Do you remember Irving Fisher? He may have been America’s first celebrity economist. A professor who taught at Yale, he doled out pearls of investment wisdom to the business press during the early years of the twentieth century.
But one interview, in particular, wreaked irreparable damage to his reputation. In 1929, at the height of his fame, Fisher attempted to reassure the jittery investment markets by declaring that equity values had reached “a permanently high plateau.” He implied that investors would be wise to hold onto their stocks and ride out any period of market volatility.
Those who followed his advice were in for a very long ride. The Dow Jones Industrial Average fell 89%, and didn’t recover until the 1950s. An entire generation of investors was wiped out, the nation plunged into a Great Depression, and Irving’s followers suffered a very harsh blow.
Nevertheless, Fisher did leave an impressive legacy. His classic 1907 book The Rate of Interest and 1930 text The Theory of Interest helped popularize the Net Present Value (NPV) model of Discounted Cash Flows. It remains the dominant valuation method of modern finance.
How does it work? In essence, it incorporates the Time Value of Money into an evaluation of an investment opportunity. Cash flows that occur in the near future are worth more today than cash flows that occur in the distant future. In essence, the burden of “waiting for one’s money” cheapens the latter type of cash flows.
Although Fisher didn’t invent this model, he did as much as any other individual to establish it as the cornerstone of modern valuation theory. And by doing so, he may have helped launch our society on an unsustainable path.
Why? Because, quite simply, it discounts the future. It ensures that we’ll always choose to receive a dollar today over a dollar tomorrow.
But what if we find a business opportunity that can yield billions of dollars of profits today? An opportunity, perhaps, that would trigger the impoverishment of our descendants one century in the future? Along with the utter degradation of our planet?
At any reasonable rate of interest, the impact of that future catastrophe would be discounted to zero by the NPV model. Indeed, any event that far in the future would be insignificant from an NPV perspective.
That’s the sustainability conundrum that faces our contemporary investment community. Although we may care about our distant future, our long-established investment methods fail to place any significant value on it. And yet, as the effects of climate change increasingly impact our environment, events that were initially expected to occur in the distant future are beginning to be felt in the present.
If Irving Fisher were alive today, would he still choose to defend the NPV model in our era of sustainability? Although he gave such wrong-headed advice to “stay the course” in 1929, we can only hope that he would offer more sensible advice to “change our course” today.