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

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

 

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

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

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

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

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

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

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

 

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Nicolaas Smith

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

Benefits of daily inflation-indexing the entire money supply

Benefits of daily inflation-indexing the entire money supply

 

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

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

 

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

 

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

 

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Nicolaas Smith

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

Running an economy in constant values

Iran is currently in hyperinflation.

 

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

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

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

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

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

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

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

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

 

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Nicolaas Smith

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

DEFINITION OF FINANCIAL CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

DEFINITION OF FINANCIAL CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER

Financial capital maintenance in units of constant purchasing power is the automatic maintenance of the real value (constant purchasing power) of capital (equity), based on the principle that the real value (constant purchasing power) of equity is always equal to the real value of net assets for an indefinite period of time in all entities that at least break even in real value – all else being equal – at all levels of inflation and deflation, including during hyperinflation as authorised in current IFRS in The Conceptual Framework (2010), Par. 4.59 (a) in terms of a Daily Consumer Price Index or other daily index.

STABLE MEASURING UNIT ASSUMPTION NEVER IMPLEMENTED

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

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

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

VALUE DATE

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

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

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Nicolaas Smith

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Managerial Accounting under Financial Capital Maintenance in Units of Constant Purchasing Power

Financial capital maintenance in units of constant purchasing power is the same as Constant Item Purchasing Power Accounting at all levels of inflation and deflation, including during hyperinflation.

It is a departure from Historical Cost Accounting. The fundamental difference is that the stable measuring unit is never implemented under financial capital maintenance in units of constant purchasing power. Everything is done at real value: in Managerial Accounting too. I equate Managerial Accounting to Cost and Management Accounting.

Simply take any item in Managerial Accounting and update it to its current real value, i.e. it´s value today at today´s Daily CPI.

First you will have to find the Daily CPI for your country. If your government issues government capital inflation-indexed bonds, then you already have a Daily CPI in your country. The Daily CPI for your country is the one or two month lagged daily interpolated index that is used in your country to price your government inflation-indexed bonds on a daily basis: these bonds are bought and sold on a daily basis in your country´s capital markets.

If your country, like Venezuela, does not issue government inflation-indexed bonds, then you have to calculate the Daily CPI in your country from your country´s monthly published CPI using the formula for the calculation of the Unidad de Fomento in Chile as described by Prof. Robert Shiller. It is detailed as follows:

‘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 1998:3

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 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).

You have to use the general case formula.

All you do then is multiply any item in your Managerial Accounts by the update factor you derive from dividing the value of your Daily CPI today, with the value of the Daily CPI on the date the item was purchased / came about / was contributed / etc. Then you have its real value today.

Since the Daily CPI changes daily, all your Managerial Accounts (and financial accounting) values change daily in terms of the daily changing Daily CPI.

There you have it.

Obviously you have to abandon the Historical Cost Accounting model and change over to the Financial Capital Maintenance in Units of Constant Purchasing Power model (which is the same as Constant Item Purchasing Power Accounting) in your financial accounting.

This is authorised at all levels of inflation and deflation, including during hyperinflation, in The Conceptual Framework (2010), Par. 4.59 (a).

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Nicolaas Smith

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Financial capital maintenance in units of constant purchasing power during hyperinflation is authorized in current IFRS

Financial capital maintenance in units of constant purchasing power during hyperinflation is authorized in current IFRS

Under IAS 29 Financial Reporting in Hyperinflationary Economies, financial capital maintenance in nominal monetary units is implemented; i.e., the Historical Cost Accounting model which includes the application of the stable measuring unit assumption during hyperinflation.

‘‘Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting.’

PricewaterhouseCoopers, Understanding IAS 29, 2006, Page 5.

IAS 29 was implemented during the last six years of hyperinflation in Zimbabwe with no effect at all.

IAS 29 is only required for the restatement of Historical Cost or Current Cost financial statements during hyperinflation.

IAS 29, Par. 8 states:

‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or a current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.’

IAS 29 is thus not required when an entity implements financial capital maintenance in units of constant purchasing power during hyperinflation as authorized at all levels of inflation and deflation, including hyperinflation, in current IFRS in The Conceptual Framework (2010), Par. 4.59 (a) which states:

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

Financial capital maintenance in units of constant purchasing power during hyperinflation is thus authorized in terms of current IFRS.

The stable measuring unit assumption is, in principle, never implemented under financial capital maintenance in units of constant purchasing power. When it is implemented in practice, e.g., with the measurement of monetary items in nominal monetary units, then the net monetary loss or gain is calculated and accounted under financial capital maintenance in units of constant purchasing power accounting.

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

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Nicolaas Smith

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

Historical Cost financial statements technically always wrong

Historical Cost financial statements technically always wrong

 

All HC financial reports are out of date the day after the date of the financial report because the Daily Consumer Price Index is generally different every day. HC financial statements are generally never published on the date of the financial statements.

 

This fact is very easily understood during hyperinflation as stated by the South African Institute of Chartered Accountants in 2008. Under IAS 29, HC or CC financial statements are “restated” in terms of the monthly published CPI at the balance sheet date. The stable measuring unit assumption is applied during hyperinflation in terms of IAS 29. IAS 29 is an extension to not a departure from HCA as stated by PwC and required by IFRS. All financial reports prepared in terms of IAS 29 are out of date the day after the date of the financial reports.

 

Under the CIPP paradigm all finacial reports are updated daily to the current, i.e., today´s, date in terms of the Daily CPI or other daily index during low and high inflation and deflation and hard currency parallel rate or other daily index during hyperinflation.

 

Digital CIPP financial reports are never out of date: they are always updated to the current, i.e., today´s, daily index or rate.

 

All digital CIPP non-monetary accounts in the ledger are never out of date: they are always updated to the current, i.e., today´s, daily index or rate. They are updated daily. It is better not to print hardcopy CIPP financial reports since hard copy financial reports are out of date the day after the date of the financial report.

 

HC financial reports are generally never valid in terms of the current, i.e., today´s real values or Daily CPI. All HC financial reports are thus technically always wrong in that sense while all CIPP financial reports are technically always right in that sense.

 

All financial reports perpared in terms of IAS 29 have very little use at all as a result of always being very out of date.

 

Digital CIPPA financial reports are never out of date.

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Nicolaas Smith

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

IAS 29 is not an alternative accounting model to HCA

IAS 29 is not an alternative accounting model to HCA

 

What capital maintenance concept is implemented under IAS 29?

 

Answer: Financial capital maintenance in nominal monetary units, i.e., Historical Cost Accounting - during hyperinflation!!

 

In my opinion HCA should be specifically banned by law during hyperinflation.

 

A certain multinational state in its 2011 annual report that it implements HCA for management control purposes - during hyperinflation!! The last thing you want to implement during hyperinflation is HCA. This multination thinks it is very useful to implement HCA during hyperinflation – for management control purposes!!

 

The lack of understanding of the real value eroding effect of the stable measuring unit assumption and the real value maintaining effect of financial capital maintenance in units of constant purchasing power is astonishing.

 

PricewaterhouseCoopers state in their publication: Understanding IAS 29 (2006), Page 5:

‘Inflation-adjusted financial statements are an extension to, not a departure from, historical cost accounting.’

Both the IASB and PricewaterhouseCoopers thus promote and support HCA during hyperinflation. Unbelievable, but true.

Financial capital maintenance in nominal monetary units is a popular accounting fallacy not yet extinct: it is impossible to maintain the real value of capital constant with financial capital maintenance in nominal monetary units per se during inflation and deflation.

 

‘It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.’

FAS 33 1979: 69

The constant purchasing power (real value) of capital can only automatically be maintained constant for an indefinite period of time in all entities that at least break even in real value – all else being equal – at all levels of inflation and deflation, including during hyperinflation, with financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Conceptual Framework (2010), Par. 4.59 (a) which states:

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

IAS 29 is not required when an entity implements financial capital maintenance in units of constant purchasing power during hyperinflation. IAS 29, Par. 8 states:

‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.’

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Nicolaas Smith


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

Difference between Historical Costs under HCA and CIPPA

Difference between Historical Costs under HCA and CIPPA

 

Historical Cost Accounting

 

The stable measuring unit assumption is implemented under financial capital maintenance in nominal monetary units (HCA). Historical Costs under HCA are thus always nominal Historical Costs, i.e., always wrong in terms of today´s real value, namely in terms of today´s Daily CPI.

 

There is not even one set of HC financial statements technically correct in terms of today´s real value. All HC financial statements are wrong in this sense: they are all wrong in terms of real value since they are all based on nominal Historical Costs during inflation and deflation. The higher the accumulated rate of inflation or deflation since the original date of the Historical Cost and the date it is accessed (read) in the financial statements, the greater the degree of error. HC financial statements prepared during hyperinflation is generally completely useless.

 

Constant Item Purchasing Power Accounting

 

The stable measuring unit assumption is never implemented under financial capital maintenance in units of constant purchasing power (CIPPA). Historical Costs under CIPPA are thus never nominal Historical Costs: they are always Historical Costs updated to the current, i.e., today´s, real value in terms of today´s Daily CPI or other daily index when the financial statements are in a digital format, i.e., automatically updated daily.

 

This would result in daily updated real gross and net margins. It would result in daily updated real profit before tax, real tax payable, real dividends payable and real profit after tax, i.e. real net income; all continuously maintained constant in real value by means of financial capital maintenance in units of constant purchasing power and automatically updated to the current, i.e., today´s, Daily CPI or other daily index. This would result in the automatic maintenance of the constant purchasing power of capital in all entities that at least break even in real value – ceteris paribus – at all levels of inflation and deflation.

 

This would maintain (instead of erode) hundreds of billions of US Dollars in real value in the world´s capital investment base each and every year at the current level of world inflation.

 

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Nicolaas Smith

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

Exception to the implementation of IAS 29 during hyperinflation

Exception to the implementation of IAS 29 during hyperinflation

 

It is not true that International Financial Reporting Standards always require the implementation of IAS 29 Financial Reporting in Hyperinflationary Economies during hyperinflation.

 

IAS 29 states in Par. 8:

 

‘The financial statements of an entity whose functional currency is the currency of a hyperinflationary economy, whether they are based on a historical cost approach or current cost approach, shall be stated in terms of the measuring unit current at the end of the reporting period.’

 

IAS 29 states nothing about an entity whose financial statements are based on financial capital maintenance in units of constant purchasing.

 

The 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.’

 

Par. 4.59 (a) applies at all levels of inflation and deflation, including hyperinflation.

 

An entity whose financial statements are based on financial capital maintenance in units of constant purchasing power is thus not required to implement IAS 29 during hyperinflation.

 

 

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Nicolaas Smith

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

NATURAL LAWS OF ACCOUNTING

NATURAL LAWS OF ACCOUNTING

1. For every debit there is a corresponding credit.

    2. The constant purchasing power of capital is equal to the real value of net assets.

3. The three basic economic items are

(a)       monetary items,

(b)       variable real value non-monetary items and

(c)       constant real value non-monetary items.

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

The three parts of the economy are the

(i)                  monetary economy,

(ii)                 variable item economy and

(iii)                constant item economy.

4. Inflation only erodes the real value of (and deflation only creates real value in) money and other monetary items.

Inflation and deflation have no effect on the real value of non-monetary items. Measuring all monetary items on a daily basis in terms of a Daily Consumer Price Index under complete co-ordination removes the entire cost of inflation from the economy.

5. Money is never (assumed to be) perfectly stable during inflation and deflation.

Measurement of constant items is required in units of constant purchasing power in terms of a Daily Consumer Price Index during inflation and deflation.

In the above:

 

Inflation includes low inflation, high inflation and hyperinflation.

Daily Consumer Price Index includes other daily index (or daily parallel rate during hyperinflation).

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Nicolaas Smith

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