Wednesday, February 11, 2009

Challenging the time value of money

Why is it that we expect our savings to ‘grow’ all by themselves? What would happen if our savings diminished over time instead?

Let’s first have a look at the historical coincidences that led to the absolute acceptance that the future should be discounted. Before any banking system existed, to save you must store your valuables, whether it be precious metals, grains or other food, somewhere where they can be preserved. To save them for the future, you must invest MORE in the present, in the form of preserving food, building defensible stores, and if there was enough gold in there, possibly paying for protection, to have LESS in the future. Thus prior to banking , the future was valued MORE than the present.

The logic behind this is simple. The future is risky, and to maintain your wealth for future times of uncertainty, you must invest in the present to protect it.

So where did the idea of earning a return on savings originate?

It must have been some time ago when the idea of lending money with interest first came into being – it even gets a mention in religious texts. I imagine that the ancient Greeks and Romans were the first to consider the problem I am considering today.

I guess there were two interrelated issues that led to money lending at interest – the advent of central banking in the form of paying goldsmiths to store and protect your gold, and the advent of international ‘trade’. I use the term trade loosely because much of the trade was involuntary in ancient times – by that I mean that that trade was achieved by waging war. But the point is that through trade increased wealth could be achieved easily, which could then be used to pay interest.

To get back to the questions I raised at the beginning of the blog, I would suggest that the reason we expect our savings to grow is because that is how it has been for a long time. Most of the time we can generate a small positive return on savings if there is a little growth in production.

But what if we have reached some resource limits, and growth is now a little more difficult to achieve. How can we lend money with interest in an environment of negative growth? On a national scale, how can we generate the wealth necessary to pay the interest? In short, we can't.

Maybe some readers have already noticed a major problem with negative interest rates (or a deteriorating money supply, or a reversal of the principle of the time value of money). Those who hold wealth will have a much more difficult time preserving its value. Challenging this one basic principle raises questions of the validity of land ownership and rents, and how it may be possible to own any income producing asset, let alone value it? Imagine capitalising an asset at 0.00001% - any income producing asset would be almost infinitely valuable. Where would be the motivation to invest in any capital equipment?

Where does this leave us? To be honest, the more I think about it, the more I see the importance of maintaining economic growth. A sustained period of negative growth would destroy the system – the money supply, capital values, rents – but what would it be replaced with? I am yet to think of a reasonable alternative, but I am sure there must be one.


  1. Muzz,

    Have you seen this series at all?
    Was on in the UK when I got back... quite interesting touches on a few of the issue you have raised! Worth a look if you can get a hold.