It is impossible for a bond to have a negative real yield under Capital Maintenance In Units of Constant Purchasing Power in terms of the Daily CPI under all possible economic environments: low inflation, high inflation, hyperinflation and deflation.
Please note: you cannot make calculations in nominal Historical Cost terms during deflation under Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI.
During inflation under both the CMUCPP in terms of the Daily CPI paradigm as well as the current nominal Historical Cost Accounting paradigm:
Assumptions: Nominal bond interest rate = +2% and inflation = +1%.
Real interest = Nominal - inflation = +2 -(+1) = +2-1 = +1%
Real Values Invert automatically during Deflation
During deflation - the moment inflation passes zero percent and arrives at a minus or negative value - under the CMUCPP in terms of the Daily CPI paradigm, real values invert automatically which results in the constant purchasing power of all capital and all constant real value non-monetary items (eg., salaries, wages, pensions, taxes, trade debtors, trade creditors, etc.) being maintained constant automatically - obviously with the accounting of all net monetary gains and losses, something that does not happen under the current, generally accepted nominal Historical Cost paradigm.
Why and how?
Why do real values invert automatically during deflation?
Because of the principles of mathematics.
Under CMUCPP in terms of the Daily CPI the constant purchasing power of capital and all constant real value non-monetary items are automatically maintained constant because of maths during inflation. The same maths principles and concepts are valid during both inflation and deflation.
Because the fundamental principle in the economy is to maintain the real value of capital. Why? Because that is the only way the double entry accounting model works correctly and automatically and the only way to achieve that is with the CMUCPP in terms of the Daily CPI paradigm.
How do real values automatically invert at the arrival of deflation?
The fundamental principle underpinning the economy based on financial capital is the result of - or, is only made possible because of - the double entry accounting model: every economic act has two sides, debit and credit. The only way it can work properly is when real value equality on both sides is automatically maintained under all economic environments (low inflation, high inflation, hyperinflation and deflation) on the debit and on the credit side. That makes real value capital maintenance the central principle in the economy.
Because of the monetary effect of money caused by the process of inflation (deflation when inflation passes below zero), the only possible paradigm for automatically maintaining real value equivalence in an economy running on the double entry accounting model, is CMUCPP, but - only in terms of the Daily CPI. In terms of the monthly CPI does not work.
Example
CMUCPP
Inflation
Period 1
Assumptions at start or period:
Capital = 1000
Wages = 100
Cost of 100 kg of potatoes = 100
Pension = 100
Tax = 10
Trade debtor = 10
Trade creditor = 10
Inflation = 0%
End of period 1
Capital = 1000
Wages = 100
Cost of 100 kg of potatoes = 100
Pension = 100
Tax = 10
Trade debtor = 10
Trade creditor = 10
Result: Constant purchasing power of all items has been maintained automatically.
Period 2
Inflation during period = 1%
End of period 2
Capital = 1010
Wages = 101
Cost of 100 kg of potatoes = 101
Pension = 101
Tax = 10.10
Trade debtor = 10.10
Trade creditor = 10.10
Result: Constant purchasing power of all items has been maintained automatically.
All items are exactly the same in real value as in Period 1, only the nominal values changed automatically in terms of 1% inflation in terms of CMUCPP in terms of the Daily CPI.
Assumption: Period 2 experienced 1% deflation instead of 1% inflation.
End of Period 2
Capital = 990
Wages = 99
Cost of 100 kg of potatoes = 99
Pension = 99
Tax = 9.90
Trade debtor = 9.90
Trade creditor = 9.90
Result: Constant purchasing power of all items has been maintained automatically.
All items are exactly the same in real value as in Period 1, only the nominal values changed automatically in terms of 1% deflation in terms of CMUCPP in terms of the Daily CPI.
You have to look at the above values at the end of Period 2 during deflation in terms of CMUCPP in terms of the Daily CPI. You cannot look at them in terms of the nominal Historical Cost paradigm. Very difficult, I know. :-)
Our minds have to get used to the fact that during deflation under the CMUCPP in terms of the Daily CPI paradigm, 99 is the same a 100 at the start of the period and often a smaller nominal value will in fact be a bigger real value depending on the specific rates involved in the specific item.
Result: Negative real yield bonds impossible under CMUCPP in terms of the Daily CPI.
Reading list
1. Banks Near Tipping Point as Negative Rates Draw Danish Warning.
2. Bankers Get No Mercy in Denmark as Request for Help Is Rejected.
3. Negative Interest Rates Threaten the Financial System.
THEN: REAL INTEREST CALCULATION IS STILL = NOMINAL - DEFLATION (DEFLATION IS NEGATIVE INFLATION = BELOW ZERO)
DEFLATION = 1% = -1% FOR REAL INTEREST RATE CALCULATION PURPOSES.
ASSUMPTIONS: NOMINAL BOND INTEREST = + 1%. DEFLATION = 1%.
REAL INTEREST = NOMINAL - DEFLATION
= +1 -(-1) = 1+1 = 2%
FACT: REAL INTEREST = +2%.
REAL INTEREST CAN NEVER BE NEGATIVE DURING INFLATION AND DEFLATION WITH CMUCPP In Terms Of the DAILY CPI.
No black holes. It is the answer to the world´s problem with negative rates.
However, nothing will ever be done about it.
Nicolaas Smith
Copyright (c) 2005-2019 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Wednesday 17 July 2019
Sunday 14 January 2018
Daily CPI is the effective general price level index
The general price level changes at least daily in all national economies and monetary unions under all monetary environments - low inflation, high inflation, hyperinflation and deflation.
The Daily CPI is thus the effective general price level index for a specific economy or monetary union.
This is confirmed by all countries that issue sovereign inflation-indexed bonds. They have to necessarily calculate their specific Daily CPIs and they have to make them publicly available by publishing them. They all update these government inflation-adjusted bonds daily in terms of their specific country Daily CPIs - the absolute proof the Daily CPI is the effective general price level index for an economy or monetary union.
The Daily CPI is an approximation of the monthly published CPI in that it is a lagged daily interpolation of the CPI.
The Daily CPI is always known in advance. There are never any surprises.
Some of the countries issuing sovereign inflation-indexed bonds:
- Argentina
- Australia
- Brazil
- Canada
- Chile
- Colombia
- Finland
- France
- Germany
- Greece
- Holland
- Hong Kong
- Iceland
- India
- Israel
- Italy
- Japan
- Kuwait
- Mexico
- New Zealand
- Portugal
- Qatar
- Saudi Arabia
- South Africa
- South Korea
- Spain
- Sweden
- Turkey
- United Arab Emirates
- United Kingdom
- United States
Nicolaas Smith Copyright (c) 2005-2018 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Zero monetary effect
Zero inflation, deflation and hyperinflation effect.
Implementing IFRS and US GAAP authorized Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI
during
1. low inflation results in zero low inflation effect,
2. high inflation results in zero high inflation effect,
3. hyperinflation results in zero hyperinflation effect and
4. deflation results in zero deflation effect.
South American countries´ central banks called it "monetary correction" in the 1970s to 1990s. The best example was the implementation of this principle with the use of the Daily Unidade Real de Valor in Brazil in 1994.
Zero monetary effect can only be achieved when CMUCPP is implemented to reflect every change in the general price level, that is, at least daily in terms of the Daily CPI in non-hyperinflationary economies.
CMUCPP also has to be implemented in terms of the Daily CPI or daily parallel rate when a Daily CPI is not available during hyperinflation.
However, it must be remembered that the general price level can and sometimes does change more than once a day during hyperinflation. This must be accompanied in the whole hyperinflationary economy, in accounting records and in contracts in order to correctly achieve zero hyperinflationary effect.
Under all the above circumstances, the constant purchasing power of all constant real value non-monetary items (e.g., all items in shareholders equity, trade debtors, trade creditors, salaries, wages, pensions, taxes payable, taxes receivable, etc.) would automatically be maintained constant - ceteris paribus.
Nicolaas Smith Copyright (c) 2005-2018 Nicolaas J Smith. All rights reserved. No reproduction without permission.
Implementing IFRS and US GAAP authorized Capital Maintenance in Units of Constant Purchasing Power in terms of the Daily CPI
during
1. low inflation results in zero low inflation effect,
2. high inflation results in zero high inflation effect,
3. hyperinflation results in zero hyperinflation effect and
4. deflation results in zero deflation effect.
South American countries´ central banks called it "monetary correction" in the 1970s to 1990s. The best example was the implementation of this principle with the use of the Daily Unidade Real de Valor in Brazil in 1994.
Zero monetary effect can only be achieved when CMUCPP is implemented to reflect every change in the general price level, that is, at least daily in terms of the Daily CPI in non-hyperinflationary economies.
CMUCPP also has to be implemented in terms of the Daily CPI or daily parallel rate when a Daily CPI is not available during hyperinflation.
However, it must be remembered that the general price level can and sometimes does change more than once a day during hyperinflation. This must be accompanied in the whole hyperinflationary economy, in accounting records and in contracts in order to correctly achieve zero hyperinflationary effect.
Under all the above circumstances, the constant purchasing power of all constant real value non-monetary items (e.g., all items in shareholders equity, trade debtors, trade creditors, salaries, wages, pensions, taxes payable, taxes receivable, etc.) would automatically be maintained constant - ceteris paribus.
Nicolaas Smith Copyright (c) 2005-2018 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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