Beautiful countryside in southern California

Capital for the future

Making the economy sustainable may require an unprecedented amount of capital in the form of knowledge and outfits like solar panels, sustainable farms and energy-efficient transportation systems. It is hard to imagine that it can be done. And imagining it is still a lot easier than really doing it. It is going to require some economic magic to divert investment capital from destructive activities to the future of humanity. We may need more useful capital and less consumption.

Perhaps the invisible hand can be of some help. It is easier to finance a great endeavour from investments than from taxation because nobody wants to pay taxes but everybody is happy to invest. It is the secret of the success of the European empires that conquered the world after the Middle Ages. England, France, Spain and the Netherlands were much poorer and smaller than China, India or the Ottoman Empire, but they didn’t finance their conquests with taxation, but with the use of investment capital.1

Europe won out because European conquerors took loans from banks and investors to buy ships, cannons, and to pay soldiers. Profits from the new trade routes and colonies enabled them to repay the loans and build trust so they could receive more credit next time.1 The same logic may need to be applied to making the economy sustainable. The challenge is so enormous that it may never be possible to finance it by taxes. Nowadays interest rates are so low because there is plenty of investment capital.

It’s the economy stupid!

It is often argued that the economy is unsustainable because of short-term thinking. The economy must grow in order to have positive returns on investments. And it is believed that returns on investments need to be positive otherwise the economy would collapse. The economic time horizons of individuals are reflected in their time preferences. The time horizon of the economy as a whole is reflected in the interest rate.

The lower the interest rate, the longer the time horizon of the economy could be. The following example from the Strohalm Foundation can illustrate this:

Suppose that a cheap house will last 33 years and costs € 200,000 to build. The yearly cost of the house will be € 6,060 (€ 200,000 divided by 33). A more expensive house costs € 400,000 but will last a hundred years. It will cost only € 4,000 per year. For € 2,060 per year less, you can build a house that lasts three times as long.

After applying for a mortgage the math changes. If the interest rate is 10%, the expensive house will not only cost € 4,000 per year in write-offs, but during the first year there will be an additional interest charge of € 40,000 (10% of € 400,000).

The long-lasting house now costs € 44,000 in the first year. The cheaper house now appears less expensive again. There is a yearly write off of € 6,060 but during the first year there is only € 20,000 in interest charges. Total costs for the first year are only € 26,060. Interest charges make the less durable house cheaper.2

Without interest there is a tendency to select long-term solutions. Interest charges make long-term solutions less economical. Interest promotes a short-term bias in the economy. It may explain why natural resources like rainforests are squandered for short term profits. If interest rates are high, it may be more profitable to cut down a rainforest and to put the proceeds at interest rather than to manage the forest in a sustainable way.

Only, things are not as simple as the example suggests. For example, the building materials of the cheap house might be recycled to build a new house. And technology changes. For example, if cars had been built to last 100 years, most old cars would still be around. This could be a problem as old cars are more polluting and use more fuel. Nevertheless, the example shows that long-term investments can be more attractive when interest rates are lower.

This also applies to investments in renewable energy. For instance, a solar panel that costs € 100, lasts 15 years, and generates € 150 worth in electricity in the course of these 15 years, is feasible at an interest rate of 5% but not at an interest rate of 10%. Many investments in making the economy sustainable may have low returns and are only feasible when interest rates are low. Low and negative interest rates can also deal with low economic growth. That may be needed for living within the limits of the planet.

Living within the limits of the planet

When interest rates are negative, the time horizon of the economy could go to eternity so that it makes sense to invest in making the economy sustainable. A few examples from history can illustrate this. In the Middle Ages some areas in Europe had currencies with a holding fee like Natural Money. As there hardly was economic growth, interest rates were negative. It was the era of Europe’s great cathedrals. These cathedrals were built for eternity. As better investment opportunities were absent, wealthy towns people spent their excess money on cathedrals.3 For similar reasons, the people of Wörgl planted trees as the proceeds of the wood were expected to occur in the distant future.3

A bit of calculus shows why. At an interest rate of 5%, putting € 1 in a bank account turns into € 1,05 after a year, so you would rather have € 1 now than in one year’s time, even when you need the money in one year’s time. That’s because you can put the money on a bank account at interest. At an interest rate of 5%, € 100 in one year’s time is worth € 95.25 now. The distant future has even less value. The same € 100 in one hundred year’s time is worth only € 0.59. And € 100 after 1000 years has no value at all in the present.

At an interest rate of -5%, you would prefer to have the money when you need it, otherwise you would end up with less. At an interest rate of -5%, € 100 in one year’s time would be worth € 105. The same € 100 in one hundred year’s time would be worth € 13,501 now. And € 100 after 1000 years would be worth more than everything there is in the present. Income in the distant future is also very uncertain, so it is unlikely that investors will shift their time horizon to 1,000 years, but this logic may help us to come into terms with the limits our planet poses on human activities.

Living within the limits of the planet may require unprecedented investments in the future. These investments may require low or even negative interest rates as their returns may be low. Only low and negative interest rates can make these investments economical. Everyone who has money to save can help by shifting money from consumption to saving and investing. The more people act like capitalists, the lower interest rates may go, and the more sustainable the economy may become.

Capitalists think that money spent on a frivolous item is money wasted, because when you invest your money, you will have more money that you can invest again. Capitalists hardly care about interest rates. They will save and invest anyway because of their capitalist spirit. Rich people may be encouraged to save even more if luxuries that use a lot of natural resources and energy aren’t available any more. One can think of luxury yachts, private jets, but also of travel by airplane for holidays. When energy becomes a constraint, local products may replace long-distance trade.

Featured image: Beautiful countryside in southern California. James McCauley (2005). Wikimedia Commons. Public Domain.

1. A Brief History Of Humankind. Yuval Noah Harari (2014). Harvil Secker.
2. Poor Because of Money. Henk van Arkel and Camilo Ramada (2001). Strohalm.

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