Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

xxviiiMoney, Bank Credit, and Economic Cyclestheir own profits and net worth, figures which in turn encouragedthem to run risks (or better, uncertainties) with practicallyno thought of danger. Hence, we see that the IAS act in apro-cyclic manner by heightening volatility and erroneouslybiasing business management: in times of prosperity, they createa false “wealth effect” which prompts people to take disproportionaterisks; when, from one day to the next, the errorscommitted come to light, the loss in the value of assets immediatelydecapitalizes companies, which are obliged to sellassets and attempt to recapitalize at the worst moment, i.e.,when assets are worth the least and financial markets dry up.Clearly, accounting principles which, like those of the IAS,have proven so disturbing must be abandoned as soon as possible,and all of the accounting reforms recently enacted,specifically the Spanish one, which came into effect January 1,2008, must be reversed. This is so not only because thesereforms mean a dead end in a period of financial crisis andrecession, but especially because it is vital that in periods ofprosperity we stick to the principle of prudence in valuation,a principle which has shaped all accounting systems from thetime of Luca Pacioli at the beginning of the fifteenth centuryto the adoption of the false idol of the IAS.In short, the greatest error of the accounting reformrecently introduced worldwide is that it scraps centuries ofaccounting experience and business management when itreplaces the prudence principle, as the highest ranking amongall traditional accounting principles, with the “fair value”principle, which is simply the introduction of the volatile marketvalue for an entire set of assets, particularly financialassets. This Copernican turn is extremely harmful and threatensthe very foundations of the market economy for severalreasons. First, to violate the traditional principle of prudenceand require that accounting entries reflect market values is toprovoke, depending upon the conditions of the economiccycle, an inflation of book values with surpluses which havenot materialized and which, in many cases, may never materialize.The artificial “wealth effect” this can produce, especiallyduring the boom phase of each economic cycle, leads tothe allocation of paper (or merely temporary) profits, the