Money and Interest as Social Constructs
As discussed above, the discount rateand thus the time value of money is essentially determined by capital markets. This state would be acceptable if money was a technical tool serving the purpose of exchanging goods, measuring value, and preserving wealth. This view is commonly held by economists. However, other scholars (such as institutional economists, historians, or sociologists) argue that money is also asocial institution that expresses the trust and the sovereignty of a community. The use of a cur- rency indeed implies that members of a given society assume that fellow members will agree to exchange money for products and products for money. Historians have revealed that the monetization of trade has struc- tured human societies, by replacing former trust in bilateral barter 85 Time Value of Money and Sustainability
relationships with a shared trust in the value of money, hence further pro- moting the development of trade (Aglietta & Orle´an, 2002).
By linking the past, the present, and the future, money also reduces the fear of an uncertain future, and permits human societies to act as if the future were stable. This is reflected in the discounted cash flow model, which transforms expected future cash flows into present values.6Finally, we know that money has psychological, affective, and impulsive aspects, which can be observed both at the individual and macroeconomic level (Benedikter, 2010).7More than a technical answer to economic problems, money is thus also a complex socio-political construct (De Blic & Lazarus, 2007).
If we are willing to accept the above statement, it follows that the ana- lyses of investment valuation and the time value of money offered by finan- cial theory and used in financial markets cannot constitute a
“scientific” law. Rather, they express an implicit normative choice.8 In other words, the moral, political, and ideological aspects of the time value of money are concealed by the scientific appearance of financial theory.
From a critical perspective, the development and dissemination of financial models in organizations worldwide can therefore be regarded as a double movement of constructing organizational reality, while simultaneously effa- cing the process of construction behind a mask of naturalness and scienti- fic-ness (Fournier & Grey, 2000;Lagoarde-Segot, 2014).
Given current societal demands for sustainability, bestowing on conven- tional financial theory the ability to determine the socially optimal time value of money appears to be a dangerous simplification. Reexamining what the adequate level of the time value of moneyand hence, the opti- mal required rate of returnshould be, appears a legitimate and necessary endeavor. While we leave this to further research, we show in the next sec- tion that the question of socially optimal interest rates has already been the subject of much economic thought.
Theoretical Insights: Urzin and Freigeld Gesell in the History of Economic Thought
Silvio Gesell (18621930), a German merchant, social utopian, and politi- cal economist, can be regarded as one of the intellectual forerunners of the current movement for social banking and finance. Gesell’s thinking bor- rowed simultaneously from socialism and liberalism, and searched for a way to restore a “natural economic order”; in which everyone would be remunerated with the full proceeds of his/her own labor. He considered
that rent and interest on capital constituted obstacles to such free competi- tion and equitable exchange. Gesell acknowledged the two-faced nature of money, a medium of exchange and an instrument of power that is used to dominate exchange. Gesell sought to eliminate the latter and to keep the former. In other words, Gesell revived Aristotle’s distinction between eco- nomics (oikonomik) and chremastics (chrematistik), that is, an activity con- sisting in the maximum accumulation of money.9
Although Gesell’s thought belongs to the socialist tradition, unlike Marx, he considered that “exploitation” took place in the monetary sphere, rather than in the production sphere. He also rejected central planning and collective appropriation of the means of production, which he described as the “abominable rule of officials, the death of personal freedom, personal responsibility and independence” (Gesell, 1916, p. 15). Gesell could hence be considered a “libertarian socialist,” critical to both laissez-faire and State-led models, in the vein of Pierre Leroux (17971871), Pierre-Joseph Proudhon (18091865), or Rudolf Steiner (18611925).
Gesell’s Theory of Money
Gesell’s theory of money is based on two premises. First, he observed that unlike other products, money does not carry depreciation charges, and can, by virtue of its absolute liquidity, be deployed at low cost in any transac- tion. These two characteristics give money holders power in the economic realm: through their unique ability to postpone their economic decisions at will, money holders can destabilize the flow of savings, investments, supply, and demand in the economy. This unbalanced negotiation power materia- lizes in the form of a “premium” extracted from producers, the latter being forced to pay to avoid the risk of losing their perishable goods and products.
Assuming the demand for goods translates into effective demand only if it is endowed with money, Gesell stipulates that the supply of goods (SG) is always equal to the demand for money (DM) and the demand for goods (DG) is always equal to the supply of money (SM).
Further, the supply of goods is predetermined by the production level SGẳSG; and the supply of moneySMis equal to the product of the quan- tity of money QM and the velocity of circulation of money V, the latter depending on the strategic behavior of money holders (SB):
SGẳSGẳDM
DGẳSMẳQMVðSBị
87 Time Value of Money and Sustainability
The economy achieves full employment if the supply of goods (the demand for money) is equal to the demand for goods (the supply of money):
SGẳDGẳSMẳDMẳQMVðSBị
However, the supply of money depends on the strategic behavior of money holders. Gesell assumed that the latter trade only if they expect subse- quently to sell the acquired goods above the initial purchasing price. In other words, the velocity of circulation is a positive function of the expected rate of inflation π^: ∂V∂^πðSBị>0. Given that the quantity of money fixes the upper bound of supply, it follows that the economy reaches full employment only in the absence of deflation and deflationary expectations.
The velocity of money circulation, which depends on the expectations of money holders, hence determines the level of effective demand. Further, Gesell defines the observed price levelPto be equal to the effective demand to supply ratio:
PẳDG
SG
ẳQMVðSBị SG
Therefore, an initial drop in the price level P can trigger a cumulative deflation process, by diminishing the velocity of circulation of moneyV(SB), the demand for goodsDGand the level of prices.
Gesell’s Theory of Interest
For Gesell, interest is intrinsically a monetary phenomenon, and can be divided into three components: a risk premium (reflecting default risk); an inflation premium (reflecting inflation risk), and a basic interest (Urzin), reflecting the advantages of money over other goods. The concept of “basic interest” reflects the fact that owning money grants an individual the possi- bility of gaining additional money at no cost. Market products are sold for their production costs, plus a premium, corresponding to the basic interest, which is transferred from consumers to money holders via producers.
Gesell argues that the level of the basic rate of interest affects the capital endowment of the economy. He first states that the marginal productivity of capitalRkcorresponds to the ratio of demand of capitalDkto the supply of capitalSk(such as equipment and machinery). Assuming perfect capital
markets, a real investment is then implemented only if the marginal pro- ductivity of capital exceeds the basic interest rateI:
RkẳDk Sk ≥I
He concludes that the basic interest rate constitutes the core rate around which the rate of return on capital hovers. For instance, an increase in the supply of capital (Sk) will lower the marginal productivity of capital (Rk) under the monetary rate of interest (I), causing disinvestment and crisis.
The Concept of Freigeld
Given this framework, Gesell’s answer to economic crises consisted in the introduction of stamped money (Freigeld), that is, money “freed” from Urzin (which he estimated between 4% and 5%). The intuition is the fol- lowing. With depreciative fiat currency, money, like other products, is sub- ject to carrying charges, and those possessing it are no longer able to
“hoard.” This should, in turn, stabilize the velocity of circulation of money and effective demand. By reducing money to a simple instrument of exchange,Freigeldwould eliminate the strategic behavior of money holders and increase the velocity of circulation to its maximum level, thereby ensur- ing full employment. It would also allow public authorities to monitor the level of aggregate demand directly by adjusting the amount of money in circulationQM:
SGẳDMẳDGẳSMẳQMV
This is similar to an inflationary policy; however, the difference here is that prices themselves do not change, while the value of money itself decreases over time at a constant rate. It should be also noted thatFreigelddoes not imply the end of interest. In addition, the “store of value” function of money is preserved: savers may deposit their money with a financial inter- mediary, which will lend it and mitigate the devaluation effect of money through a risk premium. In addition, Freigeld was conceived to be embedded in a double monetary system: a regular monetary system, apply- ing to the national level, and a local monetary system, varying from region to region, in which fiat money is introduced.
89 Time Value of Money and Sustainability
Freigeld would also lower the discount rate and the cost of capital of firms and thus contribute to the feasibility of longer-term and sustainable projects. It is sometimes argued that the lower discount rate would lead to a consumption boom and thus compensate the positive effects on sustain- ability. However, this line of argument neglects significant opportunity costs in a stamped money system. Savings do not suffer from the deprecia- tion of money and thus preserve the purchasing power of money. With low or zero inflation rates, there is no clear incentive to consume more in a stamped money regime than in a “traditional” fiat currency regime.
Furthermore, investments in risky projects can yield returns well exceeding the returns on savings, rendering consumption less attractive.10
Finally, even if consumption increased, it would be associated with the consumption of more sustainable goods, because the longer investment horizon encourages firms to invest in sustainable projects, leading to the production of sustainable products.
CONCLUSION
This chapter investigates the relationship between sustainability and stan- dard capital budgeting tools such as the Net Present Value (NPV). We first established that a necessary requirement of sustainability is a long-term horizon and intergenerational equity, but highlighted that, for positive discount rates, commonly used capital budgeting methodologies tend to favor short-term, unsustainable projects. In addition, the ranking of all positive NPV projects may lead to the rejection of projects that require a longer investment horizon if investors face capital constraints. These poten- tially sustainable projects will often lose out against alternative projects that provide greater returns earlier.
This reasoning calls for a reconsideration of standard financial techniques from the point of view of sustainability. This might however prove to be par- ticularly challenging to implement in practice, given the fact that the estima- tion of the cost of capitalone of the building blocks of financial theory is considered to be primarily a technical issue by most finance practitioners and researchers. Nonetheless, we have shown that money and interest rates are not simply technical tools, but have important institutional, social, and political attributes. Taken together with the current global demands for sus- tainability, this observation could serve as a justification for a new research agenda seeking to redefine current capital budgeting techniques. Finally, we
took initial steps toward this research agenda by considering potential les- sons from the history of economic thought. In particular, we reformulated and discussed the concept of negative interest rates developed by Silvio Gesell (18621930). In future work, we will seek to further develop this the- oretical framework in the light of current global initiatives in the field of alternative currencies, and attempt to draw practical implications for the management of sustainable organizations.
NOTES
1. These include triple bottom line accounting, socially responsible investment, and social return on investment (SROI).
2. The initial outlay could also be positive and written similar to the cash flows in periods 1 toTwith a discount factor equal to one, that is,IO/(1 +r)0= IO/1
= IO.
3. There is a large literature in finance focusing on the liquidity of markets and the inverse relationship between the cost of capital and liquidity, that is, lower cost of capital for higher levels of liquidity.
4. Intergenerational equity implies that the future is as important (and thus not discounted) as the present, that is, the time value of money is zero.
5. This model relates the “equilibrium rate of return” of a financial asset to a single variable: the sensitivity of the asset’s financial returns to variations in the market portfolio return (thebeta).
6. Note that this transformation using positive interest rates assumes that the value of the future is lower than the value of the present. This assumption is consis- tent with a decreasing value of life but not with sustainability. In other words, if the time horizon includes future generations it is not obvious why the future should be discounted.
7. The psychological dimension of money was first outlined by Keynes (1936), who argued that economic agents have no basis for making rational predictions about an unknowable future: “Investment based on genuine long-term expectation is…scarcely practicable. He who attempts it must surely…run greater risks than he who tries to guess better than the crowd how the crowd will behave” (Keynes, 1936, Chap. 12).
8. Inflation targeting by central banks is an example of such a norma- tive approach.
9. “Of everything which we possess there are two uses: both belong to the thing as such, but not in the same manner, for one is the proper, the other the improper or sec- ondary use of it” (Aristotle).
10. A numerical example of a stamped money system is the following: Money depreciates by 5% p.a., savings carry a 0% interest rate per year, and the inflation rate is 0% p.a. In this scenario, money holders have an incentive to save and not necessarily consume.
91 Time Value of Money and Sustainability
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