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A Response to Steve Hanke on Iran´s Hyperinflation

October 29, 2012 in Uncategorized

A Response to Steve Hanke on Iran´s Hyperinflation

 

http://www.iranreview.org/content/Documents/A-Response-to-Steve-Hanke-on-Iran-s-Hyperinflation.htm

Prof. Steve Hanke stated in his interview with Iran View that there are three ways in which hyperinflation can be stopped:

 

  1. Spontaneous     Dollarization (as it happened in Zimbabwe).
  2. Official     Dollariation (Ecuador)
  3. A Currency     Board

At least four countries, Turkey, Angola, Chile and Brazil, were in hyperinflation and did not use any of the above three methods to stop hyperinflation.

Brazil was in high inflation and hyperinflation for 30 years from 1964 to 1994. See How Brazil beatHyperinflation. In principle, Brazil used capital maintenance in units of constant purchasing power in terms of a government-supplied daily index plus daily inflation-adjustment of monetary items to stop hyperinflation.

 

 How Iran can immediately stop the effects of the stable measuring unit assumption and hyperinflation

 

This is how Iran can immediately eliminate

 

(I) the stable measuring units assumption(Historical Cost Accounting) and its destructive effect from the country´s constant real value non-monetary item economy (constant item economy) and

 

(II) the destructive effect of hyperinflation (not actual hyperinflation) from its monetary economy (it would be as if there were no hyperinflation in Iran):

 

 (i)                 The Iranian Accounting Standards Authority has to immediately authorize a national accounting standard requiring (not optional) Iranian companies to implement capital maintenance in units of constant purchasing power in terms of a daily index as originally authorized in International Financial Reporting Standards (IFRS) in the original Framework (1989), Par. 104 (a) [now 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. This would remove the stable measuring unit assumption (Historical Cost Accounting) and consequently its very destructive effect from the Iranian constant item economy. The stable measuring unit assumption is neverimplemented under capital maintenance in units of constant purchasing power. All constant items would always and everywhere be measured in units of constant purchasing power in terms of a daily index: the US Dollar parallel rate during hyperinflation.

 

(ii)                The Central Bank of Iran has to immediately issue a regulation requiring daily inflation-adjustment of all monetary items in the Iranian monetary economy in terms of a daily index (the USD daily parallel rate during hyperinflation) with complete co-ordination (everyone doing it). This would remove the total cost of and gain fromhyperinflation from the entire Iranian monetary economy (excluding from actual local currency bank notes and coins). It would be as if there were no hyperinflation in Iran.

 

Chile is currently inflation-indexing 25 per cent of its broad M3 money supply on a daily basis in terms of their daily Unidad de Fomento which is a daily monetized indexed unit of account first started in 1967. Chile is a low inflation country. More than USD 3.5 trillion in government capital inflation-indexed bonds are inflation-indexed daily in the world economy in mostly low inflationary economies – as well as in Venezuela´s hyperinflationary economy – in terms of country specific Daily CPIs.

 

 Monetary items are local currency units held and items expressed in terms of the local currency with an underlying monetary nature being substitutes of the former.

 

 Iran would have to currently use their daily US Dollar parallel rate as a substitute for a daily index (Daily CPI) when Consumer Price Index data are not available. The USD parallel rate is constantly available in hyperinflationary economies.

 

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

 

Non-monetary items are sub-divided in:

(a)       Variable real value non-monetary items (variable items), e.g., property, plant equipment, inventories, foreign exchange, etc. valued daily in terms of IFRS authorized measurement bases, for example, fair value (e.g., market value), net realisable value, recoverable value, present value, etc., excluding measurement in terms of the stable measuring unit assumption, e.g., excluding nominal Historical Cost (daily updated HC would be used under capital maintenance in units of constant purchasing power).

 

I believe Ben Bernanke, the head of the US Federal Reserve Bank, stated in a book of which he is a co-author that in hyperinflation there are generally no price increases. I agee with him. That is what I told Zimbabweans on a daily basis on the New Zimbabwe internet forum during the last two years of their hyperinflation. All items´ prices generally stay the same in US Dollars during hyperinflation within the hyperinflationary economy. Nominal prices are simply updated in terms of the rapidly depreciating local currency. That´s all that is happening. Update everything (all prices) in an inflationary and hyperinflationary economy and the total cost of and gain from inflation and hyperinflation are completely eliminated in the economy. This requires complete co-ordination (everyone doing it).

 

(b)       Constant real value non-monetary items (constant items), e.g., capital (all items in shareholders´ equity), trade debtors, trade creditors, all non-monetary payables and receivables (e.g., taxes payable and receivable), salaries, wages, rents, all items in the income statement, etc., always and everywhere measured in units of constant purchasing power in terms of a daily index, e.g. a Daily Consumer Price Index (the daily US Dollar parallel rate during hyperinflation). This automatically maintains their constant purchasing power constant under capital maintenance in units of constant purchasing power in terms of a daily index or rate (the daily US Dollar parallel rate during hyperinflation).

 

Any Iranian company can immediately start implementing capital maintenance in units of constant purchasing power even without a specific requirement from the Iranian National Accounting Stanards Authority because it was authorized as an option in IFRS in 1989, i.e., 23 years ago.

 

A specific Iranian national accounting standard requiring capital maintenance in unit of constant purchasing power in terms of a daily index (US Dollar parallel rate) would put the entire Iranian constant item economy operating on a constant item basis: in units of constant purchasing power.

 

Then it would be necessary for the Iranian Central Bank to requiredaily inflation-adjustment of the entire money supply under complete co-ordination to completely eliminate the effect of hyperinflation from the complete Iranian monetary economy.

This would not affect hyperinflation in actual local currency bank notes and coins created via an excessive creation of money in the monetary economy – only the effect of hyperinflation in the rest of the monetary economy. However, once the entire constant item andmonetary economies operate in terms of constant real values (as if there were no hyperinflation in the case of the monetary economy – although the rial would be in hyperinflation), the comprehenisive advantages of stability in the constant item and monetary economies (excluding actual bank notes and coins) would quickly outweigh the very transitory advantages of creating hyperinflation via the excessive creation of money in the monetary economy. The full understanding of the effects of the stable measuring unit assumption by Iranians may even remove all advantages of hyperinflation for whoever is creating the hyperinflation in Iran via excessive money creation.

Accounting dollarization

Iranian companies may also choose to do their accounting in terms of the daily US Dollar parallel rate, i.e., accounting dollarization: the US Dollar being used as the reporting currency for daily internal management control and normal external financial reporting. This is the same as capital maintenance in units of constant purchasing power in terms of the daily US Dollar parallel rate, but with the reporting currency being the US Dollar instead of the Iranian rial. The great advantage of accounting dollarization is that it is much easier to work with relatively stable US Dollar management and financial reports than financial reports in Iranian rial when the rial is in hyperinflation, even when the rial management and financial reports are done in terms of capital maintenance in units of constant purchasing power in terms of a daily index (daily US Dollar parallel rate) with the rial as the reporting currency.

A company may even never do any business in actual US Dollars and still use accounting dollarization in order to facilitate daily operatoins and financial reporting in terms of a relatively stable unit of account as reporting currency during hyperinflation.

The International Accounting Standards Board

The IASB voted unanimously in May 2012 to submit the replacement of IAS 29 Financial Reporting in Hyperinflationary Economies to research. The replacement process is not yet a full IFRS project.

In 6 to 8 years´ time a new IFRS would require (not optional) capital maintenance in units of constant purchasing power (what I am suggesting now for Iran) in terms of a Daily CPI or other daily index at 10 percent annual inflation or 26 percent cumulative inflation over three years, i.e., at the start of high inflation instead of at the start of hyperinflation. The IASB encourages early adoption of a proposed new standard.

The IASB defined hyperinflation in 1989 as cumulative inflation approaching or equal to 100 per cent over three years, i.e., 26 percent annual inflation for three years in a row. This is the generally accepted definition of hyperinflation since 1989 by millions of accountants and all countries implementing IFRS worldwide. Cagan´s definition of hyperinflation being 50 per cent monthly inflation is mainly followed by academics. It is not the generally accepted definition of hyperinflation in the world economy since 1989. No country uses it nor could be required to use it for any purpose. Nor would any country use Cagan´s definition especially as our understanding increases regarding the difference between the cost of inflation/hyperinflation and the cost of the stable measuring unit assumption mistakenly thought to be the same as the cost of inflation/hyperinflation.

Although capital maintenance in units of constant purchasing power was authorized (it passed the IASB´s due process at that time) as an optionto HCA in 1989, its requirementas stated above has to go through the IASB´s very extensive due process procedure. This is done very thoroughly and takes time (several years). I expect the IASB to authorise the new IFRS in 6 to 8 years´ time. It is only at the reseach stage at the moment.

However, since capital maintenance in units of constant purchasing power was authorized as an option in 1989 at all levels of inflation and deflation – including during high inflation and hyperinflation – any entity in the world, including all Iranian companies, can start implementing it immediately. The new IFRS would give detailed guidance regarding the implementation of capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index. The draft IFRS ´X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER is available here. I submitted it to the IASB in January 2012. It is my comprehensive amendments to the Argentinean Accounting Federation´s draft IFRS ´X´ INFLATION submitted to the IASB in 2010. The Argentinean Federation´s draft IFRS was the combined effort (started in 2009) of the accounting authorities of Brazil, Mexico, Chile and Argentina. I changed the core principle from inflation to capital maintenance in units of constant purchasing power in terms of a daily index.

Inflation and hyperinflation have no effect on the real value of non-monetary items. Inflation and hyperinflation only erodes (destroys) the real value of money and other monetary items –nothing else. The stable measuring unit assumption – as it forms part of traditional Historical Cost Accounting – erodes (destroys) the real value of constant items never maintained constant during inflation and hyperinflation, e.g., the real value of that portion of a company´s capital (equity) not maintained constant by the real value of its net assets.

Capital maintenance in units of constant purchasing power, on the other hand, automatically maintains the real value (constant purchasing power) of capital constant in all entities that at least break even in real value – all else being equal – at all levels of inflation and deflation, including during high inflation and hyperinflation, whether these entities own any fixed assets or not.

If the new IFRS requiring capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index were already authorized by the IASB and implemented in Iran today, the Iranian constant item economy would today be stable during hyperinflation – not the monetary economy (daily inflation-indexing the entire money supply is required for that). It would be the same as what Brazil implemented during those 30 years of very high and hyperinflation. Brazil had positive economic growth during hyperinflation because they kept their constant item economy stable with daily measurement in units of constant purchasing power in terms of a government-supplied daily index.

I do not expect the replacement of IAS 29 to require daily indexing of the entire money supply although I mentioned it in the draft IFRS ‘X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASINGPOWER. That is a monetary policy. I do not think the IASB has the authority to require that. That has to be done by the monetary authority, normally the central bank.

The solution the Iranian population is looking for

The above solution is what the Iranian population is looking for right now for the whole economy. It is up to the Iranian Accounting Authorities and the Central Bank of Iran to implement it.

Individual Iranian companies can save themselves only from the erosive (destructive) effects of the stable measring unit assumption of their constant items by spontaneously implementing capital maintenence in units of constant purchasing power in terms of the daily US Dollar parallel rate with either the rial or the US Dollar as reporting currency while they wait for their Accounting Authority to require it on a national basis.

To avoid the erosion (destruction) of the real value of their rials – while they wait for the Central Bank of Iran to officially require daily inflation-indexing of the entire Iranian money supply – they and Iranian individuals have to limit their holding of rials over time (inflation and hyperinflation only happen over time) to the absolute minimum. The perfect solution is to hold no rials from the one day to the next. Allways invest in (buy) non-monetary items that maintain their real values during hyperinflation on a daily basis with spare cash. That is what I did during Angola´s hyperinflation in the company where I was responsible for financial reporting from 1994 to 1997 and where I developed (during 1995) and implemented accounting dollarization which I implemented in Auto-Sueco (Angola) – the Volvo agents in that country – as from 1 January 1996. I then studied the principles of capital maintenance in units of constant purchasing power in terms of a daily index or rate over the next 16 years.

To stabilize and grow the entire Iranian economy during hyperinflation (like what Brazil did for 30 years from 1964 to 1994) for the Iranian population an innovative combined effort is required from the Central Bank of Iran and the Iranian Accounting Authorities. The accounting solution (authorized as an option 23 years ago) will be required by the IASB in 6 to 8 years´ time from all countries that implement IFRS with annual inflation equal to or higher than 10 per cent per annum or cumulative inflation equal to or higher than 26 percent over three years.

Nicolaas Smith

Constant Item Purchasing Power Accounting

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

Fourth benefit of daily inflation-indexing the entire money supply

October 19, 2012 in Uncategorized

Another (the fourth) very important benefit of  daily inflation-indexing the entire money supply at all levels of inflation and deflation under complete co-ordination (which is the rejection of the stable measuring unit assumption in the monetary economy) would be that it would logically compliment the rejection of the stable measuring unit assumption in the constant item economy (the non-monetary or real economy being made up of the constant and variable item economies) under financial capital maintenance in units of constant purchasing power in terms of a Daily CPI or other daily index as already authorised in IFRS.

Financial capital maintenance in units of constant purchasing power as authorised in IFRS would automatically maintain the constant purchasing power of equity (capital) 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.

This means the constant real value of the entire capital investment base in an economy would automatically be maintained constant for an indefinite period of time as qualified above, i.e., in all entities that at least break even in real value, all else being equal under financial capital maintenance in units of constant purchasing power.

Nicolaas Smith

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

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

October 18, 2012 in Uncategorized

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.

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

October 17, 2012 in Uncategorized

 

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.

 

Nicolaas Smith

 

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

Running an economy in constant values

October 4, 2012 in Uncategorized

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.

 

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