From the discussion on accounting in Part 1, Accounting Nuances of Credit, it is immediately visible that your real profit is consistently lower than the taxable profit you report and pay taxes on. At times, you will be subject to taxation even though a loss of capital eventuated that period. The other major area of impact, after profit and income taxes, is capital gains taxation. Perhaps the best way to understand CGT implications is with an example.
Owning a property or Owning shares in a company:
An individual, business, or other entity, purchase an asset (property or shares) for $100,000. Five years later this asset is valued at $161,000. When purchased, all other comparable assets were $100,000. And today, all other comparable assets have increased to $161,000. New currency was created and directed to certain areas in the economy at 10% p.a. during this five-year period.
The economic reality of this situation is that the purchaser is no better off than at the time the purchase was made. He has no more assets than at the time he made the purchase, and his asset has not performed any better than all other assets in the marketplace. If measured in an equivalent asset, the value remains 1:1. What has occurred is new AUDs have entered the marketplace. Five years ago, 1 trillion AUD existed in totality. Then 1.1 trillion (+10%), the next year 1.21T (+10%), then 1.33T (+10%), then 1.46T (+10%). This year 1.61 trillion (+10%) AUDs exist. A 61% increase in 5 years.
In this scenario, the the price to purchase the asset in AUD increased by 61%. Said another way, the price to purchase AUD decreased. Five years ago, the owner could buy 100,000 AUD with his asset. Today, he can buy 161,000 of the now abundant AUD with this same asset. So far so good, at least he knows his reality.
Consider the ‘no gain’ scenario. At the beginning of this period, the $100,000 asset controlled .00001% (100,000 / 1T) of the global purchasing power of AUDs existing. If this asset made no gain, by the end of the period the $100,000 asset now controls 0.0000062% of the global purchasing power of AUDs. A 37.8% reduction in 5 years. From a taxable income perspective no gain and no loss has been recorded.
The owner decides to sell. He finds a buyer and sells for $161,000. Under the Income Tax Assessment Act 1997 certain laws and exemptions apply to capital gains depending on the circumstances. The issue here is the claim that this entity has made a capital gain, i.e. a gain of capital.
Capital is the permanent fund of productive wealth, the accumulation of the products of past labour capable of being used in the support of present or future labour. It is the actual estate, which is owned or employed by an individual, firm, or corporation in business and implies ownership and does not, without qualification, include borrowed money. – William P. G. Harding.
According to William P. G. Harding, 2nd Chairman of the Federal Reserve, “Capital is the permanent fund of productive wealth, the accumulation of the products of past labour capable of being used in the support of present or future labour. More specifically, it is the wealth employed in carrying on a particular business or undertaking. It is the actual estate, whether in money (gold) or property, which is owned or employed by an individual, firm, or corporation in business and implies ownership and does not, without qualification, include borrowed money.”1
The man in this example has no such gain of estate or capital. Indeed, after fees, he is poorer for his efforts. He could not buy back the very estate he just sold, nor buy any of the comparable assets. Regardless of how the tax department treat the ‘capital gain’, the real issue is that this man has not made a capital gain. He is the victim of a currency becoming abundantly cheap.
A more truthful treatment would be, each period to book a loss to the value of the opening asset multiplied by the percentage currency inflation. Thus by the time of the sale, a loss of $61,000, or near-to it, will have been booked and held, whether in the same account, in a contra account or in an equity reserve account. The gain of $61,000, booked to capture the realised share of the new money that he managed to obtain, will net with the loss booked above, to reflect the break-even reality of the situation. These are two distinct events; i) a loss as soon as new currency is created, and ii) a gain as some portion of this new currency is captured by the asset. If the man sold for $171,000, he then has made a good investment and has achieved an inflow of economic resources, an increase in his capital, and has a faithfully represented capital gain of 10,000. If he sold for $151,000, he has a faithfully represented capital loss of $10,000.
Central bank and government policies may be good policies. The world certainly is not in the worst of shapes considering our long history. However, good policy does not justify lies and falsehoods in reporting and recording of its methods. Truth forms the foundation for the well-being of a nation. Our systems of account ought to update to adapt to the ideas of money today that are being applied by governments around the world. This article attempts to begin that process.
The prudent individual must, for the management of their own affairs, become aware of this systemic deviation from truth.
- Credit, currency and business by William P. G. Harding (1922).