Posted on April 17, 2006
Filed Under Uncategorized |
Excerpted and adapted from pp.242-248 of The Future of Money, © Bernard Lietar
Monetary specialists and Greens alike typically see no connection between the money system and sustainability. What follows will show that this is a massive oversight. The gentlest way to acquaint ourselves with that connection is through a short fairy tale for my godchild:
The Man with the Near-Seeing Glasses
(Fairy tale for Kamir, Seven years old)
Once upon a time, in a very near place, there was a man who had been wearing glasses for so long that he even forgot he had them on. The main problem, however, was that his glasses, instead of correcting his vision, were making him so near-sighted that he couldn’t see anything further than his nose.
He would bump against everybody or everything because they would always suddenly appear to him without warning, when it was already too late to avoid the obstacle. He was getting worried enough about the problem that he finally went to consult a Scientist.
The Scientist listened to the problem carefully, then pulled out a very thick book on Optics filled with equations and diagrams. And he showed him that it was very normal to see better closer up than far away. He explained something about the number of light particles decreasing by the square of the distance from which he saw them. The Man with the Near-Seeing Glasses did not quite understand the explanation, but he was very relieved to hear that there was a scientific reason for his situation, which made it all very normal.
So he went on bumping against people, trees, even his own green front door and everything else which popped up suddenly as he was hitting them with his nose. After he hit a particularly hard red brick wall with his forehead, he began getting worried again and felt depressed about all the bumps he kept collecting. So he went to see a Psychiatrist.
The Psychiatrist told him to lie down on a big couch and started asking him a lot of questions… Then he told him that it was very normal that he was depressed, and asked him to come back every week for some in depth treatment about all that.
One day, much later, as the Man with the Near-Seeing Glasses came back from his appointment with the Psychiatrist more depressed than ever, he bumped against his little five-year old granddaughter who was waiting for him in front of his house. He was very happy to see her again, and they went into the house to play together.
As the little girl was playing horsy on her grandfather’s knees, she suddenly grabbed at the horse’s bridle and ripped off the Near-Seeing Glasses from her grandfather’s nose. Just as suddenly, the Man discovered that he could see much further than his nose after all! His granddaughter’s smiling face was clear. The green door he’d smashed into last week was clear. He even noticed that the red brick wall needed some repairs where he had hit his head. Seeing things beyond his own nose before bumping into them made a lot of sense after all.
We can now rephrase the relationship as follows: interest rates create a built-in tendency to disregard the future, to create a world-view with “near-seeing glasses.” Furthermore, the higher the interest rate, the more that tendency prevails.
We have already seen how interest rates are deeply woven into the very process of creating money in our prevailing money system. Understanding the relationship between interest rates and time perception will be accomplished in the three following steps:
1) Comprehend how capital allocation decisions are generally made through the financial technique of “discounted cash flow”;
2) Understand how such discounting of the future is one of the key underlying causes which create a direct conflict between financial criteria and ecological sustainability under our present monetary system;
3) See how the discount rate used in the discounted cash flow technique is directly affected by the interest rate of the currency used in the cash flow analysis
Discounted Cash Flow = ‘Discounting the Future’
“Discounted cash flow” is the financial technique generally used to decide on whether to invest in a given project, or to compare different projects. It is presented in full detail in any finance textbook.
What we need to understand about it here can be explained by a simple example. Let’s assume that a particular project requires a $1,000 investment today, and that it will produce a net profit of $100 each subsequent year for the next 15 years. Let’s further assume that there is no inflation during that period of time. Figure 8.3 shows what the real cash flow of that project would like: it starts with a negative - $1,000 when the cash outflow occurs today, and for each of the next 15 years we earn back $100.
Financial analysts, however, will see the project differently. (Figure 8.4) The project still requires a $1000 initial investment in year 0. But the income of $100 after the first year is worth only $91, assuming a flat interest rate of 10% per year for the entire duration of the project. (All values are rounded to the nearest dollar for illustration pursposes, since carrying a lot of decimals would not modify the argument presented)
We all “know” that money in the future is worth less than money today. How much less depends critically on the ‘discount rate’ applied to the project.
Our analyst knows that he could deposit $91 in a bank today at a 10% risk free rate of return, and automatically get $100 a year from now. Therefore the $100 a year from now is identical to $91 today. By the same reasoning, the second year’s $100 is only worth $83, the third’s $75, etc. By the tenth year, the $100 inflow only represents only $39 to him, and in the fifteenth year, a paltry $24.
So what looked like a perfectly reasonable investment – getting back $1,500 on a $1,000 investment – turns out to be a lackluster project when looked at through the Near-Seeing Glasses of the modern financial analyst.
If we projected this forward for a century, the last $100 would really be worth only seven cents. Two centuries out, we are looking at a few hundredths of a cent. No wonder that in our societies we do not usually think about the effect of our decisions on the future, let alone “for the seventh generation,” a process which would require us to take into account looking two centuries into the future…
There is nothing wrong with the financial analyst’s eyesight or his reasoning. He just applies the straightforward financial logic that he has been taught to a currency which has a positive interest rate.
Short-term Vision Versus Sustainability
As this same reasoning applies to all financially motivated investments, it collectively creates the well-known pressure by the financial system for short-term returns at the expense of any longer-term consideration – including long-term sustainability.
When a corporate executive complains that financial pressures force him to focus only on the next quarter’s results, he is the victim of the Near-Seeing Glasses. When the Chinese say they cannot afford cleaner energy production technologies, they are really saying the costs of the long-term future economic consequences discounted to today are negligible compared with the immediate cost savings made possible with the “dirty” technologies they are planning to use. When a homeowner decides it is too expensive to install solar panels for heating the household water, she is implicitly saying that the cost of purchasing electricity or gas from the grid in the long run discounted to today is cheaper than the initial capital outlay required. When we build a house on the cheap, without appropriate insulation, we are really making a trade-off between the higher heating costs in the future discounted to today and the higher construction costs.
Far Seeing Glasses
What happens when you reverse the way you look into binoculars? Suddenly, instead of bringing distant objects closer, it makes everything look far away.
In our metaphor of the Near-Seeing Glasses, positive interest rates are the feature of our current monetary system, which creates a generalized financial myopia, and makes the future appear less relevant. The higher the interest rates, the stronger the myopia. In other words, the result of positive interest rates is what happens when one looks through the wrong end of binoculars.
What would happen if we reversed the financial analyst’s glasses? Remember the demurrage charges mentioned at the end of the previous chapter? Demurrage was the brainchild of Silvio Gesell (1862-1930), and was most recently used as an anti-hoarding device for the stamp scrip currencies of the 1930’s. Gesell’s starting premise was that money is a kind of public service, like a bus ride. So a small fee is charged for the time that one hoards it.
From a financial perspective, a demurrage charge on money is mathematically equivalent to a negative interest rate. For reasons that will soon become clear, I will call this time-related charge a “sustainability fee.” Now, what would such a sustainability fee or demurrage charge do to the eyesight of our financial analyst?
The project described in Figure 8.3 would suddenly appear to him as described in Figure 8.5.
This is true not just due to the mechanical application of the equations of discounted cash flow. Even if it looks strange at first sight, even if it contradicts what we are used to with our normal currencies, it still makes perfect financial sense.
Let’s assume that I give you a choice between 100 units of an inflation-proof currency charged by a sustainability fee, either today, or a year from now. If you do not need the money for immediate consumption, and you are not worried about my creditworthiness over the next year, then you should logically prefer the money a year from now. Why? By receiving the money in a year’s time, you will not have to pay the sustainability fee for that year. In technical terms, discounted to today’s value, the 100 units will be more valuable a year from now than if you received them today. They will be worth 100 plus the sustainability fee.
When sustainability-fee-charged currencies are used, the future becomes more valuable with time, exactly the opposite of what happens with our normal, positive-interest rate currencies.
There remain two fundamental issues to be addressed:
How could such an idea be implemented? Who could take the initiative for such a new global currency system in the foreseeable future?
Is such an unorthodox money system sound? What would be its economic consequences?
Excerpted and adapted from pp.242-248 of The Future of Money, © Bernard Lietar
Comments welcome below.