Dollar-indexation

Dollar-indexation

Updated on 11-11-2014

Dollar-indexation (indexing your fiat local currency values in terms of the daily USD parallel rate) is running your daily business and doing your daily accounting in terms of the US Dollar daily parallel rate or another foreign currency daily parallel rate during hyperinflation although you many never even receive or make payments in the US Dollar or another foreign currency.  

It is not the same as translating year-end financial statements prepared under Historical Cost Accounting in a hyperinflationary economy at the US Dollar exchange rate at the period-end date.

Dollar-indexation results in capital maintenance in units of constant purchasing power in terms of the daily US Dollar parallel rate which would maintain the constant purchasing power of capital relatively constant for an indefinite period of time in all entities that at least break even during hyperinflation – ceteris paribus.

Translating year-end HC financial statements at the year-end US Dollar rate does not result in capital maintenance in units of constant purchasing power.

‘The use of units of account separate from money has been known for millennia.’ (Shiller, R.J., 1998)

I developed Dollar-indexation during 1995 in Angola´s hyperinflationary economy and implemented it during 1996 in Auto-Sueco (Angola).

Before 11-11-2014 I mistakenly called Dollar-indexation by the name of accounting-dollarization. That was a mistake since the concept of "dollarization" implies that it is similar to an economy-wide central bank policy of dollarizing the economy. It is not.

Dollar-indexation can be implemented in a single company as I did at Auto-Sueco (Angola). It has nothing to do with the functions of the Central Bank. 

Nicolaas Smith

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

Inflation only affects bank notes and coins

Inflation only affects bank notes and coins

Inflation and deflation have no effect on the real value of non-monetary items.

‘Inflation is always and everywhere a monetary phenomenon,’ per Milton Friedman.

‘Purchasing power of non monetary items does not change in spite of variation in national currency value.’

Gucenme, U. and Arsoy, A. P. (2005). Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005. Special Issue Accounting for the Global and the Local: The Case of Turkey. Critical Perspectives on Accounting, Volume 20, Issue 5, July 2009, p. 568–590.

Inflation erodes the real value of only monetary items not inflation-adjusted in terms of a Daily Consumer Price Index. Deflation creates real value in only monetary items not deflation-adjusted in terms of a Daily Consumer Price Index.

‘Assets and liabilities linked by agreement to changes in prices, such as index linked bonds and loans, are adjusted in accordance with the agreement in order to ascertain the amount outstanding at the end of the reporting period.’

IAS 29, Par. 13

Inflation in many different countries has no effect on the real value of monetary items inflation-adjusted in terms of a Daily CPI, for example the more than 2.68 trillion US Dollars (2009)¹ of government inflation-indexed bonds currently inflation-adjusted daily in the world economy in terms of a Daily CPI which is a lagged, daily interpolation of the monthly published CPI.

¹ (Standard Life Investments. (2012). An Investor´s Guide to Inflation–Linked Bonds. Retrieved 7 January 2012, from Standard Life Investments’s Web site.)

According to the Banco Central de Chile, 20 to 25 per cent of the broad M3 money supply in Chile is currently inflation-adjusted daily in terms of the Unidad de Fomento (Written communication. (2011)) which is a monetized daily indexed unit of account started in 1967 and published daily by the Banco Central de Chile since 1990.

The above are all monetary items that exist in a zero cost of inflation (not zero inflation) space. They are all monetary items, but, their real values are not affected by inflation. Inflation-adjusting the entire money supply (excluding bank notes and coins of the fiat functional currency created by means of fractional reserve banking within an economy) under complete co-ordination would result in zero cost of inflation (not zero inflation) in only the complete money supply (as qualified) in an economy.

It is currently (2012) impossible to inflation-adjust or deflation-adjust bank notes and coins of fiat money created by means of fractional reserve banking within an economy. Their real values are always affected by inflation and deflation.

Bank notes and coins make up about 7 per cent of the broad M3 money supply in an advanced economy.

At an inflation target of 2 per cent per annum annual inflation the erosion of real value by inflation can be limited to 2 per cent of 7 per cent of M3 under complete co-ordination; i.e. 0.14 per cent of the money supply.

The inflation dragon has been cut down to size as evidenced in the US economy.

Nicolaas Smith

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

Monetary items

Monetary items

The IFRS definitions of monetary items in IAS 29, Par. 12 and IAS 21, Par. 8 need to be improved because non-monetary items are all items that are not monetary items. The definition of monetary items thus determines which items are non-monetary items per IFRS. When the definition of monetary items is incorrect then the division of monetary and non-monetary items is incorrect as it currently is in terms of IFRS.

IAS 29, Par. 12

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

IAS 21, Par. 8

'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.'

Definition

Monetary items constitute the Money supply.

Updated on 11-05-2013

Examples of units of money held are bank notes and coins of the fiat currency created within an economy by means of fractional reserve banking. Examples of items with an underlying monetary nature which are substitutes for money held include the capital amount of: bank loans, bank savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds, Treasury Bills, all capital and money market investments, notes payable, notes receivable, etc. when these items are not in the form of money held.

Nicolaas Smith

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

Two totally different processes of real value erosion in an economy during inflation

There are two totally different processes of real value erosion involved in an economy during inflation: 

(1) One eroding the real value of only monetary items not inflation-adjusted daily in terms of a Daily CPI, namely, the economic process of inflation and

(2) A totally different one eroding only the real value of constant real value non-monetary items not maintained constant daily, namely, the implementation of the Generally Accepted Accounting Practice of applying the stable measuring unit assumption during inflation under HCA as authorized in IFRS in 1989.

Nicolaas Smith

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

Borrowing costs are not monetary items

Borrowing costs are not monetary items

Borrowing costs, interest paid, bank charges, interest received, etc are constant real value non-monetary items.

They appear to be monetary items because banks almost always charge them to bank accounts on the day they are due.

Inflation has no effect on the real value of non-monetary items. The above items are thus never affected by inflation.

When they are not measured in units of constant purchasing power in terms of a Daily Consumer Price Index then their real values are eroded – at the rate of inflation because money is used as the medium of exchange – by the stable measuring unit assumption.

Nicolaas Smith

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

Zero cost of inflation

It is noted that:

‘Inflation is always and everywhere a monetary phenomenon,’ per Milton Friedman.

‘Purchasing power of non monetary items does not change in spite of variation in national currency value.’

Gucenme, U. and Arsoy, A. P. (2005). Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 – 2005. Special Issue Accounting for the Global and the Local: The Case of Turkey. Critical Perspectives on Accounting, Volume 20, Issue 5, July 2009, p. 568–590.

Inflation and deflation have no effect on the real value of non-monetary items. Capital contributed and comprehensive income, for example, are constant real value non-monetary items. IAS 29 defines them as non-monetary items. The definition of a constant real value non-monetary item is derived in IFRS.

It is not inflation and deflation affecting the real value of constant real value non-monetary items not maintained constant over time. It is the implementation of the stable measuring unit assumption as part of the traditional Historical Cost Accounting model during inflation and deflation.

Inflation erodes the real value of only monetary items not inflation-adjusted on a daily basis in terms of a Daily Consumer Price Index over time. Deflation creates real value in only monetary items not inflation-adjusted on a daily basis in terms of a Daily Consumer Price Index over time. It is currently (2012) impossible to inflation-adjust or deflation-adjust bank notes and coins.

Inflation in many different countries has no effect on the real value of monetary items inflation-adjusted on a daily basis, for example the more than 2.68 trillion US Dollars (2009)¹ of government inflation-indexed bonds currently inflation-adjusted daily in the world economy in terms of a Daily Consumer Price Index which is a lagged, daily interpolation of the respective monthly published CPI.

¹ (Standard Life Investments. (2012). An Investor´s Guide to Inflation–Linked Bonds. Retrieved 7 January 2012, from Standard Life Investments’s Web site.)

According to the Banco Central de Chile, 20 to 25 per cent of the broad M3 money supply in Chile is inflation-adjusted on a daily basis in terms of the Unidad de Fomento (Written communication. (2011)) which is a monetized daily indexed unit of account started in 1967 and published daily by the Banco Central de Chile since 1990.

The above are all monetary items that exist in a zero cost of inflation (not zero inflation) space. They are all monetary items, but, their real values are not affected by inflation.

The entire cost of inflation can be eliminated under complete co-ordination when the entire money supply in an economy (excluding bank notes and coins that generally make up about seven per cent of the money supply in an advanced economy) is inflation-adjusted on a daily basis in terms of a Daily Consumer Price Index.

The requirement in IAS 29, Par. 9 that ‘the gain or loss on the net monetary position shall be included in profit or loss and separately disclosed,’ deals with the ‘effects of inflation’ and deflation on monetary items only during hyperinflation.

However, the definitions of monetary items in IAS 29, Par. 12 and IAS 21, Par. 8 need to be improved because non-monetary items are all items that are not monetary items. The definition of monetary items thus determines which items are non-monetary items per IFRS. When the definition of monetary items is incorrect then the division of monetary and non-monetary items is incorrect as it currently is in terms of IFRS.

Everything else in IAS 29 unsuccessfully² deals with the effect of the stable measuring unit assumption (not the ‘effects of inflation’) on constant real value non-monetary items, e.g. capital contributed and comprehensive income, not maintained constant during hyperinflation.

² See my comment letter on the IASB Agenda Consultation 2011.

A monetary item is one of the three basic economic items:

(a) Monetary items

(b) Variable real value non-monetary items

(c) Constant real value non-monetary items

Definition

Monetary items are units of money held and items with an underlying monetary nature which are substitutes for units of money held.

Examples of units of money held are bank notes and coins of the fiat currency created within an economy by means of fractional reserve banking. Examples of items with an underlying monetary nature which are substitutes of money held include the capital amount of: bank loans, bank savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds, Treasury Bills, all capital and money market investments, notes payable, notes receivable, etc. when these items are not in the form of money held.

Nicolaas Smith

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

Measurement of economic items

Measurement of economic items

Daily measurement is required under Constant Item Purchasing Power Accounting of all items in terms of

(a) a Daily Consumer Price Index or monetized daily indexed unit of account, e.g. the Unidad de Fomento in Chile, during low inflation, high inflation and deflation and

b) in terms of a relatively stable foreign currency parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate during hyperinflation. Hyperinflation is defined in IAS 29 as cumulative inflation being equal to or approaching 100 per cent over three years, i.e. 26 per cent annual inflation for three years in a row.

Monetary items

Monetary items are units of money held and items with an underlying monetary nature which are substitutes for units of money held.

Examples of units of money held are bank notes and coins of the fiat currency created within an economy by means of fractional reserve banking. Examples of items with an underlying monetary nature which are substitutes of money held include the capital amount of: bank loans, bank savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds, Treasury Bills, all capital and money market investments, notes payable, notes receivable, etc. when these items are not in the form of money held.

Measurement

Historic and current period monetary items are required to be inflation-adjusted on a daily basis. When they are not inflation-adjusted on a daily basis during the current financial period then the net monetary loss or gain as defined in IAS 29 is required to be calculated and accounted.

Variable real value non-monetary items

A variable real value non-monetary item is a non-monetary item with a variable real value over time.

Examples include quoted and unquoted shares, property, plant, equipment, inventory, intellectual property, goodwill, foreign exchange, finished goods, raw material, etc.

Measurement

Current period variable real value non-monetary items are required to be measured on a daily basis in terms of IFRS excluding the stable measuring unit assumption and the cost model in the valuation of property, plant, equipment and investment property after recognition. When they are not valued on a daily basis, then they as well as historic variable real value non-monetary items are required to be updated daily in terms of a daily rate as indicated above. Current period impairment losses in variable real value non-monetary items are required to be treated in terms of IFRS. They are constant real value non-monetary items once they are accounted. All accounted losses and profits are constant real value non-monetary items.

Constant real value non-monetary items

A constant real value non-monetary is a non-monetary item with a constant real value over time whose value within an entity is not generally determined in a market on a daily basis.

Examples include pensions, salaries, wages, rentals, all other income statement items, issued share capital, share premium accounts, share discount accounts, retained earnings, retained losses, capital reserves, revaluation reserves, all accounted profits and losses, all other items in shareholders´ equity, trade debtors, trade creditors, dividends payable, dividends receivable, deferred tax assets, deferred tax liabilities, all taxes payable, all taxes receivable, all other non-monetary payables, all other non-monetary receivables, provisions, etc.

Measurement

Historic and current period constant real value non-monetary items are always and everywhere required to be measured in units of constant purchasing power in terms of a daily rate as indicated above.

Nicolaas Smith

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

Inflation and deflation do not necessarily affect monetary items

Inflation and deflation do not necessarily affect monetary items

Inflation and deflation affect only monetary items in the economy. Inflation and deflation have no effect on the real value of non-monetary items.

However, inflation and deflation do not affect all the monetary items in the economy.

Inflation and deflation only affect monetary items not being inflation-adjusted or deflation-adjusted, respectively.

A monetary item that is being inflation-adjusted or deflation-adjusted is not affected by inflation or deflation, respectively.

According to the Banco Central de Chile, 20 to 25 per cent of the broad M3 money supply of Chile is currently inflation-adjusted on a daily basis in terms of the Unidad de Fomento which is a monetized daily indexed unit of account started in Chile in 1967.

Those are monetary items not affected by annual inflation, currently at 4.4 per cent (December 2011) in Chile.

Global inflation-indexed government bonds amount to more than2.680 trillion US Dollars (December 2009) which are all inflation-indexed on a daily basis (these bonds trade daily) in many different countries in the world. They are all monetary items not affected by inflation.

So, inflation in many different countries has no effect on the real value of these monetary items worldwide.

It is thus not correct to state that inflation and deflation affect monetary items. The correct statement is that inflation and deflation affect monetary items not inflation-adjusted and deflation-adjusted, respectively.

Bank notes and coins are the only monetary items that are always affected by inflation and deflation. It is impossible in 2012 to inflation-adjust or deflation-adjust actual physical bank notes and coins.

The entire money supply can be inflation-adjusted excluding bank notes and coins. That would eliminate the total cost of inflation (not actual inflation) from the monetary economy excluding from bank notes and coins which generally make up about seven per cent of the money supply in an advanced economy. This would result in zero cost of inflation in the entire monetary economy excluding bank notes and coins at all levels of inflation .

The same is true under deflation. Under deflation the real value creation effect of deflation in monetary items not deflation-adjusted would be completely eliminated in the monetary economy excluding in bank notes and coins.

Nicolaas Smith

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

Principles involved in financial capital maintenance in units of constant purchasing power

The principles involved in financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation include:
1 The constant purchasing power of capital is always equal to the real value of net assets.

2 The capital concept to be implemented: Constant purchasing power capital.

3 The capital maintenance concept to be implemented: Financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation in terms of a daily rate.

4 The stable measuring unit assumption is never implemented.

5 Monetary items are units of currency held and items with an underlying monetary nature. Monetary items with an underlying monetary nature are substitutes for units of currency held.

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

7 Non-monetary items are sub-divided in:

(a) Variable real value non-monetary items and

(b) Constant real value non-monetary items.

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

Constant real value non-monetary items are non-monetary items with constant real values over time.

8 Daily measurement is required of all items in terms of

(a) a Daily Consumer Price Index or monetized daily indexed unit of account, e.g. the Unidad de Fomento in Chile, during low inflation, high inflation and deflation and

(b) in terms of a relatively stable foreign currency parallel rate (normally the US Dollar daily parallel rate) or a Brazilian-style Unidade Real de Valor daily index rate during hyperinflation. Hyperinflation is defined in IAS 29 as cumulative inflation being equal to or approaching 100 per cent over three years, i.e. 26 per cent annual inflation for three years in a row.

Measurement

9 Historic and current period monetary items are required to be inflation-adjusted on a daily basis. When they are not inflation-adjusted on a daily basis during the current financial period then the net monetary loss or gain as defined in IAS 29 is required to be calculated and accounted. All monetary items except actual bank notes and coins can be inflation-adjusted on a daily basis. This would remove the total cost of inflation from the entire money supply except from actual bank notes and coins which generally make up about seven per cent of the money supply in advanced economies.

10 Current period variable items are required to be measured on a daily basis in terms of IFRS excluding the stable measuring unit assumption. When they are not valued on a daily basis, then they as well as historic variable items are required to be updated daily in terms of a daily rate as indicated above. Current period impairment losses in variable items are treated in terms of IFRS. They are constant items once they are accounted. All accounted losses and profits are constant items.

11 Historic and current period constant real value non-monetary items are always and everywhere required to be measured in units of constant purchasing power in terms of a daily rate as indicated above.

12 When constant items are not measured daily in units of constant purchasing power, then the calculation and accounting of the net constant item loss or gain is required.

13 Once an entity has started financial capital maintenance in units of constant purchasing power it is required to continue with that model at all future levels of inflation and deflation.

14 Entities in economies with inflation rates below 10 per cent per annum or cumulative inflation over three years below 26 per cent should be very strongly encouraged to implement financial capital maintenance in units of constant purchasing power in terms of a daily rate as proposed by the Argentinean Federation.

15 Inflation and deflation only affect the real value of monetary items not inflation-adjusted and deflation adjusted respectively

16 The stable measuring unit assumption affects the real value of constant items not maintained constant during inflation and deflation.

17 The terms ‘restatement’, ‘restated’, ‘inflation restatements’ and ‘inflation-adjustment of financial statements’ should not be used in a proposed new IFRS regarding capital maintenance in units of constant purchasing power.

18 The proposed new IFRS is a departure from Historical Cost Accounting at all levels of inflation and deflation.

Nicolaas Smith

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

Financial capital maintenance in units of constant purchasing power requires a daily rate

Financial capital maintenance in units of constant purchasing power requires a daily rate

It is noted that:

(1) When it is intended to maintain the real value of an item, for example, a government inflation-indexed bond, it is immediately realized that a daily rate is required since these bonds trade on a daily basis. Many countries use Daily CPIs to value these bonds on a daily basis.

(2) During hyperinflation a daily US Dollar parallel rate is always spontaneously used by the population and in the consumer markets.

(3) Brazil, for example, used government supplied daily index rates from 1964 to 1994 to index variable and constant real value non-monetary items on a daily basis in the entire economy.

(4) Chile has been using a monetized daily indexed unit of account, the Unidad de Fomento, since 1977. Its daily value has been calculated and published daily by the Central Bank of Chile since 1990.

(5) Prof. Robert Shiller stated:

‘Another coordination problem is that we must decide, and agree, on a way to smooth the CPI. We should not define prices just in terms of the latest CPI because the CPI is vulnerable to sudden jumps from month to month. This is particularly true when we are talking about indexing financial contracts to the CPI. A unit of account like the UF would smooth out the CPI movements, otherwise there would be important jumps in deposit balances on the dates of new announcements of the CPI. Thus, the smoothing of the CPI in producing the UF has also been a fundamental part of the functioning of the UF as an analogue of money.’

Shiller, R.J. (1998). Indexed Units of Account: Theory and Assessment of Historical Experience. Cowles Foundation Discussion Paper, No 1171, p. 13.

A Daily CPI is thus a fundamental requirement when implementing financial capital maintenance in units of constant purchasing power as the basic accounting model in the economy.

Many countries issue government and commercial inflation-indexed bonds. The most liquid markets are US Treasury Inflation Protected Securities (TIPS), the UK Index–linked Gilts and the French OATi/OAT€I market. Japan, Germany, Italy, Canada, Australia, Sweden, Iceland, Portugal, Greece, Finland, Netherlands, Spain, Saudi Arabia, Qatar, Kuwait, UAE, South Korea, New Zealand and Hong Kong also issue inflation–indexed government bonds, as well as a number of Emerging Markets such as Brazil, Turkey, Chile, Mexico, Colombia, Argentina and South Africa.

The British government began issuing inflation–linked Gilts in 1981.

Most of these countries use a Daily Consumer Price Index to value these bonds on a daily basis. A Daily CPI is a one or two month lagged, daily interpolation of the monthly published CPI.

A country which issues inflation–indexed government bonds and uses a one or two month lagged interpolated Daily CPI to determine the daily price of these bonds can use the Daily CPI for the implementation of financial capital maintenance in units of constant purchasing power in terms of a daily rate at all levels of inflation and deflation as proposed by the Argentinean Federation. Daily CPIs are thus already in use in many economies. A country with no inflation–indexed sovereign bond market can use a Daily CPI based on the formula used to calculate the Unidad de Fomento in Chile.

The Central Bank of Chile translates the Unidad de Fomento on their website as An Inflation–Indexed Accounting Unit and CPI–Indexed Unit of Account (UF).

The UF´s nominal value in Chilean escudos was originally (1967) updated every quarter which would be the official rate for the following quarter. The nominal index was updated monthly from October 1975, with the currency changeover to pesos, till 1977. Since July 1977 the change in the nominal value was calculated daily by interpolation between the tenth of each month and the ninth of the following month, according to the monthly variation of the Indice de Precios al Consumidor (IPC), the Chilean Consumer Price Index. The Banco Central de Chile has calculated and published the UF´s value daily since 1990. The UF is a monetized lagged daily interpolation of the monthly published Chilean CPI. The IPC is independently calculated and published monthly by the Chilean National Statistical Institute.

The UF daily rate is available on the Chilean Central Bank´s website.

A daily instead of a monthly general price–level index is required to implement financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation. Using the CPI published monthly may result in sudden increases or decreases in values on the date the new monthly CPI is published. A Daily CPI solves this problem. The UF is a very successful monetized daily indexed unit of account used in Chile during the last 45 years (2012) and was copied by Colombia, Ecuador, Mexico, and Uruguay.

A Daily CPI is the daily index value used to calculate the daily price of a government inflation–indexed bond in a particular country, e.g. the formula to calculate the daily price of TIPS in the US, or is based on the formula used to calculate the UF in Chile.

The UF in Chile is the most successful monetized daily indexed unit of account to date.

The monthly published CPI for the first day of any month is only available – at the earliest – round–about the tenth of the next month; up to 41 days later. The South African CPI for the first day of a calendar month can become available up to the twenty-fourth day of the next calendar month; i.e. up to 55 days later. This is very impractical for daily financial capital maintenance in units of constant purchasing power.

Formula

‘The UF is now a lagged daily interpolation of the monthly consumer price

index. The formula for computation of the UF on day t is:

UF _t = UF _t–1 × (1+ π) ^1/d

where π is the inflation rate for the calendar month preceding the calendar month in which t falls if t is between day ten and the last day of the month (and d is the number of days in the calendar month in which t falls), and π is the inflation rate for the second calendar month before the calendar month in which t falls if t is between day one and day nine of the month (and d is the number of days in the calendar month before the calendar month in which t falls).’ (Shiller, 1998)

The above formula applies to the UF in Chile where the CPI for the current calendar month used to be available on the tenth of the next calendar month. The general case formula for a UF – based Daily CPI is stated as follows:

On day t    

DI _t = DI _t–1 X (1 + π) ^1/d

where π is the monthly inflation rate for the second calendar month before the calendar month in which t falls if t is on or between day one and the day of publication of the CPI of the previous calendar month (and d is the number of days in the calendar month before the calendar month in which t falls), and π is the monthly inflation rate for the calendar month preceding the calendar month in which t falls if t is on or between the day the CPI for the previous calendar month is published and the last day of the month (and d is the number of days in the calendar month in which t falls).

The monthly inflation rate for a calendar month is calculated using the CPI for that month and for the preceding month. The Daily CPIs within a given calendar month thus depend on the CPI for each of the three preceding months. For example the July Daily CPIs depend before the day the June CPI is published on the CPI for April and May, and starting with the day the June CPI is published on the CPI for May and June.

A Daily CPI is very similar to, but not exactly the same as a monetized daily indexed unit of account, e.g. the UF in Chile. The UF is monetized; i.e. it is stated in terms of the Chilean peso. That is not automatically the case with a Daily CPI. A Daily CPI is not automatically monetized.

A Daily CPI is, like the monthly CPI on which it is based, a non–monetary general price–level index value. Monetization depends on generally accepted monetary practices in an economy (see the UF in Chile). A Daily CPI can be monetized and used as a monetized daily indexed unit of account with payments being made in the national monetary unit – depending on users in an economy. Monetization is not a necessity.

Nicolaas Smith

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

The concept of a constant real value non-monetary item is derived in IFRS

The concept of a constant real value non-monetary item is derived in IFRS

The original Framework (1989), Par. 104 (a) [now the Conceptual Framework (2010), Par. 4.59 (a)] states: ‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’ When financial capital maintenance is measured in units of constant purchasing power it means, in principle, that certain economic items have constant real values over time.

Everybody will agree that this certainly does not refer to monetary items. Thus, certain non–monetary items are constant real value non–monetary items, e.g. pensions, salaries, wages, rentals, all other income statement items, issued share capital, share premium accounts, share discount accounts, capital reserves, all other items in shareholders´ equity, trade debtors, trade creditors, dividends payable, dividends receivable, deferred tax assets, deferred tax liabilities, all taxes payable, all taxes receivable, all other non-monetary payables, all other non-monetary receivables, provisions, etc.

On the other hand: non–monetary items which are not constant real value non–monetary items are thus variable real value non–monetary items valued in terms of IFRS (excluding the stable measuring unit assumption and the two definitions of monetary items which need to be improved), e.g. property, plant, equipment, inventory, shares, foreign exchange, etc.

Nicolaas Smith

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

No stable measuring unit assumption under financial capital maintenance in units of constant purchasing power

No stable measuring unit assumption under financial capital maintenance in units of constant purchasing power

There is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power at all levels of inflation and deflation.

Thus it is required that

A All items have to be valued daily.

1 Historical and current period monetary items have to be inflation-adjusted daily.

2 Historical and current period variable real value non-monetary items are valued daily in terms of IFRS. When not valued daily in terms of IFRS they are required to be updated daily.

3 Historical and current period constant real value non-monetary items are measured in units of constant purchasing power daily.

Daily inflation-adjustment (of only monetary items), updating (of only variable items) and measurement in units of constant purchasing power (of only constant items) are done

(a) During low and high inflation and deflation in terms of:

(i) The Daily Consumer Price Index, which is simply a lagged, daily interpolation of the CPI, now (today) used in most of the important economies in the world to price government inflation-indexed bonds in those particular countries, or

(ii) A monetized daily indexed unit of account, e.g. the 45 year old Unidad de Fomento in Chile. A Daily CPI does not need to be monetized.

(iii) A Daily CPI based on the very successful Unidad de Fomento formula when a country does not currently issue government inflation-indexed bonds or commercial inflation-indexed bonds.

(b) During hyperinflation in terms of

(i) A Brazilian-style Unidade Real de Valor daily index, or

(ii) A daily relatively stable foreign currency parallel rate, normally the US Dollar daily parallel rate.

B All financial reports have to be updated daily

When a financial report of any kind is prepared and finalized on the final day of the period, then it is out of date the next day because there is a new Daily CPI, monetized daily indexed unit of account, daily index or parallel rate.

Financial reports should ideally never be printed on hard copy, but always in electronic format with daily updating of all values daily.

Nicolaas Smith

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

Entire money supply can be inflation-adjusted on a daily basis

Poor demand at inflation-linked auction (Fin24 article)

Total co-ordination (everybody doing it) of inflation-adjusting all monetary items in the SA or any other economy on a daily basis in terms of a Daily Consumer Price Index which is simply a lagged, daily interpolation of the CPI would remove the total cost of inflation (not actual inflation in only Rand notes and coins) from only the monetary economy in SA. That would mean zero cost of inflation or zero inflation only in the SA monetary economy excluding in actual Rand notes and coins (normally about 7% of the money supply).

A glimpse of what the future holds.

The inflation-linked bonds mentioned in this article trade daily. That means there is already a Daily index calculated to determine the daily price of the above bonds. SA and all (most) countries in the world which issue government inflation-linked bonds already calculate and use Daily indices on a daily basis to determine the daily price of these inflation-linked bonds.

Chile currently inflation-indexes about 20 to 25 per cent of its broad M3 money supply on a daily basis (according to the Central Bank of Chile) in terms of their Unidad de Fomento which is their monetized daily indexed unit of account.

A Daily CPI does not need to be monetized. The UF has been in use since 1967.

Nicolaas Smith

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

Attributes of CIPPA - Part 3 of 3: Constant items measured in units of constant purchasing power daily

Attributes of CIPPA - Part 3 of 3: Constant items measured in units of constant purchasing power daily
[Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily]

[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]

Constant items measured in units of constant purchasing power daily

Constant items are always and everywhere measured in units of constant purchasing power in terms of a DCPI or monetized daily indexed unit of account during low and high inflation and deflation and in terms of a daily hard currency parallel rate of daily index rate during hyperinflation under CIPPA. This would eliminate the entire cost of the stable measuring unit assumption (mistakenly thought to be the same as the cost of inflation) – currently hundreds of billions of US Dollars per annum – from the constant item economy only in the unlikely case of complete co-ordination right from the start of changing over to financial capital maintenance in units of constant purchasing power in terms of a daily rate.

Valuation and accounting of constant items within an entity – with no third parties involved – are always and everywhere done in units of constant purchasing power in terms of a daily rate under CIPPA. This includes all items in shareholders´ equity, provisions, pensions, salaries, wages, rentals, all other items in the income statement, accounts payable, accounts receivable, all other non- monetary payables, all other non–monetary receivables, etc.

[Attributes of CIPPA - Part 1 of 3: Monetary items inflation-adjusted daily]

[Attributes of CIPPA - Part 2 of 3: Variable items updated daily]

Nicolaas Smith

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