The current compound interest is liable not only for what I depicted in the last article but also for pouring money arbitrarily into short-term projects while those with a longer time span find it quite difficult to be sufficiently financed. Stefan Brunnhuber, another German who has been tacking this issue, gives a clear picture on all about it on his book “Wie wir wirtschaften werden”(to be published in English as “Our Future Economy”).
Let’s say that you have two projects to choose from: which project would you invest to?
a) a €10 pine tree which will grow to €100 in 10 years
b) a €10 oak tree which will grow to €1000 in 100 years
The interest rate plays an essential role on your choice although most of you aren’t aware of it: the positive interest rate is synonym of the depreciation of future assets because what will be bigger in the future is smaller in the past. Provided that the interest rate is fixed at 5% per year your € 1000 in 2006 is equivalent to €1628.89(1000×1.05^10) in 2016, but this means that your € 1000 in 2016 is reduced to only €613.91(1000/1.05^10) in 2006. From this viewpoint the pine tree is worth now € 61.39 while the oak tree is only worth € 7.60(1000/1.05^100) and everybody is therefore inclined to plant a pine tree while nobody is interested in oak.
This explains why entrepreneurs rush into China to set up new factories because profits are expected to be brought soon. Long-term projects such as reforestation and education are unlikely to call the attention of the business world because they aren’t profitable in this framework.
But this paradigm will see a fundamental shift as the interest rate changes: future assets can be appreciated instead of being depreciated in case there should be a negative interest rate. The pine tree will be worth €162.89 instead of € 61.39 and the oak tree €131,501.26 instead of € 7.60 with 5% of negative interest rate. This will favor long-term projects or those which will churn out profit constantly, enabling more projects to be financed.
But how can we make a negative interest rate possible? Next time I’d like to deal with this issue.