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Eliminating the Effects of Hyperinflation in Iran at No Cost: Part 2

Tuesday, November 20, 2012

Interview with Nicolaas Smith
By: Kourosh Ziabari

Accounting expert Nicolaas Smith believes that by taking certain measures, the effects of hyperinflation in Iran can be eliminated overnight and Iran’s currency can regain its value with time.

It’s been a few months that Iran’s currency market is facing fluctuations which the analysts consider to be a consequence of the economic sanctions imposed against Iran by the United States and European Union over Tehran’s nuclear program.

These unjustifiable sanctions are taking a toll on the ordinary Iranian citizens and affecting their daily life critically, but the Western politicians are oblivious and indifferent to the plight of the Iranian nation and seemingly intend to repeat the catastrophe they created in Iraq, by killing thousands of innocent civilians as a result of their economic embargo. However, some senior economic experts believe that the crisis in Iran’s currency market and the growing hyperinflation can be tackled using scientific methods.

Mr. Smith has stated that he is ready to negotiate with the officials of the Central Bank of Iran and Iran’s accounting standards authorities and present them his solutions for ending the economic crisis in Iran.

Nicolaas Smith has a solution for Iran’s economy which he calls Daily Index Plan and believes is more effective than the Real Plan which was implemented in 1994 in Brazil.

“The principles and workings of the Daily Index Plan are so mathematically correct and logical in real value that I am now completely confident in stating that I can stop the total effect of hyperinflation – not actual hyperinflation in bank notes and coins (their nominal values are permanently printed on them) – in the monetary economy as well as the very destructive effect of the stable measuring unit assumption in the constant item economy overnight at no cost when the plan is implemented correctly with complete coordination. The crucial factor is the fact that you use the US Dollar daily rate as the index,” he says.

The part 1 of Iran Review’s interview with Mr. Smith was published on November 14. What follows is the full text of the second part of our interview with him.

Q: You have suggested that the Central Bank of Iran should issue a regulation requiring daily inflation-adjustment of all monetary items in the country’s monetary economy in terms of a daily index. This is a good idea, but doesn’t seem to restore the value of national currency. Am I right?

A: Yes, you are right, in the short term. To restore the real value of the rial in the short term, the measures I stated in 2 above would have to be implemented or you would have to implement the Daily Index Plan.

However, successfully inflation-adjusting the entire rial money supply on a daily basis in terms of the US Dollar daily parallel rate under complete co-ordination (everyone doing it in Iran) would transform all rial monetary items (rial loans, bank deposits, etc.)  - except rial bank notes and coins - into constant real value monetary items. This would have a very positive effect on the Iranian economy. Everybody would be able to keep their money in the bank like people in Chile do with their 90 – day deposits. They get it back inflation-adjusted plus real interest. It would still not restore the real value of the rial. You would only be using a Generally Accepted Accounting Practice (GAAP), namely, measurement in units of constant purchasing power in terms of a daily index to maintain the real value of monetary items – not actual rial money (rial bank notes and coins) – constant over time.

If you were to keep Historical Cost Accounting as the basic accounting model in Iran you would not get the desired improvement in the constant item economy because most (all) businesses would keep on taking advantage of the stable measuring unit assumption and keep workers’ salaries and wages fixed over time – during hyperinflation! A portion of Iranian companies’ capital would continue to be destroyed by the stable measuring unit assumption under Historical Cost Accounting. Workers would not have enough money to buy their monthly purchases with fixed rial salaries during hyperinflation.

However, when you combine daily inflation-adjustment of all rial monetary items with banning the Historical Cost Accounting model and immediately changing over to capital maintenance in units of constant purchasing power in terms of the daily US Dollar parallel rate with complete co-ordination, then you would have a massive improvement in your economy overnight: the constant item economy would stabilize overnight. There may not be any advantage from excessive money creation in Iran under such circumstances; the policy would almost certainly be abandoned and the real value of the rial would rapidly increase. It would be the Daily Index Plan without the New Currency. It would be the Daily Index Plan while maintaining the current rial. The real value of the rial would rapidly be restored, but only with a combination of the two measures.

Q: One interesting thing for me is that the Kuwaiti dinar, Bahraini dinar and Omani rial are the world’s top three highest-valued currency units. How have these currency units reached such a level of value that can buy the highest number of other currencies or the largest amount of a given good, while these countries are not economically thriving countries in terms of such indicators as GDP and PPP? Generally, what factors affect the value of a given country’s currency unit? Is it possible for Iran to salvage its currency from the current depreciation and improve its value?

A: Regarding your neighbors: this should give you a clue as to one of the reasons for their strong currencies: Inflation in Kuwait: 1.9 percent per annum; Bahrain: 3.7 percent per annum and Oman: 2.4 percent per annum.

The real value of a country’s currency within the country is maintained by the combined real values of all underlying value systems in a country, which include, but are not limited to, e.g., good governance, sound economic policies, sound labor policies, sound monetary policies (no excessive money creation, for example), sound international relations, a sound education system, a sound legal system, a sound health system, an appropriate accounting system, etc., etc. I have already answered the last of your questions in 4. 

Q: Has the distribution of economic subsidies in the form of cash to people contributed to the current hyperinflation in Iran? Iran is currently facing the excess of money supply, that is, the total amount of monetary assets available in the country’s economy. What do you think? Does Iran need an expansionary policy?

A: If the cash had come from taxes levied by the government or from loans to the government from the banking system or foreign banks, then the cash would not be hyperinflationary.

But, if the cash were simply excess money printed or monetary items created by the government without an increase in productivity and without a real increase in demand for money in Iran, then it would add to hyperinflation.

You state: “Iran is currently facing the excess of money supply”.  That is your expansionary policy. Only hopelessly too much monetary expansion.

Q: You have proposed accounting dollarization and advised the Iranian companies to use the U.S. dollar for the preparation of financial and accounting reports in their daily internal management control and normal external financial reporting. Does this suggestion have any practical outcomes as well? I’m asking because you have indicated that the companies many continue doing their transactions in the local currency, but use the U.S. dollar for the financial reports. What’s the advantage of this solution?

A: An example should illustrate the advantage of accounting dollarization during hyperinflation:

Last month inflation in Iran was estimated at 70 percent per month. What follows is simply an example. Let us assume the monthly rate maintains for the next 11 months. This can easily happen during hyperinflation. It is not an indication that I think this is what is going to happen in Iran. I do not know what is going to happen in Iran during the next 11 months.

The stable measuring unit assumption is never applied in this example. The concept of a nominal historical “value” does not exist under capital maintenance in units of constant purchasing power. Nominal historical items are reference items, not values since the value date is always today, i.e., today’s USD parallel rate or daily index reference.

Let us assume I am the financial director of a company in Iran with average sales of USD 100,000 per month. The company does all its business in terms of the daily US Dollar parallel rate but only in rials. It never receives US Dollars as payment or makes payments in US Dollars. The USD parallel rate at the end of October was 35,000 rials per USD.

At the board meeting, I would present the monthly sales for last month, October as follows:

October 2012 Sales:     3,500 Million Rials

At the November board meeting with the USD parallel rate at 35,000 * 1.7 = 59,500

October 2012 Sales      5,950 Million Rials
November 2012 Sales  5,950 Million Rials

At the December board meeting with the USD parallel rate at 59,500 * 1.7 = 101,150

October 2012 Sales    10,115 Million Rials
November 2012 Sales 10,115 Million Rials
December 2012 Sales 10,115 Million Rials

At the January 2013 board meeting with the USD parallel rate at

101,150 * 1.7 = 171,955
October 2012 Sales    17,196 Million Rials
November 2012 Sales 17,196 Million Rials
December 2012 Sales 17,196 Million Rials
January 2013 Sales      17,196 Million Rials

At the February 2013 board meeting with the USD parallel rate at

171,955 * 1.7 = 292,323.5
October 2012 Sales   29,232 Million Rials
November 2012 Sales 29,232 Million Rials
December 2012 Sales 29,232 Million Rials
January 2013 Sales    29,232 Million Rials
February 2013 Sales   29,232 Million Rials

And so forth and so forth, until September 2013 when the USD parallel rate (increasing at 70 percent per month) would be 20,391,778. This is very possible during hyperinflation.

At the September 2013 board meeting I would present the annual sales as follows:

October 2012 Sales      2,039 Billion Rials
November 2012 Sales   2,039 Billion Rials
December 2012 Sales   2,039 Billion Rials
January 2013 Sales      2,039  Billion Rials
February 2013 Sales     2,039 Billion Rials
March 2013 Sales         2,039 Billion Rials
April 2013 Sales            2,039 Billion Rials
May 2013 Sales            2,039 Billion Rials
June 2013 Sales           2,039 Billion Rials
July 2013 Sales             2,039 Billion Rials
August 2013 Sales        2,039 Billion Rials
September 2013 Sales  2,039 Billion Rials

Or I could use Accounting Dollarization with the US Dollar as reporting currency. The year-end meeting would then be:

October 2012 Sales      USD 100,000
November 2012 Sales  USD 100,000
December 2012 Sales  USD 100,000
January 2013 Sales       USD 100,000
February 2013 Sales     USD 100,000
March 2013 Sales         USD 100,000
April 2013 Sales            USD 100,000
May 2013 Sales            USD 100,000
June 2013 Sales            USD 100,000
July 2013 Sales             USD 100,000
August 2013 Sales        USD 100,000
September 2013 Sales   USD 100,000

The advantage is that using the US Dollar as reporting currency allows you to work with a relatively stable unit of account, which makes it much easier to grasp the actual position of a company. I am sure you can see the advantage from the above example.

Q: As you have said, capital maintenance in units of constant purchasing power was authorized as an option in 1989 at all levels of inflation and deflation and it’s advisable that Iranian companies implement this method. Would you please explain more about this model and its superiorities to the traditional Historical Cost Accounting model? How will this model help Iran to combat hyperinflation?

A: The stable measuring unit assumption is implemented under Historical Cost Accounting. The stable measuring unit assumption is never implemented under capital maintenance in units of constant purchasing power in terms of a daily index or rate.

Under HCA it is assumed, in practice, that the rial is perfectly stable as far as the accounting of, for example, companies’ issued share capital, capital reserves and invested profits (all of them together are called equity) are concerned. What then happens is that the real value (constant purchasing power) of that portion of a company’s equity that is not maintained constant by its net assets, is being eroded/destroyed by the stable measuring unit assumption, i.e., a globally implemented, generally accepted, 3,000-year-old accounting principle (not hyperinflation) during hyperinflation: last month at 70 per cent during one month in Iran. Most accountants and economists mistakenly believe the real value of capital and invested profits of companies is eroded by inflation. It is stated like that in US Financial Accounting Standards.

Under capital maintenance in units of constant purchasing power in terms of a daily index or rate the constant purchasing power (real value) of equity is automatically maintained constant for an indefinite period of time in all companies that at least break even in real value – all else being equal – at all levels of hyperinflation, low inflation, high inflation and deflation. In this way the capital investment base in Iran would automatically be maintained constant for an indefinite period of time as qualified above.

Getting rid of HCA and the very destructive stable measuring unit assumption is a paradigm change, a sort of world economic regime change. The only paradigm the world has ever known is the Historical Cost paradigm.

Salaries, wages and rents are constant items. They are correctly measured in units of constant purchasing on an annual basis under HCA. They are then paid in fixed monthly payments again implementing the stable measuring unit assumption under HCA. Under capital maintenance in units of constant purchasing power in terms of a daily index they are always and everywhere measured in units of constant purchasing power at all levels of inflation and deflation, including during hyperinflation. Workers would always have the same real value as the previous month under this model – all else being equal. When salaries and wages are kept fixed under HCA their real values are being destroyed by the stable measuring unit assumption, not inflation or hyperinflation.

Debtors and creditors are constant items. They are mistakenly treated as monetary items under HCA. They were correctly measured in units of constant purchasing power in terms of the URV daily index and other government-supplied daily indices during 30 years of high and hyperinflation in Brazil. This was ignored by international accounting standard setters in 1989. Under capital maintenance in units of constant purchasing power they are always measured in units of constant purchasing power in terms of a daily index or rate.

The International Accounting Standards Board (IASB) will require (not optional) capital maintenance in units of constant purchasing power from all countries implementing IFRS with annual inflation equal to or greater than 10 percent or accumulated inflation greater or equal to 26 percent over three years in 6 to 8 years’ time when they authorize IFRS ‘X’ CAPITAL MAINTENANCE IN UNITS OF CONSTANT PURCHASING POWER. I submitted this draft IFRS to the IASB in January 2012. It was my comprehensive amendments to the Argentinean Federation’s draft IFRS ‘X’ INFLATION.

The IASB’s International Financial Reporting Standards Interpretation Committee will issue an interpretation (IFRIC) at their January 2013 meeting that capital maintenance in units of constant purchasing power is already authorized during hyperinflation. This IFRIC will become part of IFRS. I requested this interpretation in September, 2012. An IFRIC has the same authority as an IFRS.

Capital maintenance in units of constant purchasing power in its narrow interpretation, being the rejection of the stable measuring unit assumption in the measurement of constant real value non-monetary items, does nothing directly to hyperinflation because hyperinflation is a monetary phenomenon. Hyperinflation does nothing to the real value of non-monetary items. It only destroys the real value of money and monetary items over time. However, in its broad interpretation, i.e., including the rejection of the stable measuring unit assumption in the measurement of monetary items, this model eliminates the complete cost of or gain from hyperinflation from the monetary economy, but not actual hyperinflation from bank notes and coins. The nominal values of bank notes and coins are permanently printed on them.

It would be as if there were no hyperinflation with daily inflation-adjustment of the entire money supply. Actual hyperinflation can only be eliminated by a reduction of the rate of hyperinflation/inflation. The complete cost of hyperinflation can be eliminated with daily inflation-adjustment of the entire money supply in terms of a daily index or rate.

Q: In what ways do the economic sanctions imposed against Iran by the U.S. and its European allies affect Iran’s economy and cause hyperinflation? How should Iran tackle this problem? These sanctions have proved to be targeting the innocent civilians by increasing tenfold the price of consumer goods, medicine, foodstuff, etc. What’s your take on that?

A: As I explained above, when you implement capital maintenance in units of constant purchasing power in terms of a daily index, civilians’ salaries would also be increased ten-fold and they would be able to afford the consumer goods with ten-fold increases in nominal rial prices, but generally stable US Dollar prices. We have to get your accounting authority to adopt this model.

Q: The economic sanctions against Iran have gone so far as to include a ban on the exporting of medicine, agricultural goods and even milk. Don't these sanctions violate international trade regulations? Aren't they contrary to principles of human rights? What are the practical scientific ways to circumvent and skirt them?

A: I don’t know much about international trade regulations. I have to read the Declaration of Human Rights. I think access to health care must be a basic human right. I don’t know much about sanction busting. I think sanctions are always overcome by countries in many ways. Sanctions also represent additional business opportunities to interested business people.

Key Words: Hyperinflation, Iran, Depreciation of Rial, Daily Index Plan, Real Plan Monetary Reform, Currency Market, Central Bank of Iran, Smith

More By Nicolaas Smith:

*Eliminating the Effects of Hyperinflation in Iran at No Cost: Part 1: http://www.iranreview.org/content/Documents/Eliminating-the-Effects-of-Hyperinflation-in-Iran-at-No-Cost-Part-1.htm

*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

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