Shohei the time value of money

FERVENT thanks should go to Shohei Ohtani, the Japanese baseball star who last weekend signed a 10-year contract worth US$700 million to move to the Los Angeles Dodgers. That’s the biggest contract ever for a baseball player. But now, we have the details of how it’s structured, and that turns it into one of the best financial stories in years.

Ohtani’s money is going to be back-loaded. Essentially, he and his agents negotiated “Show me the money, but not yet”. Indeed, he’s only going to receive an annual US$2 million for the next decade. Starting in 2034, once his contract is completed, the Dodgers will start paying him US$68 million per year, and do so for a decade. The last payment is due to arrive when he is 50. This is within the rules established by Major League Baseball, and both sides entered freely into the deal. Indeed, it was apparently the idea of Ohtani himself, and his agents made the same proposal on back-loading to all the other teams who approached them. So if they want to do it, there’s no reason why they shouldn’t. But why would you want to structure a deal this way?

Both the Dodgers and Ohtani know all about Bobby Bonilla, the former New York Mets player whose contract was structured so ridiculously into the future that the Mets are still paying him US$1.19 million each year and must continue until 2035. He retired in 2001. July 1, the day when the Mets write him the cheque each year, is now celebrated as Bonilla Day among baseball cognoscenti. This is all extremely embarrassing for the Mets, who have a history of spending money not wisely but too well, and also to an extent for Bonilla, as there’s a sense that he’s being paid for doing nothing.

Not only is Ohtani the most versatile player since Babe Ruth, but it now also looks as though he is going to displace Bonilla as the greatest living illustration of the Time Value of Money (TVM). I assume all readers are familiar with the concept. Just in case: money promised to you in the future is worth less than money in the hand now, and must be discounted by the interest rate you could have earned on it if you were paid it now. The higher the interest rate (or “discount rate”), the more money you are surrendering by deferring it into the future. The US$1.19 million Bonilla receives in 2035 will be worth a lot less than it would have been in 2001, and both he and the Mets knew this when they did the deal.

Below is the basic TVM formula everyone learns, with PV = present value, FV = future value, and r = rate of interest. It looks simple, but that doesn’t stop first-week MBA students banging their heads. For readers interested or survivors willing to trigger post-traumatic stress disorder, a far more thorough analysis from Iowa State University is worth a delving into.

PV = FV/(1+r)

What’s most interesting is that Ohtani happens to be from Japan. He was born in July of 1994, and thus cannot remember rates of even 1 per cent. Three-month Japanese bonds have been yielding less than that since shortly before he turned two. For his generation of Japanese, and indeed those 10 or 20 years older, the Time Value of Money has been an irrelevant and academic concept for as long as they can remember; $1 million in 10 years’ time is worth just as much as $1 million today, if you don’t need it now.

Ohtani and his advisers know all of this. But it’s still fascinating that this exceptionally aggressive deferment was proposed by someone Japanese. So many things are possible if you’re used to the idea that there’s little or no cost to waiting. All the following statements have a degree of truth to them:

• Ohtani was never being paid US$700 million or US$70 million per year. Discounted at the current 10-year yield, it’s worth US$46 million a year for the next 10 years (that’s the official Major League Baseball number). For the calculations of baseball’s competitive balance tax, that is what he will be getting. The Dodgers’ payments to teams with lower payrolls will be based on this amount.
• By structuring the deal this way, Ohtani gives the Dodgers far more money to spend on other good players while he’s playing for them. That’s purely for his benefit. Meanwhile, the Dodgers are taking a risk. If they somehow don’t win a bunch of championships with Ohtani, the payments they will keep making to him until 2044 will be even more embarrassing than the Mets’ payments to Bobby Bo. They will also make it far harder for them to sign new good players in that time.
• Structuring the payments this way gives Ohtani the chance to go somewhere with much lower taxes than California before he gets his money. (Although this will be subject to whatever laws against tax evasion and money laundering are in force 10 years from now.)
• Ohtani is being paid so much that he can afford to wait until he turns 40 before he gets his money. His endorsement income is already fabulous. Nobody was going to pay him US$70 million in 2024 dollars next year — but he’s wealthy enough and confident enough in his earning power to forsake tens of millions into the future.
• Ohtani and his advisers must have really great faith in Jerome Powell and the Fed. If inflation doesn’t fall back into line, and manages instead to move up towards double figures, this is going to look like a massive mistake for him.
• This means immortality for Shohei Ohtani. Even if his baseball career flames out (unlikely), his place as the first example finance professors offer to MBA students at the beginning of their course is assured, for far longer than his contract will keep paying.
• The whole episode shows why the Bank of Japan is so cautious.

The central problem that the Bank of Japan has been trying to combat for essentially all of Ohtani’s lifetime has been the collapse of the belief that there is any cost to deferring purchases or payments. If interest rates are always zero, there’s no reason not to wait. If they’re negative, there’s even a reason to defer. In those conditions, it’s hard to get people to spend, consumption and investment stall, and the economy stays constipated. In countries where people expect to have to pay interest, and are accustomed to rising prices, deferring seems much more costly, and so there is greater urgency.

And apparently the Bank of Japan sees no urgency to move overnight rates back into positive territory from their current level of -0.1 per cent. Last week, as Points of Return reported, comments from the BOJ’s deputy governor that some businesses might even benefit from higher rates were taken as a hint that a move could be imminent – it was more realistic to view them as the start of a steady campaign to get the Japanese people ready for the change.

Japan’s wage negotiations to start the new year could be crucial. If workers act like Ohtani, and decide they don’t need to press for money here and now to compensate for inflation over the last year, then it might be that much harder to escape the deflationary morass. The latest producer price inflation data, showing year-on-year increases almost back to zero, is another reminder that rumours of Japanese deflation’s death might be much exaggerated.

The Ohtani episode is a reminder of why Japan alone among the major economies actually wants inflation to rise. Having positive interest rates could transform consumer and business behaviour. The dilemma is that moving to positive rates too quickly could strangle the return of inflation before it takes hold. And while they wait, Japanese and the rest of the world can enjoy watching an extraordinary young man who is revolutionising baseball and also, apparently, finance.