X

Blog Article

Tuesday 10 May 2022

A commentary on inflation

Interesting what you hear, sitting in a Tabac in rural France, sipping on a grand crème:

"Fuel prices...have you seen them of late?!?"

"...and my favourite moules frites...up"

"...and this crème...how come coffee is so expensive now!"

Why interesting?  Well it is very similar to conversations overheard in deepest Cornwall in the UK just a few weeks ago:

"Fuel costs...another price hike"

"...and fish and chips…same fish, same potatoes, but more money – what’s going on?"

"...and don’t talk to me about coffee...are these beans gold plated or what?!?"

Interesting. Different countries, different language, similar issues; conversations no-doubt repeated in many other cafes in many other locations across the globe. Inflation is back.

With the return of rising prices come those conversations and these questions, "how are we going to manage?" – "how can we make sense of things when prices change so quickly?". Further, inflation creates more uncertainty in what is already a very uncertain world. And, with that uncertainty comes volatility, as evidenced by the impact of decisions made by two central banks last week, both actions intended to reverse these inflationary trends.

First up, the US’s Federal Reserve raised interest rates by 50 basis points, a decision ‘liked’ by the markets, action seen as being a strong but correct response. The Dollar rose sharply. Sterling, after taking a hit over several days, itself saw a brief reprise from downward pressures as the market quickly priced in the expectation of a similar response from the Bank of England. The actual response of our central bank was indeed similar – but not the same. When the BOE announced its interest rate decision – an increase of 25 basis points – this was quickly seen as evidence of a ‘dovish’ attitude to keeping inflation in check, and all-of-a-sudden the market was not so impressed. The Pound promptly took another dive, a sharp one, suffering its worst week against the other major currencies since the start of the pandemic. The impact of that currency depreciation – for us in the UK at least – is inflation, more of it, caused by the simple fact that to import from the US or the Eurozone now takes more £ to buy the same $ or €. Back to the US, and now, just a few days later, the Financial Times is reporting that the Federal Reserve believes further sharp increases in interest rates to tame inflation would ‘pose a risk to the American economy with a higher-than-normal chance that trading conditions in US financial markets would suddenly deteriorate’. The dollar starts to retreat. In effect the Fed is now saying (for interest rates) "What goes up, may not go up so much in the future". "What goes up, will please, hopefully, come down".

That’s what we’re hoping for in terms of prices. But it’s not happening yet. Certainly, in the currency markets, and also it seems for equities, the impact of inflation on assets and economic activity is changing very quickly. Inflation = uncertainty = volatility.

Now, back to those café conversations, and here’s one you’ll maybe not hear, or at least maybe not so often....

"Do you know, I’ve been looking over the latest figures of Big Corp, and what with all this rampant inflation they don’t really make sense anymore. How can I compare two-years of the financials when prices this year are so different from last? HELP!"

There it is again. Inflation. After not having to concern ourselves with the impact of general inflationary pressures for so many years, now that it has returned in full force, it is interesting to see how much extra cost it is capable of creating. And it’s not just the costs that can be seen in those fuel prices, in that food, in the cost of that cup of coffee. It’s also the hidden cost of trying to keep information meaningful. As we know, the markets, the economy, us in general cannot function efficiently without information that is decision useful. So, when do constantly rising prices make information not useful? Well, it makes me think of what, arguably, is the IASB’s least used Standard – IAS 29 Financial Reporting in Hyperinflationary Economies. Ok, we’re not in hyperinflationary territory, but some of the points raised in IAS 29 do make for interesting reading.

Consider this, in a hyperinflationary economy,

"Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, even within the same accounting period, is misleading".

And then this,

"In a period of inflation, an entity holding an excess of monetary assets over monetary liabilities loses purchasing power and an entity with an excess of monetary liabilities over monetary assets gains purchasing power to the extent the assets and liabilities are not linked to a price level."

"So, if inflation continues to increase rapidly then even similar transactions within the same period lack comparability, without some adjustment. And, as we know, debt gets ‘eaten away’ during times of inflation; that’s very bad news for those holding cash, hence one of IAS 29’s indicators of a hyperinflationary economy being ‘a general population that prefers to keep its wealth in non-monetary assets". As I say, we’re not in that arena yet, but we do know quite simply that £100 today is worth about £90 in one-years’ time if inflation is running at 10% without any compensation for that loss in value.

The objective of IAS 29 is to try and restore meaning, and comparability to financial statements prepared in economies where inflation is basically off-the-scale. It does this by restating the financials – the opening equity, the non-monetary assets, the transactions for the period – are all remeasured, applying a price index to reflect price levels and economic worth at the reporting date. This might all sound rather academic and straightforward, yet reading between the lines of IAS 29 its plain to see that a lot of extra work is involved. That ‘without some adjustment’ referred to above takes effort. First, there’s the decision as to how to arrive at the relevant price index, then there’s the record keeping of previous transactions and restatements, then of course there’s the restatement process itself, which might be required for the entity as well as its subsidiaries, associates, joint arrangements.

That’s a lot of work, and a lot of judgement, both of which mean a lot of time spent, and of course time means more money. This, all in the name of making the information more useful, but which could be out-of-date again within a very short space of time.

The current economic situation might be a painful one, but at least it’s not hyperinflationary painful – and long may that ‘good’ news continue. So, we might not be dusting down our copies of IAS 29 just yet. Afterall, another hyperinflationary indicator is where, "the cumulative inflation rate over three years is approaching, or exceeds, 100%." Now, that really would be interesting, and most definitely not in a good way.

About the Author

Stay Updated with IASeminars

Join 20,000+ other professionals on our global mailing list.

Settings