In the Long Run We Are All Rich: What Negative Interest Rates Mean for Good Policy

The Dutch have records that go back to the time of Martin Luther - 500 years. In that entire time, including the European settlement of continents, 30-year religious war, the end of knighthood, serfs, industrial revolution, the car, telegraph, telephone, TV, computer, modern medicine, introduction of democracy .... interest rates never went negative. Until about 2 years ago.

Now the Dutch, the EU, Japan and even the US (for the US still only briefly and after adjusting for inflation) have all had and / or have negative interest rates.

This is huge.

One of the things I've not seen anyone talk about is how valuable it makes investments.

Imagine that you start with $100 income. Each year that income grows by 5%. You want to price this income stream for the next 50 years.

If you assume that interest rates are +1%, then you discount next year's income by that amount. $100 next year is worth only $99 this year. You discount the amount by 1%. And of course the further out in time, the more you discount that income stream.

If you assume that interest rates are negative 1%, -1%, you actually increase next year's income. $100 next year is worth $101.

What is the price of a 50 year income stream growing at 5% a year when interest rates ....

are 1%? $1,903.

are -1%? $1,014,861,688

It's the difference between two thousand and one billion.

What does this mean? The lower interest rates are, the bigger the reward for investments now. What kind of investments will pay off long term? R&D. Education. Startups. Infrastructure.

As we come out of this incredibly painful downturn, we should invest money as if we were drunk or billionaires. This will do two things. One, it will employ a lot of people right now in construction of infrastructure, R&D, teaching and working in or managing startups. Two, it will generate future income that is worth more than it ever has before.

Negative interest rates signal a wonderful thing. It means that the future has never been more valuable and with capital so cheap, never a better reason to invest in this future. In a twist on Keynes, in the long run, we are all rich.

Republican Recalcitrance

As Obama tries to win over the Republicans on his health care reform, it is worth remembering how the votes in Congress fell when Clinton passed the legislation that reversed decades of deficits. Not a single Republican voted for his plan. Gingrich led opposition in the House and Dole in the Senate, where the vote was 50-50 (Gore broke the tie).

Clinton was not, as the Republicans would now want you to believe, forced into deficit reduction by Newt. Advised to lower interest rates, he was instead reducing the deficit in order to win over the Fed (Greenspan could lower short term rates) and bond traders (who could lower long term rates). His strategy worked and helped to stimulate the greatest expansion of the last century.

When Clinton left office, the projection for the surplus through 2015 was $4 trillion. In what now seems almost comical, Greenspan was worried about what would happen when there were no T bills as an investment option. By the time Bush left office, the projection for the same period was a deficit of nearly $4 trillion, a reversal of about $8 trillion (which would fund Obama's health care plan for 80 years - an entire lifetime).

Newt's biggest play for spending reduction was to make drastic cuts to Medicare in the wake of Republicans winning the midterm election in 94. Clinton called his bluff on this, defending health care for the elderly to the point of a government shut down. The result was a rise in the polls for Clinton and a drop for Gingrich and the Republicans.

It is lovely that Obama is inclined towards including the Republicans in the formulation of a health care plan. The lesson from Clinton's presidency,though, may be that the Republicans will simply be an obstructionist party and Obama has to give them a deadline by which they should either come along or stay behind.