Fixed in real terms

Fixed in real terms

Updated on 9-8-11

General price level non-monetary indices, e.g. the CPI and Daily Index, are fixed in real terms but have changing nominal values like monetized daily indexed units of account. There is also another unit of account, the UF, which is fixed in real terms. Shiller, p2

What does fixed in real terms mean?

It means the UF´s and the DI´s nominal values are not fixed over time but change daily during inflation, deflation and hyperinflation because money, unstable in real value, is being used as the fixed nominal unit of account in the economy.

So, what then is fixed?

None of the abovementioned three is a permanently fixed index value. The CPI changes monthly. The UF and the DI change daily. The UF and DI are not fixed in nominal value, but, any price or value quoted or measured or accounted in terms of them remains fixed in real terms over time, meaning the price or accounted item´s nominal value changes daily during inflation, deflation and hyperinflation because money unstable in real value is being used the fixed nominal unit of account in the economy.

We say its real value is fixed meaning its nominal value changes daily – because we state all values in money - unstable in real value - which is used as a fixed nominal unit of account for accounting purposes; i.e. its real value changes daily during inflation, deflation and hyperinflation.

What is fixed in real terms is the initial real value of the typical basket of consumer goods on which the CPI is based. The UF and DI are based on their respective CPIs. Their real values are thus also fixed over time meaning their nominal values change daily during inflation, deflation and hyperinflation because unstable money (unstable pesos in the case of Chile) - fixed in nominal value but continuously changing in real value - is being used as the unstable medium of exchange, unstable store of value and unstable unit of account in the economy.

There is no cost of inflation at any level of inflation when there is complete coordination and everyone rejects the stable measuring unit assumption and inflation-adjusts all monetary items in terms of a Daily Index. This requires accounting the daily inflation-indexing of all monetary items in terms of a Daily Index with the total money supply in the banking system. Monetary items are inflation-adjusted daily because there is no stable measuring unit assumption under financial capital maintenance in unit of constant purchasing power during inflation and deflation; i.e. under CIPPA.

There will also be no cost of the stable measuring unit assumption which requires accounting constant items in units of constant purchasing power in terms of a Daily Index and accounting variable items in terms of IFRS with all historical variable items and historical constant items updated in terms of a Daily Index because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA).

Under CIPPA each of the three economic items consists of three elements at the date of an event/exchange/transaction/contract: (1) the nominal economic value of the item expressed in terms of unstable money (the legal unstable unit of account fixed in nominal value), (2) the date of the event/exchange/transaction/contract and (3) the nominal index value of the Daily Index on that date which is fixed in real terms. The nominal monetary value of, for example, a constant item changes daily in terms of the Daily Index, but, its real value is maintained constant over time during inflation and deflation under CIPPA. A constant item´s constant real value is not expressed as a constant value under CIPPA because there is no fixed constant real value unit of account available yet.

A single unit of constant real value

Theoretically a global perfectly stable unit of fixed constant real value would be equal to one monetary unit in a world economy in a global monetary union with a single currency under indefinite perfectly sustainable zero inflation.

It is argued that important practical problems in implementing indexation are solved by creating such indexed units of account. The author advocates creating such units in other countries, even countries with relatively low rates of inflation such as the
United States. (Shiller, 1998, P1)

Nicolaas Smith Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Daily Consumer Price Index compared to daily monetized indexed unit of account

Daily CPI compared to daily monetized indexed unit of account

Updated on 1-9-11

Unstable money is the unstable medium of exchange, unstable store of value and unstable unit of account in the economy. Pre-monetary economies had units of account without money being available in the economy.

Today the economic values of all economic items are stated in terms of unstable money. Prices are expressed in unstable monetary units. Unstable money is the generally accepted unstable monetary unit of account used to value and account all economic activity by entities applying the stable measuring unit assumption as part of the traditional Historical Cost Accounting model under which they implement financial capital maintenance in fixed nominal monetary units with unstable real values in the world economy during inflation, deflation and hyperinflation.

Unstable money is not fixed in constant real value. Unstable money is fixed in nominal value in economies subject to inflation, deflation and hyperinflation. Unstable money is a constant nominal unit of account with a continuously changing real value (purchasing power). Financial capital maintenance in nominal monetary units, although approved in IFRS and by the US FASB and implemented worldwide, is still a very popular accounting fallacy not yet extinct since it is impossible to maintain the real value of capital constant in nominal monetary units per se during inflation, deflation and hyperinflation.

Bank notes and bank coins cannot currently be indexed which makes it impossible for money held (currency) or the monetary unit of account to be a constant indexed unit of account or a perfectly stable unit of constant real value during inflation, deflation and hyperinflation.

However, notwithstanding or despite the above, monetary items in the form of bank deposits - not the actual bank notes and coins - have been inflation-indexed in, for example, Chile since 1967 by means of the Unidad de Fomento which is now a monetized daily indexed unit of account.   The Central Bank of Chile translates the “Unidad de Fomento” on their site to An Inflation-Indexed Accounting Unit and CPI-Indexed Unit of Account (UF). The UF´s value in Chilean escudos was originally updated every quarter which would be the official rate for the following quarter. It was updated monthly from October, 1975 with the currency changeover to pesos till 1977. Since July 1977 it was calculated daily by interpolation between the 10th of each month and the 9th of the following month, according to the monthly variation of the IPC. The Chilean Central bank has calculated and published its value daily since 1990. The UF is a lagged daily interpolation of the Chilean consumer price index (IPC).

The UF daily rate is available at the Central Bank of Chile

Most bank deposits in Chile are 30-day non-indexed deposits or 90-day indexed deposits whose rates are expressed in terms of the UFs. Interest rates on the indexed deposits are expressed as a premium over the UFs. On maturity, the deposits are converted back to pesos at the current UF rate. Shiller, 1998, p3

Treasury Inflation-Protected Securities (TIPS) are inflation-adjusted or indexed money loans to the US government. The principle or capital amount of the loan is indexed on repayment. On maturity, the loans are converted back to US Dollars at the current CPI rate. Interest is paid on TIPS. Inflation-indexed loans which are monetary item securities or investments are available in other countries too. Inflation-indexing monetary items is thus not a relatively new concept. Chile is the country which is closest to inflation-indexing its entire money supply although 30-day deposits are still not indexed. Money outside the banking system is not indexed.

The Consumer Price Index is an example of a non-monetary general price level index. The annual percentage change in the CPI indicates the annual rate of inflation. The CPI is published monthly.

A daily instead of a monthly general price level index is required to implement financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA). Using the CPI published monthly may result in sudden increases or decreases in values on the date the new CPI is published. A lagged CPI smoothed by means of the formula used to calculate the UF solves this problem. The UF is a very successful monetized daily indexed unit of account used in Chile during the last 44 years and was copied by Ecuador, Mexico and Columbia. (See Shiller, 1998, p6.)

Constant Purchasing Power Accounting (CPPA) during hyperinflation requires either a parallel hard currency exchange rate – normally the US Dollar parallel rate - or a Brazilian style Unidade Real de Valor daily index primarily based on a parallel hard currency. The URV was an excellent daily non-monetary index during hyperinflation in Brazil because it was mainly based on the US Dollar parallel rate (a hard currency parallel rate essential during hyperinflation which is an exceptional circumstance), but, the CPI was also included in the formula.

The CPI is the weighted average index value of a typical basket of consumer goods purchased by a typical consumer statistically stated as a non-monetary initial index value of 100 at the start date. The CPI is thus fixed in real terms.

An example is the harmonized consumer price index of the Euro Zone stated as the non-monetary index value of 100 in 2005. This fixed internal unit of real value is then compared to the weighted average price of the typical basket of consumer goods and services a year later in order to determine the annual rate at which inflation is eroding the real value of only money and other monetary items in only the monetary economy or deflation is creating real value in only money and other monetary items in only the monetary economy. Inflation and deflation have no effect on the real value of non-monetary items. The same is true for hyperinflation.

The stable measuring unit assumption (not inflation and hyperinflation) erodes the real value of constant items never maintained constant (never measured in units of constant purchasing power in a double-entry accounting model where the real value of capital is equal to the real value of net assets) during inflation and hyperinflation under the HC paradigm. Similarly, it is not deflation, but, the stable measuring unit assumption that creates real value in constant items never maintained constant (qualified as per the previous sentence) during deflation under HCA.

The annual percentage change in the CPI indicates the annual rate at which only the real value of the national (or monetary union, e.g. the European Monetary Union) monetary unit and other monetary items is being eroded by the economic process of inflation / hyperinflation or being increased by the economic process of deflation.

The Daily Consumer Price Index (DCPI) is a lagged daily interpolation of the CPI based on the formula used to calculate the UF. In practice, the DCPI is used to inflation-adjust monetary items, to update historical variable items and to measure constant items in units of constant purchasing power when an entity implements financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA) because there is no stable measuring unit assumption under this IFRS-authorized accounting model.

The DCPI is calculated and published daily. The monthly published CPI for the first day of any month is only available round-about the tenth of the next month: up to 41 days later. The UF is a monetized daily index of account.

“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) to the power 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).”

Robert J. Shiller, Indexed Units of Account: Theory and Assessment of Historical Experience, Cowles Foundation Discussion Paper No 1171, 1998, p3.

The above formula applies to the UF in Chile where the CPI for the current calendar month is available on the 10th of the next calendar month. The general case formula can be stated as follows:

On day t

                                  DI t = DI t-1 X (1 + π) to the power 1/d

where π is the annual 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), and π is the annual 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 falls).

The inflation rate for a calendar month is calculated using the CPI for that month and for the preceding month. The DIs within a given calendar month thus depend on the CPI for each of the three preceding months. For example, the July DIs 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.

The DCPI 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 the case with the DCPI. The DCPI is not automatically monetized.

“The UF was and is an amount of currency related to the Indice de Precios al Consumidor (IPC), the consumer price index for Chile.” (Shiller, 1998, p3)

A DCPI is, like the monthly CPI on which it is based, a non-monetary index value. Monetization depends on generally accepted monetary practices in an economy: see the UF in Chile. The DCPI can be used as a monetized unit of account with payments being made in the national monetary unit depending on users in an economy.

“An exchange rate between the unit (the UF) and the true money or legal tender, in Chile the peso, is defined using an index number (such as the consumer price index), and payments are executed in money. Thus, the indexed units of account facilitate payments that are tied to the index number, without being a means of payment.” (Shiller, 1998, p2)

A DCPI is not a unit of account just like the CPI is not a unit of account for accounting purposes. The US Dollar, Euro, Yen, Yuan, etc are the nominally fixed monetary units of account, unstable in real value, used in their respective countries as the national unit of account for accounting purposes during inflation, deflation and hyperinflation. The US, EU, Japanese and Chinese CPI´s are not units of account for accounting purposes. They are non-monetary general price level indices. Prices are not quoted in CPIs or in DCPIs – although they can be.

The DCPIs for Portugal and South Africa are available on this blog.

Inflation-adjusting or indexing the entire money supply with all the money in the banking system eliminates the cost of inflation (not inflation in the monetary unit) completely, only in the money supply; i.e. the monetary economy.

Financial capital maintenance in units of constant purchasing power during inflation and deflation under which all constant items are always and everywhere valued and accounted in units of constant purchasing power by means of a DCPI because there is no stable measuring unit assumption under this accounting model eliminates the entire cost of the stable measuring unit assumption (which is not the cost of inflation) from only the constant item economy. This amounts to hundreds of billions of US Dollars per annum of the real value of constant items never maintained constant in the world´s constant item economy which are currently being eroded unnecessarily by the implementation of the stable measuring unit assumption (not inflation) as it forms part of the traditional HCA model that would be maintained constant under CIPPA.

When all variable items are also measured in terms of specific IFRS with all historical variable items updated in terms of a DCPI because there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power during inflation and deflation as authorized in IFRS, then CIPPA automatically maintains the constant purchasing power of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribus.

Nicolaas Smith Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Daily CPI Formula

Daily CPI Formula

Updated on 6-9-11

A Daily Consumer Price Index (DCPI) is a lagged daily interpolation of the CPI based on the formula used to calculate the Chile´s Unidad de Fomento. In practice, a DCPI is used to inflation–adjust monetary items, to update historical variable items and to measure constant items in units of constant purchasing power under Constant Item Purchasing Power Accounting. The UF is the most successful monetized daily indexed unit of account.

A Daily Consumer Price Index is calculated and published daily. The monthly published CPI for the first day of any month is only available round–about the tenth of the next month: up to 41 days later.

“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) to the power 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).”

Robert J. Shiller, Indexed Unitsof Account: Theory and Assessment of Historical Experience, Cowles FoundationDiscussion Paper No 1171, 1998, p3.

The DCPI is a lagged daily interpolation of the consumer price index. The formula for calculating the DCPI is based on Chile´s Unidad de Fomento published daily by the Central Bank of Chile.

The above formula applies to the UF in Chile where the CPI for the current calendar month used to be available on the 10^th of the next calendar month. The general case formula can be stated as follows:

On day t
                                  DI t = DI t-1  x  (1 + π) to the power 1/d

where 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), and π is the 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).

Since the inflation rate for a calendar month is computed using the CPI for that month and for the preceding month, the DIs within a given calendar month will depend on the CPI for each of the three preceding months (e.g., the July DIs will 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 publised on the CPI for May and June).

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IFRS authorize daily indexed units of account

IFRS authorize

1. Daily indexed units of account since they also authorize:


2. The Constant Item Purchasing Power Accounting model under which there is no stable measuring unit assumption ever which means that:

(i) only constant items are always and everywhere measured in units of constant purchasing power (not inflation-adjusted because inflation is always and everywhere a monetary phenomenon: inflation has no effect on the real value of non-monetary items) on a daily basis in terms of a daily index unit per se during inflation and deflation and in terms of the daily parallel rate or daily index rate during hyperinflation automatically resulting in the complete elimination of the cost of the stable measuring unit assumption (universally mistakenly taught and understood to be the same as the cost – the net monetary loss or gain - of inflation/deflation/hyperinflation) amounting to hundreds of billions of US Dollars per annum in the world´s constant item economy (the above values per annum to be maintained instead forever);

(ii) all variable items are measured in terms of IFRS and all historical variable items are updated (not inflation-adjusted: see above) on a daily basis in terms of a daily index unit during inflation and deflation and per se in terms of the daily parallel rate or daily index rate during hyperinflation;

(iii) all monetary items are inflation-adjusted on a daily basis in terms of a daily index unit during inflation and deflation and in terms of the daily parallel rate or daily index rate during hyperinflation resulting in the automatic complete elimination of the cost of or gain from inflation, deflation and hyperinflation from the economy.

The combination of the above results in CIPPA automatically maintaining the constant purchasing power of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribus.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

IFRS authorize

(Summary of CIPPA)


IFRS authorize:

1. Financial capital maintenance in units of constant purchasing at all levels of inflation and deflation in the original Framework (1989), Par 104 (a). This leads to:

2. The split of non-monetary items in variable real value non-monetary items and constant real value non-monetary items. When some items are authorized to be measured in units of constant purchasing power it logically means that some items have constant real values. These constant items cannot be monetary items since monetary items have unstable real values during inflation and deflation. They have to be non-monetary items with constant real values. When some non-monetary items have constant real values it logically means that some non-monetary items have variable real values.

3. The rejection of the stable measuring unit assumption. This leads to:

4. The elimination of the entire cost of the stable measuring unit assumption from the constant item economy: all constant items are always and everywhere measured in units of constant purchasing power (not inflation-adjusted: inflation is always and everywhere a monetary phenomenon and has no effect on the real value of non-monetary items) which results in zero erosion of real value in constant items.

5. Updating (not inflation-adjustment – see above) of all historical variable items since there is no stable measuring unit assumption under financial capital maintenance in units of constant purchasing power (CIPPA).

6. Daily inflation-adjustment of all monetary items: there is no stable measuring unit assumption, thus, monetary items are inflation-adjusted which is required on a daily basis based on a lagged and smoothed Consumer Price Index to avoid excessive arbitrage speculation. This leads to:

7. The elimination of the entire cost of inflation from the economy. This leads to:

8. The extinction of the concept of a net monetary loss or gain in the economy.

All the above leads to:

9. Automatic maintenance of the constant purchasing power of capital forever in all entities that at least break even during inflation and deflation – ceteris paribus (CIPPA). This should lead to:

10. The end of the Historical Cost Accounting model/paradigm.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

No stable measuring unit assumption (stop HCA) and the entire cost of inflation is removed from the economy

No stable measuring unit assumption (stop HCA) and the entire cost of inflation is removed from the economy

Inflation-adjusting all monetary items (all monetary item assets and all monetary item liabilities) in the economy eliminates the cost of or gain from inflation completely from the economy when all monetary items are in the banking system: there is no net monetary gain or loss when all monetary items are inflation-adjusted daily as they are apparently doing in Chile with the Unidad de Fomento (UF) and all monetary items are in the banking system.


This has been authorized in International Financial Reporting Standards in the original Framework (1989), Par 104 (a) which states "Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power" for the last 22 years since financial capital maintenance in units of constant purchasing power - as authorized in IFRS - means there is no stable measuring unit assumption at all in the economy under Constant Item Purchasing Power Accounting.

All three basic economic items are thus free from the stable measuring unit assumption:

1. Monetary items are inflation-adjusted on a daily basis in terms of the daily CPI (UF in Chile) under financial capital maintenance in units of constant purchasing power during inflation and deflation (Constant Item Purchasing Power Accounting) as authorized in IFRS: no stable measuring unit assumption.

Non-monetary items are split in

(a) constant real value non-monetary items (e.g. shareholders´ equity, trade debtors, trade creditors, salaries, wages, rents, all other items in shareholders´ equity, all other items in the income statement, etc.) and

(b) variable real value non-monetary items (e.g. property, plant, equipment, shares, stock, foreign exchange, etc.)

2. Constant items are measured in units of constant purchasing power in terms of the CPI under financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA) as authorized in IFRS: no stable measuring unit assumption.

3. Variable items are measured in terms of IFRS. Historical variable items are updated in terms of the CPI during inflation and deflation (CIPPA) as authorized in IFRS: no stable measuring unit assumption


Inflation-adjusting all monetary items daily does not stop inflation since inflation is always and everywhere a monetary phenomenon (Friedman). However, it eliminates the entire cost of or gain from inflation and deflation from the economy when all monetary items are in the banking system.

I am sure Chilean accountants do not account the net monetary loss or gain from inflation because there is no net monetary loss or gain from inflation when they inflation-adjust all monetary items in Chile on a daily basis in terms of the UF.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Banks with no fixed assets

Banks with no fixed assets

Updated on 27-7-11

Under financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA) there is no stable measuring unit assumption: thus, all monetary items are inflation-adjusted. All bank deposits, monetary item loans, all monetary items (monetary item assets and monetary item liabilities) are inflation adjusted. This completely removes the the cost of or gain from inflation and deflation from the economy. IFRS thus authorizes the elimination of the cost of or gain from inflation and deflation from the economy. There is no net monetary gain or loss when all monetary items are inflation-adjusted on a daily basis as it is currently happening in Chile with the Unidad de Fomento.
Constant items are measured in units of constant purchasing power in terms of IFRS in all accounts under all circumstances and in all published forms.

Variable real value non-monetary items are valued in terms of IFRS. All historical variable items are updated in terms of the CPI during inflation and deflation (either daily  - see the Unidad de Fomento in Chile - or monthly)  and in terms of the daily parallel or daily index rate during hyperinflation.

Variable and constant items are not inflation-adjusted by definition. Inflation is always and everywhere a monetary phenomenon. Inflation has no effect on the real value of non-monetary items. The stable measuring unit assumption (not inflation) erodes the real value of constant items never updated.

All monetary items are inflation-adjusted since inflation can only erode the real value of money and other monetary items.

The result of CIPPA is that a bank that at least breaks even in real terms during inflation and deflation - ceteris paribus - can automatically maintain the constant purchasing power of its capital constant forever even if it has no fixed assets at all. Completely virtual banks are thus possible under CIPPA.

This is only possible under financial capital maintenance in units of constant purchasing power (CIPPA) as originally authorized in IFRS in the Framework (1989), Par 104 (a) as qualified above. All monetary items have to be in the banking system and have to be inflation-adjusted.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Unidad de Fomento

Hi Motley Fool,


Thank you very much for your comment on my previous blog. I tried to reply via the "Reply" link on my blog and the "Comment" option on my and your blogs, but, nothing worked. So, here is my reply.

I did not know about the UF.

Yes, the Unidad de Fomento results in Chile implementing most of Constant Item Purchasing Power Accounting (CIPPA) since 1967. The wiki article does not indicate whether they account the net monetary gain or loss from inflation. The UF is similar to the Brazilian Unidade Real de Valor (URV). Brazil supplied their economy with a daily index from 1964 to 1994. I also do not know whether Brazil calculated the net monetary loss or gain. I will have to find out.

This will strenghten the case for CIPPA tremendously. I state in the book that all that is missing is due process before CIPPA will replace the Historical Cost Accounting model.

Chile has already taken the next step without the rest of the world even being ready to take the first step towards implementing financial capital maintenance in units of constant purchasing power (CIPPA): Chile not only update constant real value non-monetary items and historical variable real value non-monetary items, but, also monetary items. This is a logical next step. I just did not realize that Chile has been doing it since 1967. So, it seems to me Chile learnt from Brazil. Now it is time for us to learn from them.

"It was created on January 20, 1967, for the use in determining principal (monetary item) and interest (constant item) in international secured loans for development, subject to revaluation according to the variations of inflation. Afterwards it was extended to all types of bank loans (monetary items), private or special financing (monetary items), purchases or investments on installments (constant items), contracts (constant items), and some special situations. Also it is used in legal standards such as the par value of stock/capitalization of companies (constant items), fines (constant items), etc. It has become the preferred and predominant measure for determining the cost of construction (historical variable items: Historical Cost), values of housing (historical variable items) and any secured loan (monetary items), either private or of the Chilean government."

The Wiki article is a very good example of the fact that everyone thinks inflation erodes the real value of non-monetary items: the stable measuring unit assumption is not mentioned at all in the article.

Thank you very much for this information.

Kind regards,

Nicolaas.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Money is an unstable store of value

Money is an unstable store of value


Unstable money is an unstable store of value. Unstable money is a depreciating store of value during inflation and an appreciating store of value during deflation.

Unstable money has to maintain most of its real value over the short term in order to be accepted as an unstable medium of exchange. It would not solve barter’s double coincidence of wants problem if it could not be stored over time and still remain valuable in exchange.

The fact that inflation is eroding the real value of unstable money means it is a store of depreciating real value during inflation. Money was a store of value right from the start. First types of money consisted of gold or silver coins. The metals from which the coins were made had an actual real value in themselves and these coins could be melted down and the metal could be sold in its bullion form when the bullion price was above the coin price. Next money was not made of precious metal but money consisted of bank notes, the real values of which were fully backed by gold reserves. Today depreciating or appreciating fiat money´s real value is backed by all the underlying value systems in an economy while the actual bank notes and coins simply represent depreciating real value since the materials the notes and coins are made of have almost no intrinsic value. Although the store of value function and permanently fixed nominal values of depreciating or appreciating bank notes and bank coins are legally defined, fiat money´s real value is determined by all the underlying values systems in an economy. The change in fiat money´s depreciating or appreciating real value is indicated by the economic processes of inflation and deflation respectively.

The abuse of money’s store of value function led to inflation.

Money is a liquid medium of exchange; i.e. it is readily available as cash and it is normally easy to obtain on demand in banks in most economies under normal economic conditions – all else being equal. A property, e.g. a well–located plot of land with a well–maintained and well–equipped building – which is a variable real value non–monetary item – is also a store of value. It is however quite an illiquid store of value. The real value is not immediately available in easily transportable and divisible cash. Money’s high liquidity makes it more desirable as a store of value in comparison with other stores of value like gold, property, marketable securities, bonds, etc. Money is obviously not the best store of value in an inflationary economy where its real value is continuously being eroded by inflation. Money is normally available in convenient smaller denominations which facilitate everyday small purchases. As such, money is very user friendly. It is easily transportable especially with electronic transfer facilities.

Inflation actually manifests itself in money’s store of value function since inflation always and everywhere erodes the real value of only money and other monetary items. Inflation does not manifest itself in money’s medium of exchange function in the case of spot transactions (since the exchange is made between money and the other item considered to be equal in real value to the money amount at the moment of exchange) or unit of account function (the stable measuring unit assumption manifests itself in money´s unit of account function) which vindicates the fact that inflation can only erode the real value of money and monetary items; i.e. inflation has no effect on the real value of non–monetary items. Money is always a medium of exchange of equal real value at the moment of exchange. Free market prices are adjusted in the market in a price setting process that takes the decreasing real value of money during inflation or the increasing real value of money during deflation into account (amongst many other factors) so that economic items (the product or service or right and the amount of money) of equal real value are exchanged at the moment of exchange.

Depreciating money has a constantly decreasing real value during inflation. Depreciating “bank money” deposits have the same attributes as depreciating money with the single exception that they are not physical depreciating bank notes and bank coins but accounted depreciating monetary items. The depreciating money represented by depreciating bank money also has a depreciating store of value function during inflation. Money appreciates in real value during deflation.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Functions of money

Functions of money

Money performs the following three functions:

1.    Unstable medium of exchange

2.    Unstable store of value

3.    Unstable unit of account

1. Unstable medium of exchange

Money has the basic function that it is an unstable medium of exchange of equivalent real values at the moment of exchange. It overcomes the inconveniences of a barter economy where there must be a double coincidence of wants before a trade can take place. For a trade to take place in a barter economy one person must want exactly what the other person has to offer, at the exact time and place where it is offered.

In a monetary economy the real value of goods and services are measured in terms of unstable money, the unstable monetary medium of exchange, which is generally accepted to buy any other good or service. Without this function or attribute the invention cannot be money.

 We use payment with unstable money instead of barter to exchange real values in our economies in the transactions we enter into when we buy and sell goods, services, ideas, rights and any kind of property whether physical, virtual or intellectual. Unstable money is the lifeblood of an economy even though it is continuously changing in real value. Without unstable money the creation and exchange of real value in an economy would be severely restricted, as it would become a barter economy.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Consumer Price Index - Part 2 of 2

Consumer Price Index - Part 2 of 2

We also use the annual change in the CPI as a measure to calculate the creation of real value in monetary items and constant real value non–monetary items never maintained constant (nominal values never decreased in line with deflation) over time in a deflationary economy that uses the HCA model.


Financial capital maintenance is measured in units of constant purchasing power by valuing only constant items – per se – in terms of the change in the CPI on a monthly basis during inflation and deflation (CIPPA). Financial capital maintenance is measured in units of constant purchasing power by valuing all non–monetary items (variable and constant items) – per se – on a daily basis in terms of the change in the US Dollar parallel rate (when it exists officially or unofficially) or a Brazilian–style daily non–monetary index during hyperinflation (Constant Purchasing Power Accounting – CPPA).

There is no CPI in a barter economy as there is no money in such an economy. The CPI is essential to correctly index the real value of constant items in the economy with continuous measurement of financial capital maintenance in units of constant purchasing power (CIPPA) being used as the fundamental model of accounting during inflation and deflation.

The nominal value of money stays the same over time while the real value of money is automatically determined by inflation and deflation: eroded by inflation and increased by deflation, respectively. The nominal value of a constant item changes inversely with the level of the CPI with measurement in units of constant purchasing power under CIPPA resulting in its real value remaining constant during inflation and deflation. The real value of money changes inversely with the level of inflation.

The CPI is the sine qua non in an inflationary and deflationary economy to correctly fix the problem created by the fact that money is the only universal unit of account that is not a stable unit of measure: the monetary unit of account has no fundamental constant. Under the Historical Cost paradigm (implementing the HCA model) it is assumed that money is perfectly stable in all cases where the stable measuring unit assumption is applied.

It would be difficult to measure the erosion in the real value of money and the creation of real value in money correctly during inflation and deflation, respectively, and to correctly implement financial capital maintenance in units of constant purchasing power without the CPI during inflation and deflation. The CPI is calculated during hyperinflation, but, it is impossible to maintain the constant purchasing power of constant items constant in terms of the CPI that becomes available a month or more after a transaction or event during hyperinflation of hundreds of millions or more per cent per annum. The daily change in the parallel or index rate is used for that purpose during hyperinflation. See Brazil´s use of daily indexing during very high and hyperinflation from 1964 to 1994.

Financial capital maintenance in units of constant purchasing power in terms of the CPI makes it relatively easy to fix the problem and to stop the erosion of hundreds of billions of US Dollars in real value in the world´s constant item economy each and every year during low inflation.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Valuing / accounting variable items

Valuing / accounting variable items

Variable items are valued in terms of IFRS under CIPPA. They are accounted in terms of the CPI at the date of the valuation during inflation and deflation. They are valued / accounted in terms of the daily parallel rate or the daily index rate during hyperinflation.

Under CIPPA and CPPA all valuations (accounting entries) contain four elements:

1.    An indication whether the item valued / accounted is

a.    A monetary item (m),

b.    A constant item (c) or

c.     A variable item (v).

2.    The value of the item expressed in terms of the functional currency.

3.    The date of the valuation.

4.    The CPI at the date of the valuation / accounting during inflation and deflation or the daily parallel or index rate during hyperinflation.

         Variable items valued in terms of IFRS at Historical Cost as well as all other historical variable item IFRS valuations are updated in ledger accounts and in financial reports and publications in whatever format in terms of the CPI (monthly) till the next valuation in terms of IFRS because there is no stable measuring unit assumption under CIPPA during inflation and deflation. This is done in order to always reflect the IFRS valuation in terms of the current depreciated or appreciated real value of money over time. Variable items are always updated – per se – in terms of the current daily parallel or index rate during hyperinflation.          

         The fact that specific variable items are valued at Historical Cost in terms of IFRS, e.g. stock valued at the lower of cost or net realizable value, does not mean that the HCA model is being implemented because there is no stable measuring unit assumption under CIPPA and CPPA.

        The Framework states that the concept of capital maintenance plus the measuring basis chosen determines the accounting model implemented. Under CIPPA financial capital maintenance is measured in units of constant purchasing power: there is no stable measuring unit assumption under CIPPA. Historical Cost is one of the various measurement bases used under CIPPA. HC valuations are thus always updated under CIPPA; i.e. the stable measuring unit is never applied.

         Under CIPPA monetary items in ledger accounts and in current period financial reports published during the current accounting period are valued / accounted in  nominal monetary units, but, the net monetary loss or gain is always calculated and accounted: i.e. there is no stable measuring unit assumption as implemented under Historical Cost Accounting. The net monetary loss or gain is not calculated and accounted under HCA because the stable measuring unit assumption is implemented.

       Specific variable items are valued at HC in terms of IFRS, but, then they are continuously updated during inflation, deflation and hyperinflation under financial capital maintenance in units of constant purchasing power because there is no stable measuring unit assumption under CIPPA and CPPA.

         When all variable items are always valued during whatever period or in whatever financial report or ledger account, in terms of IFRS, e.g. fair value, then they will never be required to be updated during inflation and deflation.

          Variable items are always updated in principle (per se) during hyperinflation in terms of the daily parallel rate of daily index rate.

Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

4 Reasons why CIPPA automatically maintains capital constant forever

4 Reasons why CIPPA automatically maintains capital constant forever

CIPPA automatically maintains the constant purchasing power of capital constant forever in all entities that at least break even during inflation and deflation – ceteris paribus – as a result of:


1. Financial capital maintenance in units of constant purchasing power during inflation and deflation: the rejection of the stable measuring unit assumption;

2. Double entry accounting: For every credit (e.g. capital) there is an equivalent debit (e.g. fixed assets, stock, trade debtors, cash, etc.);

3. The fact that the constant real non-monetary value of capital is equal to the real value of net assets, and

4. The fact that a company, in principle, has an unlimited lifetime.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Valuing / accounting constant items

Valuing / accounting constant items

A new as in original constant real value non-monetary item is valued today for the first time at its nominal value. For example: a company is formed today with issued share capital, issued today, at e.g. USD 1 million. The issued share capital is valued today at USD 1 million. The original constant item is accounted at today´s date with the CPI, e.g. at 100, at its nominal value of USD 1 million.

When the CPI changes to 102 tomorrow, the constant item, published in whatever format, is measured in units of constant purchasing power at USD 1 020 000: its nominal value increases, but, its real value stays the same over time. Constant items are continuously measured in units of constant purchasing power (not inflation-adjusted: inflation has no effect on the real value of non-monetary items) in all ledger accounts and in all possible forms of publication at all future values of the CPI in order to reflect / show / state / present their constant real non-monetary values (always higher nominal values) at the current (always lower or depreciated) real value of the national currency (which is also the monetary unit of account) during continuous inflation: over time. During hyperinflation constant items are measured in units of constant purchasing power as stated above in terms of the current daily parallel or daily index rate.

When the economy changes over from an inflationary mode to a deflationary mode, all constant items´ nominal values (e.g. issued share capital, salaries, wages, rentals, etc.) are decreased at the rate of deflation on a monthly basis in order to maintain the constant real non-monetary values of these constant items constant and maintain economic stability in the constant item economy at the new higher or appreciated real value of the national currency within the national economy during deflation.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Valuing / accounting monetary items

Valuing / accounting monetary items


A monetary item is valued and accounted in a ledger account over time at its nominal value, e.g. the nominal value of a bank coin, bank note, cheque, bond, Treasury bill, the capital value of a loan or financial instrument with an underlying monetary nature, etc. A monetary item is accounted at today´s date with today´s CPI, for example, at 100, at its nominal value of, e.g., USD 100. When the CPI changes to 102 tomorrow, the monetary item in a ledger account and in a current period financial report published during the current accounting period is always valued at its original nominal value. A monetary item is not inflation-adjusted in a ledger account or in current period financial reports published during the current accounting period. It stays at USD 100. The monetary item in a ledger account remains at its original nominal value at all future values of the CPI during inflation and deflation and at all future values of the daily parallel rate or daily index rate during hyperinflation. A current period monetary item is never inflation-adjusted in financial statements published during the current accounting period.

Historical monetary items (excluding monetary items in ledger accounts) in whatever published format are inflation-adjusted in order to state the real value of the monetary item at the historical date in terms of today´s CPI during inflation and deflation and in terms of the today´s daily parallel rate or today´s daily index rate during hyperinflation. There is no stable measuring unit assumption under CIPPA and CPPA.



Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.Nicolaas Smith

Consumer Price Index - Part 1 of 2

Consumer Price Index - Part 1 of 2

Updated on 20-7-11

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

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

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

We use the annual change in the CPI as a measure to calculate and account the erosion of real value caused by inflation in only monetary items (which cannot be inflation-adjusted in ledger accounts and current period financial reports published during the current accounting period) under CIPPA. The net monetary loss or gain resulting from holding either a net weighted average excess of monetary item assets or a net weighted average excess of monetary items liabilities during a specific period is not accounted under the traditional HCA model used by most entities worldwide. It is calculated and accounted when financial capital maintenance is measured in units of constant purchasing power under CIPPA as authorized in IFRS in the original Framework (1989) Par 104 (a) during inflation and deflation and under Constant Purchasing Power Accounting (CPPA) during hyperinflation as required by IAS 29.

The annual change in the CPI is also used to calculate the erosion of real value caused by the stable measuring unit assumption – i.e. by the HCA model – (not inflation) in constant real value non–monetary items never maintained constant (thus being treated as monetary items) over time in an inflationary economy only under the Historical Cost paradigm. This cost of the stable measuring unit assumption is – like the cost of inflation – not accounted under HCA. Most people mistakenly believe this erosion in, for example, companies´ capital and profits never covered by sufficient revaluable fixed assets, is caused by inflation. This cost of the stable measuring unit assumption only incurred under the HCA model is mistakenly believed by most people to be the same as the cost of inflation. They are taught and thus mistakenly believe that it is caused by inflation. Since the cost of inflation (the net monetary loss from holding a net weighted average excess of monetary item assets over net weighted average monetary item liabilities during inflation) is not calculated and accounted under the HCA model, entities – mistakenly believing that the cost of the stable measuring unit assumption is the same as the cost of inflation – are satisfied to do nothing about it because net monetary losses and gains are not calculated and accounted under HCA. They are taught and thus mistakenly believe that both are caused by inflation and that it is not their but the central bank´s duty to lower inflation and lower this erosion.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Fiat money has real value

Fiat money has real value


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

The actual material today´s fiat money is made of has no intrinsic value as fiat money is the natural product of the development of the concept of money through time. In the beginning a monetary unit was a (supposedly) full value metal coin. Later it was not a full value metal coin but it was the next best thing as far as economic agents were concerned: it was 100 per cent backed by gold. Today the material fiat money is made of has no intrinsic value and the monetary unit is not backed by gold but is backed by the combined macroeconomic real value of all the underlying value systems in a particular economy or monetary union. These underlying value systems include, but, are not limited to sound governance, a sound economic system, a sound manufacturing system, a sound industrial system, a sound monetary system, a sound political system, a sound social system, a sound educational system, a sound defence system, a sound health system, a sound security system, a sound legal system, a sound accounting system and so on, to name but a few.

Changes in the real value of unstable money – which is also the unstable accounting monetary unit of account – are determined by inflation and deflation over time. The real value of money and thus the monetary unit of account are not stable. The real value of money and other monetary items are currently not updated or inflation-adjusted over time in ledger and bank accounts.

Fortunately, (1) the generally accepted accounting principle of financial capital maintenance in units of constant purchasing power, (2) double entry accounting, (3) the fact that the constant real non-monetary value of capital is equal to the real value of net assets and (4) the fact that companies have unlimited lifetimes, make it possible to automatically maintain the real value of constant items constant forever in entities that at least break even – ceteris paribus – when they implement Constant Item Purchasing Power Accounting during low inflation and deflation as authorized in IFRS – whether they own any fixed assets or not.

The bank notes and coins that make up about 7% of the fiat money supply can almost be stated to be created out of nothing - out of thin air – as a result of the fact that the actual materials used to create physical bank notes and coins have – in principle – almost no intrinsic value. The unstable real value of the total fiat money supply 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 almost 7 billion people to buy anything and everything in the world 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. Many people also know 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 bank notes and coins have insignificant intrinsic values. 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 – almost 7 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 all 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 cannot 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 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 creditable references to the fact that fiat money has real value. Statistics authorities are generally creditable sources.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Money versus real value

Money versus real value


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

Today national monetary units are mostly created in economies subject to inflation. The Japanese economy is regularly in a state of deflation. The Japanese Yen increases in real value inside the Japanese economy during deflation.

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

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

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

Money is an invention. Its existence can be terminated while real value is a fundamental economic concept, which exists, while we exist. The Zimbabwe Dollar´s existence was terminated in November 2008 when Gideon Gono, the Governor of the Reserve Bank of Zimbabwe issued instructions to shut down the activities of the Zimbabwe Stock Exchange which resulted in the end of trading in Old Mutual shares on the ZSE. This stopped the last exchangeability of the ZimDollar with the British Pound since the Old Mutual Implied Rate (OMIR) was being used as an implied exchange rate between the two currencies. That stopped the existence of the ZimDollar. No exchangeability means no value for a monetary unit.

Economies have already functioned without money. Barter economies operated without a medium of exchange. Cuba in the past bought oil from Venezuela and paid part in money and part by the provision of the services of sports coaches and medical doctors. Corn farmers in Argentina stored their corn in silos and paid for new pick–up trucks and other expensive mechanized farm implements with quantities of corn – the unit of real value Adam Smith described more than 230 years ago as a very stable unit of real value.

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

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


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Real value erosion under Historical Cost Accounting

Table 2 Real value erosion under Historical Cost Accounting

Table 2 above is an estimate of the state of real value erosion in the SA economy in Aug 2009:  In the 12 month period-ending in August, 2009, inflation actually eroded R1 952.799 billion x 0.064 = R124.9 billion in the real value of the Rand in the SA monetary economy. At the same time the stable measuring unit assumption unnecessarily eroded about R200 billion in the real value of constant real value non–monetary items never maintained constant which are treated as monetary items in the SA constant item economy. About R324 billion in real value was thus eroded in the SA economy in the 12 months to August, 2009 by inflation and unknowingly, unintentionally unnecessarily by the implementation of the very erosive stable measuring unit assumption as it forms part of the traditional Historical Cost Accounting model.

If inflation stays at 6.4% for the next five years and the implementation of the HCA model keeps on unknowingly eroding the real values of constant real value non–monetary items never maintained constant which are treated as monetary items with the very erosive stable measuring unit assumption then a cumulative total of R1 620 billion in real value would be eroded in the SA economy – all else being equal. The cumulative totals of real value erosion under these circumstances for 10, 20 and 30 years would be R3 240 billion, R6 480 billion and R9 720 billion respectively. These are huge values of real value erosion in the SA economy. The part which the HCA model unknowingly, unnecessarily and unintentionally erodes can easily be eliminated completely.

We can see from Table 3 what the difference would be when it is freely decided to measure financial capital maintenance in units of constant purchasing power as authorized in IFRS in the original Framework (1989), Par 104 (a).

The erosion of real value in constant items never maintained constant which are treated as monetary items under the HCA model would stop completely. There would only be real value erosion in the value of the Rand because of inflation. At 6.4% annual inflation only R124 billion in real value would be eroded in the economy as a whole instead of the about R324 billion over a period of 12 months (Aug 2009 values). Over five years the cumulative total of real value erosion would drop from R1 620 billion to R 624 billion, over 10 years from R3 240 billion to R1 249 billion, over 20 years from R6 480 billion to R2 498 billion and over 30 years from R9 720 billion to R3 747 billion.

The HCA model unknowingly erodes existing real values in existing constant real value non–monetary items never maintained constant with the very erosive stable measuring unit assumption. When the stable measuring unit assumption is rejected about R200 billion in existing constant item real values would automatically be maintained constant in all entities that at least break even – ceteris paribus - during every period of 12 months in the SA constant item economy amounting to R1 000 billion over 5 years, R 2 000 billion over 10 years, R4 000 over 20 years and R6 000 billion over 30 years. Boosting the SA real economy with these real values would make a significant difference to growth and employment in the economy over those periods.

Obviously a further reduction of inflation to an annual average of 4% would improve the SA monetary economy even more. Over 30 years it would maintain a further R1 140 billion in the monetary economy on top of the R6 000 to be gained when entities freely switch over to financial capital maintenance in units of constant purchasing power (CIPPA).

There would never more be any erosion of real value in constant real value non–monetary items never maintained constant because of a fundamentally flawed basic model of accounting under which entities simply assume there is no such thing as inflation and never has been, only for the valuation of constant real value non–monetary items when they measure financial capital maintenance in units of constant purchasing power during low inflation (implementing CIPPA). This is exactly the same as stating that there would never more be erosion of the real value of the Rand in the monetary economy at the level of R228 billion per annum (12 x 19 billion) as long as average annual inflation never again reaches 12%. There would be automatic zero per cent real value erosion in constant real value non–monetary items in all entities that at least break even – all else being equal – with financial capital maintenance in units of constant purchasing power (CIPPA) at all levels of inflation and deflation.

Stating that the SARB is responsible for limiting the erosion of the real value of the Rand and other monetary items by inflation to a maximum of 6 per cent or R117 billion per annum is the same as stating that the SARB is responsible for maintaining 94 percent or R1 808 billion of the R1 925 billion total per annum of the real value of the Rand and other monetary items in the SA monetary economy.

It is also the same as stating that the HCA model only maintains 94 % or R3 133 billion per annum of the about R3 333 billion of the existing constant real value of constant real value non–monetary items never maintained constant being treated as monetary items in the SA constant item economy under the Historical Cost paradigm since  the remaining 6% or R200 billion per annum of the real value of constant items never maintained constant is unnecessarily being eroded by the implementation of the stable monetary unit assumption. Implementing CIPPA automatically maintains the real value of the R3 333 billion in existing constant items constant forever in all SA companies at least breaking even – all else being equal – at all levels of inflation and deflation whether these companies own revaluable fixed assets or not.

It is evident from the above why Alan Greenspan stated that low inflation is what sustainable economic growth is built on.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.