par 104 (a)). This accounting model is unique to IFRS. It is not authorized under US GAAP.

IFRS also specifically require

C: Current Cost Accounting when an entity selects physical capital maintenance in terms of the Framework, Par 102 and 104 (b).

IAS 29 Financial Reporting in Hyperinflationary Economies requires

D: Constant Purchasing Power Accounting, i.e. inflation-accounting under which all non-monetary items – both variable and constant items – are inflation-adjusted ONLY during hyperinflation (different from the above Constant ITEM Purchasing Power Accounting authorized in Par 104 (a) during LOW inflation and deflation under which ONLY constant items – NOT variable items – are inflation-adjusted during LOW inflation and deflation).
© 2005-2010 by Nicolaas J Smith. All rights reserved. No reproduction without permission.

Three economic items

Science is simply common sense at its best - that is, rigidly accurate in observation, and merciless to fallacy in logic. Thomas Huxley

The economy consists of economic entities and economic items.

Economic items have economic value. Accountants do not simply record what happened in the past. Accountants are not simply scorekeepers. Accountants value economic items every time they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.

It is generally accepted that there are only two basic, fundamentally different economic items in the economy; namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. That is a fallacy.

The three fundamentally different basic economic items in the economy are:

a) Monetary items
b) Variable real value non-monetary items
c) Constant real value non-monetary items

The economy consequently consists of not just two – the monetary and non-monetary economies, but, three parts:

1. Monetary economy

The monetary economy within an economy or monetary union consists of functional currency bank notes and coins (which generally make up about 7% of the overall money supply) and other functional currency monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds and other functional currency monetary items making up the fiat money supply created in the banking system by means of fractional reserve banking.

2. Variable item non-monetary economy

The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, raw material, etc.

3. Constant item non-monetary economy

The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.

The variable and constant item non-monetary economies in combination make up the non-monetary or real economy. The real and monetary economies constitute the economy.

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

Fin24 15-3-11

Fiat money has real value and is legally convertible

All fiat money is created out of nothing: out of thin air. It is, however, backed by all - the sum total of - the underlying value systems in an economy, namely sound governance, sound economic policies, sound monetary policies, sound industrial policies, sound commercial policies, etc. Positive annual inflation indicates the excess of fiat money created in the banking system.

Fiat money is used every day by 6 billion people to buy anything and everything in the economy. Fiat money has real value. All monetary units in the world are fiat money. Every person knows exactly what he or she can buy with 1 or 10 or 100 or 1000 units of fiat money in his or her economy – today. Everyone also knows that the real value of fiat money is eroded over time in an inflationary economy and increases over time in a deflationary economy.

Yes, the special bank paper that fiat bank notes is made of and the metals that fiat bank coins are made of have almost no intrinsic value as compared to the real value of the actual gold or actual silver in gold and silver coins of commodity money in the past. That is not a logical reason to state that fiat money has no value. Every fiat monetary unit´s real value is determined by what it can buy today in an average consumer basket of goods and services. That generally changes every month.
Fiat money is money which generally has a monthly changing real value. Only the actual fiat bank notes and coins have insignificant intrinsic values. Fiat bank notes and coins constitute only about 7% of the US money supply.

All fiat monetary units – whether notes and coins or simply electronically represented virtual values - are legal tender in their respective economies.

All fiat functional currencies within economies have international exchange rates with the fiat functional currencies of other economies.

The fact that fiat money is not legally convertible into gold on demand as it was done in the days of the gold standard, is made irrelevant by the indisputable fact that fiat money is legal tender. Fiat money is used to buy gold. The fact that fiat money is not legally convertible into gold - an administrative process - is true: it is a fact. That does not negate the fact that fiat money has real value, the change of which is indicated monthly in the change in the Consumer Price Index.

The fact that fiat money has real value is so mainstream - 6 billion people know it and confirm it daily - 365 days a year - by using fiat money to buy and sell everything in all economies. The fact that fiat money has real value is confirmed once a month by about 155 to 200 economies world wide when monthly inflation indexes are published indicating the change in the real value of fiat money. It is thus misleading to imply that because it is a fact that fiat money can not administratively be converted at the central bank or any other bank into gold, that fiat money has no value.

It is an indisputable mainstream fact that fiat money has real value despite the fact that it is not legally convertible into gold on demand and that the bank paper bank notes are made of and metals bank coins are made of have no intrinsic value whereas historically gold and silver coins had intrinsic values equal to the real value of the gold and silver they were made of.

The numerous publications of CPI values world wide are the absolutely creditable references to the fact that fiat money has real value. Statistics authorities are generally creditable sources.
© 2005-2010 by Nicolaas J Smith. All rights reserved. No reproduction without permission.

The silliest idea currently going around

The silliest idea currently going around:

Quantitative easing would lead to hyperinflation.

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

No currency wars within the European Monetary Union

What the world needs is one world one currency.

If the world economy was invented today, no-one would have more than one currency for the whole world.

There are no currency wars within the European Monetary Union or among the different states in the United States of America.

The final solution would be one fiat currency with a constant real value, i.e. zero inflation.

For that to happen the eternally elusive universal unit of real value has to be defined.

Whether that is possible is not clear yet.
Interesting times ahead.


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

Gold is not money

Gold can only be money if it fulfils all three functions of money:
1. Medium of exchange
2. Store of value
3. Unit of account

Gold is an item that is generally accepted as a medium of exchange.

Gold is also a store of variable real value over time.

However, the daily gold price is not a unit of account.

Gold is thus a medium of exchange and a store of variable real value, but, not a unit of account with a constant real value.

Money is also not a unit of account with a constant real value. However, via financial capital maintenance in units of constant purchasing power as authorized 21 years ago in International Financial Reporting Standards in the Framework, Par 104 (a) which states:

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

we are able to inflation-adjust constant real value non-monetary items by means of the monthly change in the annual CPI during low inflation and deflation (Constant ITEM Purchasing Power Accounting – CIPPA).

During hyperinflation we measure in units of constant purchasing power not only constant real value non-monetary items but also variable real value non-monetary items (all non-monetary items) on a daily basis in term of the US Dollar parallel rate or in terms of a government supplied daily non-monetary index as was done so successfully in Brazil during that country’s period of high and hyperinflation from 1964 to 1994. This is Constant Purchasing Power Accounting – CPPA as authorized and defined in IFRS in IAS 29.

This was not done during Zimbabwe´s hyperinflation although the daily US Dollar parallel rate as well as the Old Mutual Implied Rate (OMIR) were available to the whole country on a daily basis.

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

No reproduction without permission.

Variable real value of fiat money backed by all underlying value systems

Fiat money is:

* money (functional currency within an economy or monetary union) declared by a government to be legal tender that is not commodity money.

* state-issued money which is a medium of exchange for all other economic items in the economy, a store of depreciating real value during inflation and a store of appreciating real value during deflation as well as the depreciating unit of account during inflation and the appreciating unit of account during deflation in an internal economy. Fiat money bank notes and coins have fixed nominal values but either depreciating or appreciating real values. The depreciating or appreciating real value of fiat money - in its form as the functional currency within an economy or monetary union - is indicated by the annual rate of inflation or deflation. Severe hyperinflation can lead to the total destruction of the real value of the entire money supply and all other monetary items within an economy: see Zimbabwe. Neither low inflation nor hyperinflation have any effect on the real value of non-monetary items. Inflation and hyperinflation can only destroy the real value of money (a functional currency) and other monetary items - nothing else.

* money of which the token bank notes and bank coins have no intrinsic value.


All fiat money is created out of nothing: out of thin air.

It is, however, backed by all - the sum total of - the underlying value systems in an economy, namely sound governance, sound economic policies, sound monetary policies, sound industrial policies, sound commercial policies, sound external policies, sound education, sound legal system, sound law enforcement, sound defence force, sound transport policies, sound health policies, sound agricultural policies, sound banking policies, sound accounting principles, etc.

The annual rate of inflation above the central bank´s target indicates how much fiat money has been created in excess of what is considered by the central bank as required in the economy.

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

No reproduction without permission.

Hyperinflation has no effect on the real value of non-monetary items

A vicious circle is created in which more and more inflation is created with each iteration of the ever increasing money printing cycle. This is not the same as and has nothing to do with, for example, the US Federal Reserve Bank´s and the Bank of Japan´s "Quantitative Easing (QE)" programs. This was, in fact, exactly the same as the Reserve Bank of Zimbabwe´s money printing program.


Hyperinflation becomes visible when there is an unchecked increase in the money supply (see hyperinflation in Zimbabwe) usually accompanied by a widespread unwillingness on the part of the local population to hold the hyperinflationary money for more than the time needed to trade it for something non-monetary to avoid further loss of real value. Hyperinflation is often associated with wars (or their aftermath), currency meltdowns like in Zimbabwe, and political or social upheavals.


"Hyperinflations have never occurred when a commodity served as money or when paper money was convertible into a commodity. The curse of hyperinflation has only reared its ugly head when the supply of money had no natural constraints and was governed by a discretionary paper money standard." p1


Hyperinflation normally results in severe economic depressions although that did not happen during the 30 years of very high and hyperinflation in Brazil from 1964 to 1994 because all non-monetary items (such as property, plant, equipment, inventory, finished goods, quoted and unquoted shares, trade marks, issued share capital, retained earnings, capital reserves, all other items in shareholders' equity, trade debtors, trade creditors, provisions, all other non-monetary payables, all other non-monetary receivables, taxes payable, taxes receivable, salaries payable, salaries receivable, etc.) in the entire economy of Brazil were updated daily in terms of a daily non-monetary index supplied by the government which was principally directly related to the change in the daily US dollar exchange rate for the Brazilian currency. This confirmed the fact that hyperinflation like low inflation can only destroy the real value of money and other monetary items. Hyperinflation (like low inflation) has no effect on the real value of non-monetary items. Purchasing power of non monetary items does not change in spite of variation in national currency value. p9

This was not done during Zimbabwe's hyperinflation although the daily change in the parallel rate for the US dollar as well as the Old Mutual Implied Rate (OMIR) were both available to everyone in Zimbabwe on a daily basis and eventually resulted in the wiping out of the real value of only those non-monetary items (such as salaries, wages, issued share capital, all other items in shareholders´ equity, trade debtors, trade creditors, salaries payable, salaries receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc.) expressed in terms of the ZimDollar and never or not fully updated (inflation-adjusted) during Zimbabwe's hyperinflation. Zimbabwe's hyperinflationary monetary meltdown, on the other hand, resulted in the wiping out of the real value of all monetary items (actual 100 trillion Zimbabwe dollar bank notes, all other bank notes, all loans payable and all loans receivable and all other monetary items) expressed in terms of the hyperinflationary Zimbabwe Dollar which became completely worthless after severe hyperinflation which stopped abruptly the moment exchangeability between the currency and all foreign currencies did not exist anymore.

"Zimbabwe’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe. On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized." p9-10.

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

No reproduction without permission

Severe Hyperinflation: Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft

My comment letter to the IASB regarding severe hyperinflation is available in the following book.


Buy the ebook for $2.99 or £1.53 or €2.68

 

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

No reproduction without permission

Valuing monetary items

Valuing monetary items

Measurement of Monetary Items in the Financial Statements

Measurement is the process of determining the monetary amounts at which monetary items are to be recognised and carried in the financial reports. This involves the selection of the particular basis of measurement. The original nominal values of monetary items can only be measured in nominal monetary units during the current accounting period.

During low inflation

The real value of money and other monetary items can not be updated or indexed or inflation-adjusted or maintained during the current financial period under any accounting or economic model during low inflation. Inflation destroys the real value of money and other monetary items evenly throughout the SA monetary economy currently at 4.6% per annum (May 2010) or about R120 billion per annum. Money and other monetary items only maintain their real values perfectly stable under permanently sustainable zero per cent annual inflation. This has never been achieved over an extended period of time of more than a month or two.


"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 rises 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.

SA accountants value monetary items at their original nominal values – at their nominal 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 mistaken. 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 accounting professors.
SA accountants value monetary items at their current depreciated generally lower real values by accounting them during the current accounting period at their original nominal HC values during inflation. Their real values are destroyed by inflation over time. Being stated at their original nominal HC monetary 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. In practice, money and other monetary items´ real values consequently generally decrease once per month – on the date the new CPI value is published by the statistics authorities – to a lower real value in low inflationary economies.

SA accountants do not destroy the about R120 billion in real value of the Rand and other monetary items in the SA monetary economy each year: 4.6% inflation does that. SA accountants value and account monetary items correctly in the SA monetary economy by stating them at their original nominal monetary HC 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. This is a generally accepted accounting practice under HCA.

The only difference between accounting and valuing monetary items under the current HCA 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 net monetary gains and losses are required by the IASB to be calculated and accounted in terms of IAS 29 during hyperinflation. These net monetary gains and losses are not calculated and accounted under the HCA model although it can be done. See Kapnick. 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 – measured in units of constant purchasing power - thereafter under the financial capital maintenance in units of constant purchasing power model or Constant ITEM Purchasing Power Accounting model as authorized by the IASB in the Framework, Par 104 (a) in 1989 as well as in terms of IAS 29 during hyperinflation.

Side note: The FASB and IASB have been working on their joint Conceptual Framework project for the last 6 years. However, they have not stated one word about valuing monetary items - or items like shareholders equity. It is called the Historical Cost mentalité - like there used to be the gold standard mentalité.
Copyright © 2010 Nicolaas J Smith

Severe Hyperinflation: Comment Letter

Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

Submitter                        Organization                                                                    Date

 Nicolaas Smith              Constant ITEM Purchasing Power Accounting              2nd November, 2010 

International Accounting Standards Board 
30 Cannon Street 
London EC4M 6XH 
United Kingdom 

Second submission via “Create Comment Letter” page on www.ifrs.org. First submission on 22-10-2010 - confirmed by IASB email - not published after 10 days. This second submission is different from the first submission. I respectfully request that you publish this – updated – submission. Thank you. 

Dear Sirs/Mesdames, 

Request for comment on IASB Exposure Draft ED/2010/12: Severe Hyperinflation - Proposed Amendment to IFRS 1 

Thank you for the opportunity to comment on the IASB Exposure Draft: Severe Hyperinflation - Proposed Amendment to IFRS 1 

I agree with the IASB´s proposal to add an exemption to IFRS 1 to allow an entity which has been subject to severe hyperinflation to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position when the date of said opening IFRS statement of financial position is on, or after, the date when the reporting currency of the reporting entity ceases to be subject to severe hyperinflation or when the reporting currency is a relatively stable foreign currency in a newly dollarized economy after a period of severe hyperinflation. 

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

My detailed answers to the questions in the Exposure Draft and my suggestions are contained in the attached appendix. 

If you have any questions regarding this submission, please do not hesitate to contact me at realvalueaccounting@yahoo.com 

Yours sincerely 

Nicolaas Smith 
Constant ITEM Purchasing Power Accounting 
http://realvalueaccounting.blogspot.com/ 

                                                                                                                                                Page 1 of 3 

Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

Appendix – Response to the questions asked in the Exposure Draft: Severe Hyperinflation 

Question 1 – Severe hyperinflation exemption 

The Board proposes adding an exemption to IFRS 1 that an entity can apply at the date of transition to IFRSs after being subject to severe hyperinflation. This exemption would allow an entity to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position. 

Do you agree that this exemption should apply when an entity prepares and presents an opening IFRS statement of financial position after being subject to severe hyperinflation? 

Why or why not? 

Yes, I agree with the IASB´s proposal to add an exemption to IFRS 1 to allow an entity which has been subject to severe hyperinflation to measure assets and liabilities at fair value and use that fair value as the deemed cost of those assets and liabilities in the opening IFRS statement of financial position when the date of said opening IFRS statement of financial position is on, or after, the date when the reporting currency of the reporting entity ceases to be subject to severe hyperinflation or when the reporting currency is a relatively stable foreign currency in a newly dollarized economy after a period of severe hyperinflation. 

I agree because it is the only economically logical, correct and common sense solution. 

I suggest that the dollarization option – which can be in any relatively stable foreign currency - be specifically added to the wording of the amendment to IFRS 1. 

Question 2 – Other comments 

Do you have any other comments on the proposals? 

Yes, I suggest that the following changes (in bold and underlined) should be made to paragraph D28 (b): 

Paragraph D28: The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics: (a) a reliable general price index is not available to all entities with transactions and balances in the currency, (b) exchangeability between the currency and most relatively stable foreign currencies does not exist, 

 Rationale for my answers and suggestions above: 

 The IASB proposes to define severe hyperinflation as follows: 

 D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics: 

 (a) a reliable general price index is not available to all entities with 

                                                                                                                                                Page 2 of 3 

Second submission: Nicolaas Smith Comment Letter: IASB Exposure Draft - Severe Hyperinflation 

transactions and balances in the currency, 

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

 In fact, it is exactly the opposite: severe hyperinflation stops when “(b) exchangeability between the currency and a relatively stable foreign currency does not exist.” (As stated in the singular it means it includes the plural since this is IFRS nomenclature.) 

 D28 (b) is thus not a definition of severe hyperinflation, but, a definition of when severe hyperinflation stops. 

 Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency. 

 The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR). 

 “The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate." p8  

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

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

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

 I thus suggest that paragraph D28 (b) should be changed to: “(b) exchangeability between the currency and most relatively stable foreign currencies does not exist,” 

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

No other issues noted.

 ______________________________________________________

This comment letter is available HERE on the IFRS.org website.

Severe hyperinflation comment letter available in the following book:

Buy the ebook 

Copyright ©  Nicolaas J Smith 2010

Definition of Severe Hyperinflation - Updated

      The IASB proposes to define severe hyperinflation as follows:
      D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
      (a) a reliable general price index is not available to all entities with transactions and balances in the currency,
      (b) exchangeability between the currency and a relatively stable foreign currency does not exist,
      In fact, it is exactly the opposite: severe hyperinflation stops when (b) “exchangeability between the currency and a relatively stable foreign currency does not exist.”
      D28 (b) is thus not a definition of severe hyperinflation, but, a definition of when severe hyperinflation stops.
      Severe hyperinflation is only possible when there is exchangeability with at least one relatively stable foreign currency.
      The one exchange rate that lasted till the end of hyperinflation in Zimbabwe was the Old Mutual Implied Rate (OMIR).
      “The ratio of the Old Mutual share price in Harare to that in London equals the Zimbabwe dollar/sterling exchange rate." p8
      Severe hyperinflation stops the moment exchangeability between the currency and all foreign currencies does not exist.
      “Zimbabwe ’s hyperinflation came to an abrupt halt. The trigger was an intervention by the Reserve Bank of Zimbabwe . On November 20, 2008, the Reserve Bank’s governor, Dr. Gideon Gono, stated that the entire economy was “being priced via the Old Mutual rate whose share price movements had no relationship with economic fundamentals, let alone actual corporate performance of Old Mutual itself” (Gono 2008: 7–8). In consequence, the Reserve Bank issued regulations that forced the Zimbabwe Stock Exchange to shut down. This event rapidly cascaded into a termination of all forms of non-cash foreign exchange trading and an accelerated death spiral for the Zimbabwe dollar. Within weeks the entire economy spontaneously “dollarized” and prices stabilized.” p 9-10 
      There was severe hyperinflation in Zimbabwe while there was exchangeability with at least one relatively stable foreign currency – the British Pound in this case. When this last exchangeability stopped it was not possible to set prices in the ZimDollar any more and severe hyperinflation stopped: no exchangeability means no severe hyperinflation.
      I thus suggest that D28 (b) should be changed to: “(b) exchangeability between the currency and most relatively stable foreign currencies does not exist,”
      1,2 Hanke, S. H. and Kwok, A. K. F., On the Measurement of Zimbabwe’s Hyperinflation, Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009), pp. 353-64 Available at http://www.cato.org/pubs/journal/cj29n2/cj29n2-8.pdf
      Copyright © 2010 Nicolaas J Smith

Severe Hyperinflation: Prof Steve Hanke´s opinion

I am of the opinion that hyperinflation - let alone severe hyperinflation - is impossible when exchangeability between the currency and a relatively stable foreign currency does not exist, as defined by the IASB in Par D28 (b) in their current Exposure Draft - Severe Hyperinflation:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
(a) a reliable general price index is not available to all entities with transactions and balances in the currency,
(b) exchangeability between the currency and a relatively stable foreign currency does not exist,

I asked Prof Steve Hanke who is a world authority on currency boards and hyperinflation for his opinion. Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University and a Senior Fellow at the Cato Institute.

This is his reply:

"The proposed amendment is to provide guidance on how an entity should resume presenting financial statements in a hyperinflationary economy. I don't have a problem with the substance of the proposal: it seems fair an entity should resume reporting after its functional currency has changed to one that is not hyperinflationary, or when the relative value of the hyperinflationary currency can be determined through a reliable price level or exchange rates.


I agree with you that the wording "severe hyperinflation" might not be most accurate in describing the situation where the relative value of the hyperinflationary currency is unrecognizable. Perhaps "unrecognizable currency value during hyperinflation" is a better name for the condition which is dubbed "severe hyperinflation" in the proposal. I see it as a nomenclature problem."

Copyright © 2010 Nicolaas J Smith

Three economic items

Science is simply common sense at its best - that is, rigidly accurate in observation, and merciless to fallacy in logic. Thomas Huxley

      The economy consists of economic items and economic entities.
      Economic items have economic value. Accountants do not simply record what happened in the past in Historical Cost terms. Accountants are not simply scorekeepers. Accountants value each and every economic item every time they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.
      It is generally accepted that there are only two basic, fundamentally different economic items in the economy, namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. That is an economic fallacy.
      The three fundamentally different basic economic items in the economy are:
1. Monetary items
2. Variable real value non-monetary items
3. Constant real value non-monetary items
      The economy consequently consists of not just two – the monetary and non-monetary economies, but, three parts:
1. Monetary economy
      The monetary economy consists of functional currency bank notes and coins and other functional currency monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds and other functional currency monetary items making up the money supply.
2. Variable item non-monetary economy
      The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, etc.
3. Constant item non-monetary economy
      The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.
      The variable and constant item non-monetary economies in combination make up the non-monetary or real economy. The real and monetary economies constitute the economy.
      The monetary economy can disappear completely or be totally destroyed like in the case of Zimbabwe as a result of hyperinflation. The real or non-monetary economy (houses, properties, buildings, infrastructure, inventories, finished goods, consumer goods, trademarks, goodwill, logos, copyright, trade debtors, trade creditors, royalties payable, royalties receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc,) can not be destroyed by hyperinflation: inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items.
      Trade debtors and trade creditors are constant real value non-monetary items and not monetary items as stated by the US Financial Accounting Standards Board, the International Accounting Standards Board, in International Financial Reporting Standards and by PricewaterhouseCoopers, amongst most probably all others.
      Under the current Historical Cost paradigm many constant items, e.g. trade debtors, trade creditors, other non-monetary payables, other non-monetary receivables, salaries, wages, etc are incorrectly treated as monetary items. The real values of these items are currently unnecessarily being destroyed by the implementation of the stable measuring unit assumption during low and high inflation. In a hyperinflationary monetary meltdown like in the case of Zimbabwe all these items are unnecessarily destroyed completely – because they are incorrectly treated as monetary items.
      Under financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) in 1989, these items are correctly treated as non-monetary items and their real values would not be destroyed at the rate of low or high inflation or they would not be completely destroyed in a hyperinflationary monetary meltdown like what happened in Zimbabwe. Their real values were not destroyed during 30 years of high and hyperinflation in Brazil from 1964 to 1994 because they were treated correctly as non-monetary items in Brazil and updated daily in terms of a daily index supplied by the government.
© Copyright 2010 Nicolaas J Smith

Our unsolved fundamental problems are the results of our inventions

In the begining before money and the double-entry accounting model were invented all items in the economy were variable real value non-monetary items not yet expressed in terms of money.

There was no International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies supplying us with the current definition of inflation accounting. There was thus no Constant Purchasing Power Accounting (CPPA) IFRS-approved inflation accounting model under which all non-monetary items (variable and constant real value non-monetary items) in Historical Cost and Current Cost financial statements were required to be restated by means of the period-end CPI to make these restated HC and CC financial statements more useful during hyperinflation.


There was also no real value maintaining financial capital maintenance in units of constant purchasing power accounting model – Constant ITEM Purchasing Power Accounting (CIPPA) – as an official IFRS-approved alternative basic accounting model to the traditional HCA model during low inflation and deflation. There was no IFRS compliant basic accounting option where under only constant items are continuously measured in units of constant purchasing power during low inflation and deflation. There was no option of continuously measuring only constant items in units of constant purchasing power by applying the monthly change in the CPI during low inflation and deflation in order to implement a constant purchasing power financial capital concept of invested purchasing power by continuously measuring financial capital maintenance in units of constant purchasing power and continuously determining profit/loss in units of constant purchasing power.

There were no financial reports: e.g. no income statements, no balance sheets, no cash flow statements, no statements of changes in shareholders´ equity, etc. There were no monetary items and no constant items. There were only variable real value items not yet expressed in monetary terms.

CIPPA stops the destruction caused by the stable measuring unit assumption in Historical Cost Accounting.

Copyright © 2010 Nicolaas J Smith

Definition of Severe Hyperinflation

I was of the opinion that severe hyperinflation was impossible if “exchangeability between the currency and a relatively stable foreign currency does not exist” as stated in Par D28 of the IASB Exposure Draft about Severe Hyperinflation.
I asked Dr Eric Bloch who is a Zimbabwean independent economist and commentator who experienced the complete hyperinflationary period in Zimbabwe whether he agreed with me. This is his reply:

"I respectfully differ with your view, for I consider that hyperinflation can exist even in an environment where :
a) No reliable/ authoritative Consumer Price Index or alternative general price index exists ; and
b) There is no exchangeability between the currency and a relative stable foreign currency ;
albeit that in the absence of the aforegoing, measurement of the extent of the hyperinflation is exceptionally difficult.
Despite the restricted ability to quantify the magnitude of inflation, in the absence of a reliable price index or authoritative exchange rates, if prices are escalating to an extent that consumer power progressively diminishes substantially, then hyperinflation exists e.g. if in one month a person’s total income will only purchase, say, one –half of the quantity of identical goods that that income would purchase in the preceding month, then clearly hyperinflation exists.
Further illustrative of the aforegoing, after Zimbabwe’s Central Statistical Office ceased computing the Consumer Price Index in July 2008, I sometimes applied as my measure of the extent of certain price movements the number of hours that I had to work in one month, as compared to previously, to purchase particular commodities."

I agree that as long as prices are being set in the local hyperinflationary currency, then there is hyperinflation. There is also exchangeability. What exchangeability? Not exchangeability between the local currency and relatively stable foreign currencies, but, exchangeability between the value of a very restricted range of goods and services in the economy and the local currency - to a very limited extent: only in some goods and services, for example the government will continue paying civil service salaries in the local currency. Locals can perhaps only use that money to pay for taxi fares because the taxi operators can buy petrol only from the government distributors paying with the local currency.
I would thus suggest that the following addition – underlined – should be made to Par D28:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:
(a) a reliable general price index is not available to all entities with transactions and balances in the currency,
(b) exchangeability between the currency and a relatively stable foreign currency does not exist,
as long as some prices are still being set in the local hyperinflationary currency.

Copyright © 2010 Nicolaas J Smith

Greenspan and Historical Cost Accounting

U.S. companies may be holding back on investment because of the rising federal deficit, which causes uncertainty about future tax policies, Greenspan said in an opinion article for the Financial Times this week. Weak investment by businesses in capital equipment and fixed assets has helped to crimp the U.S. economic recovery, he said.

Historical Cost accountants unknowingly, unintentionally and unnecessarily destroy the real value of that portion of shareholders´ equity (which is a constant real value non-monetary item) never maintained constant with sufficient revaluable fixed assets (revalued or not) at a rate equal to the annual rate of inflation each and every year with their very destructive stable measuring unit assumption: they simply assume there is no such thing as inflation – only for this purpose and only during low inflation.

Shareholders´ equity forms an important part of the financial resources available for fixed investment in a modern economy. Historical Cost accountants unknowingly destroy that permanent capital base with traditional Historical Cost Accounting as described above. This destruction amounts to about USD 280 billion per annum in the case of the US economy and about R134 billion in the SA economy at current levels of inflation.

Accountants would stop this annual unknowing destruction and instead boost the US economy by about USD 280 billion and the SA economy by about R134 billion per annum for an indefinite period of time when inflation in these two economies remains at current levels when they freely change over to financial capital maintenance in units of constant purchasing power (Constant ITEM Purchasing Power Accounting) as authorized in International Financial Reporting Standards in the Framework, Par 104 (a) in 1989 which states:

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

US accountants unknowingly destroy US companies´ shareholders´ equity´s real value resulting in these companies not having sufficient financial resources for capital equipment and fixed asset investments as described by Alan Greenspan.

Constant ITEM Purchasing Power Accounting as authorized in IFRS twenty one years ago would stop this destruction automatically (accounting is double-entry: for every already existing credit there is an equivalent already existing debit; real values of variable real value non-monetary items are maintained at mainly market prices in terms of IFRS while the constant real non-monetary values of all already existing constant items would be maintained constant forever by measurement in units of constant purchasing power plus the net monetary gain or loss would be accounted) when accountants maintain the existing constant real value of existing constant real value non-monetary items, e.g. already existing shareholders´s equity, forever - ceteris paribus - in all entities that at least break even whether these entities own any revaluable fixed assets or not when accountants freely reject their very destructive stable measuring unit assumption which is based on the fallacy that money always was, always is and always will be perfectly stable.

CIPPA is not my original idea: the IASB authorized it 21 years ago in IFRS in the Framework, Par 104 (a) as an alternative to HCA during low inflation and deflation.

Copyright © 2010 Nicolaas J Smith

Variable items

Variable items


Variable items are non-monetary items with variable real values over time.

Examples of variable items in today’s economy are property, plant, equipment, inventories, quoted and unquoted shares, raw material stock, finished goods stock, patents, trademarks, foreign exchange, etc.

The first economic items were variable real value items. Their values were not yet expressed in terms of money because money was not yet invented at that time. There was no inflation because there was no money. Inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items. There was no unstable monetary medium of exchange. There was no unstable monetary unit of account. There was no unstable monetary store of value.

There was no double entry accounting model at that time. There were no historical cost items. There was no very destructive stable measuring unit assumption approved by the International Accounting Standards Board whereby accountants assume the unit of measure is stable, i.e., they consider that changes in the general purchasing power of money are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. The stable measuring unit assumption is based on a very popular accounting fallacy since the real value of money is never absolutely stable on a sustainable basis during inflation and deflation. There was no Historical Cost Accounting model and no financial capital maintenance in nominal monetary units per se (another very popular IFRS-authorized accounting fallacy) during inflation; that is to say: there were no Historical Cost accounting fallacies. There was no value based accounting. There was also no Consumer Price Index at that time. Consequently there were no units of constant purchasing power and no price-level accounting.

Copyright © 2010 Nicolaas J Smith

Three economic items

The economy consists of economic items and economic entities.

Economic items have economic value. Accountants value economic items when they account them. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.

It is generally accepted that there are only two basic, fundamentally different economic items in the economy, namely, monetary and non-monetary items and that the economy is divided in the monetary and non-monetary or real economy. This is an economic fallacy.

The three fundamentally different basic economic items in the economy are:
a) Monetary items

b) Variable real value non-monetary items

c) Constant real value non-monetary items

The SA economy consequently consists of not just two – the monetary and non-monetary economy, but, three parts:

1. Monetary economy

The SA monetary economy consists of Rand bank notes and coins and other Rand monetary items, e.g. bank loans, savings, credit card loans, car loans, home loans, student loans, consumer loans and other monetary items making up the money supply in SA.

2. Variable item non-monetary economy

The variable item economy is made up of non-monetary items with variable real values over time; for example, cars, groceries, houses, factories, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, foreign exchange, finished goods, etc.

3. Constant item non-monetary economy

The constant item economy consists of non-monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premium, share discount, capital reserves, revaluation reserve, retained profits, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non-monetary payables and all other non-monetary receivables, etc.

The variable and constant item non-monetary economies in combination make up the non-monetary or real economy. The real and monetary economies constitute the SA economy.

The monetary economy can disappear or be totally destroyed like in the case of Zimbabwe as a result of hyperinflation. The real or non-monetary economy (houses, properties, buildings, infrastructure, inventories, finished goods, consumer goods, trademarks, goodwill, logos, copyright, trade debtors, trade creditors, royalties payable, royalties receivable, taxes payable, taxes receivable, all other non-monetary payables, all other non-monetary receivables, etc,) can not be destroyed by hyperinflation: inflation is always and everywhere a monetary phenomenon - inflation has no effect on the real value of non-monetary items.

Trade debtors and trade creditors are constant real value non-monetary items and not monetary items as stated by the US Financial Accounting Standards Board, the International Accounting Standards Board, in International Financial Reporting Standards and by PricewaterhouseCoopers, amongst others



Copyright © 2010 Nicolaas J Smith

There is no such thing as "severe hyperinflation" as defined by the IASB.

The IASB published for public comment an exposure draft Severe Hyperinflation, a proposed amendment to IFRS 1 First-time Adoption of IFRS on 30th September, 2010.

The IASB proposes to define "severe hyperinflation" in the ED as follows:

D28 The currency of a hyperinflationary economy is subject to severe hyperinflation if it has both of the following characteristics:

(a) a reliable general price index is not available to all entities with

transactions and balances in the currency.

(b) exchangeability between the currency and a relatively stable

foreign currency does not exist.

I am of the opinion that there is no such thing as "severe hyperinflation" as the IASB defined it. To have hyperinflation you need two different sets of prices: one at time A and another at time B - a different time, e.g. one month or one year later, or other time periods (hours or days or months during hyperinflation) later. I worked for 2 ½ years in Angola´s hyperinflationary economy in the 1990´s and have studied the effect of the stable measuring unit assumption ever since. I also followed Zimbabwe´s monetary meltdown on a day by day basis during the last two years of your hyperinflation.

When characteristic (b) exists – no exchangeability - then it is not possible to have two different sets of prices: so, you cannot have hyperinflation or "severe hyperinflation" when you do not de facto have a currency any more: there is no hyperinflation because there is, in fact, no currency used as a medium of exchange in the market although the government may have not yet stated officially that the currency does not have legal tender in the economy any more.

When (b) exists – no exchangeability – then transactions are impossible. (a) uses the term “transactions”. Transactions are impossible when (b) exists. A general price index is also impossible when (b) exists because there are no prices being set in the previously hyperinflationary currency any more.

Once a currency loses its exchangeability with relatively stable currencies, it is de facto dead. It is not exchangeable for stable currencies or any item: thus, it is not a currency any more: it is de facto dead – although the government has not yet officially removed it as legal tender.

So, in my opinion, it is wrong to propose that there was a period of hyperinflation in Zimbabwe , while there was a parallel rate for the USD and then at the end there was a period of this so-called "severe hyperinflation" when there was no CPI and no parallel rate for the USD. There was no hyperinflation during that period. The market already de facto Dollarized the economy although the ZimDollar still, officially, had legal tender: in the market it did not. The fact is there was no hyperinflation: the market was already Dollarized.

As soon as there was no parallel rate for the USD the ZimDollar was de facto dead: it stopped being money and a currency. It does not matter that the notes were still around: absolutely no-one would accept them as payment for items/goods/property/assets/anything.

It is wrong to me to name a period with no hyperinflation as a period of "severe hyperinflation". There was no hyperinflation, because there were no prices being set in ZimDollars. People stopped accepting the ZimDollar for any payment for goods at all.

It is misleading to state that there was a period of "severe hyperinflation" different from hyperinflation. Hyperinflation ended the moment the ZimDollar was not accepted as payment for items anymore. There was no more hyperinflation and it is wrong to call the period after that "severe hyperinflation" when there was, in fact, no hyperinflation.

As an article in the SA Mail and Guardian states:

“Inflation, identified by central bank governor Dr Gideon Gono as "the number one enemy", was stopped dead in its tracks.”

http://www.mg.co.za/article/2010-02-05-in-god-we-trust

So, it is better for the IASB to state that when a currency, after a period of hyperinflation, loses its monetary function of exchangeability, then the rules of this Exposure Draft apply and companies can fairvalue assets and use that fair value as deemed cost for IFRS 1 purposes without giving this period a name, especially not “severe hyperinflation” when, in fact, there was no hyperinflation anymore.

(b) excludes transactions as stated in (a): when there is no exchangeablity, there are no transactions.

So, (a) is logically wrong: the term transactions should be removed from (a)

I am concerned about the fact that the IASB now wants to invent this new phrase "severe hyperinflation" for the period immediately after hyperinflation when the currency is not accepted in the economy any more, although the government has not yet officially withdrawn its legal tender status: de facto the currency does not exist as a currency any more: so, setting prices in it is impossible, thus, there is no more hyperinflation. The IASB wants to call this period just after the exchangeability of the currency ended and there is no actual hyperinflation because no prices are set in the de facto dead currency, the IASB wants to call this period "severe hyperinflation". I oppose this move.

What is wrong is the actual misleading name the IASB wants to give to this period: namely "severe hyperinflation". I am against using the term for that period because there were no prices quoted in the ZimDollar during that period, thus, there was no hyperinflation.

I agree that the economy was still in the same state that caused actual hyperinflation. But, to have hyperinflation you needed prices in ZimDollars, but, there were no new prices set in ZimDollars.

It is important to get the technicalities right too if we really want to understand what actually happened.

I am of the opinion that the introduction of this new term "severe hyperinflation" should be stopped.

Once it is in the final International Financial Reporting Standard it will be in accounting and economic literature. Then hyperinflation will be, incorrectly, divided in hyperinflation and this "severe hyperinflation" as incorrectly defined by the IASB. I don´t agree with that.

I think the IASB should not introduce this new term "severe hyperinflation" into economic and accounting terminology. They should remove their definition since the term “severe hyperinflation” is used in the hyperinflation literature for periods of actual extreme hyperinflation when prices are still being set in the hyperinflationary currency. The IASB should simply state that after a currency failed or lost its exchangeability then the new ED applies: they should not give that period a misleading name. They should not give it any name.

Naming a period with no hyperinflation as "severe hyperinflation" is obviously wrong.

Someone in Zimbabwe suggested that the period immediately after the currency lost its exchangeability in the market although the government has not yet officially withdrawn its characteristic as legal tender could be called the Zimbabwean Syndrome. This person agreed that the term “severe hyperinflation” is misleading for that period of no hyperinflation.

This period is a period when the currency has no exchangeability. It should just be described as that. It should not be called a period of “severe hyperinflation” when there is no actual hyperinflation. It is obviously a mistake.

Copyright © 2010 Nicolaas J Smith