The Los Angeles Dodgers' substantial agreement with superstar free agent Shohei Ohtani provides a valuable lesson in the concept of the time value of money.
In the headlines: The publicized $700 million 10-year deal can be deceiving. The two-way player, Ohtani, will not earn $70 million annually but rather $2 million per year for the next decade. Subsequently, in the subsequent decade, after his assumed retirement from playing, he will receive $68 million annually.
So, what does the $68 million slated for each year from 2034 to 2043 translate to when converted into Japanese yen and utilized to purchase goods and services in Japan?
Reading between the lines: Ohtani is essentially making a significant wager on the future trajectory of inflation, hoping for it to remain low. If he plans to predominantly reside in his native Japan post his baseball career, he is also speculating on the real exchange rate between the dollar and yen.
By the figures: Current bond prices suggest a projected U.S. inflation rate of 2.19% annually over the next decade. If accurate, Ohtani's $68 million payout in 2034 would have a purchasing power equivalent to about $54.8 million in today's dollars.
If inflation settles at a mere 1% during that period, the value would be $61.5 million. However, if inflation unexpectedly spikes to 5% annually, it would only be worth $41.7 million.
Meanwhile, in Japan, the Bank of Japan has only recently seen signs of inflation emerging, contemplating raising interest rates above zero.
Important to note: Japan has maintained persistently low inflation throughout Ohtani's lifetime, influencing his confidence in betting on the future value of the dollar.
The ultimate worth of Ohtani's contract hinges on whether the Japanese experience of the last three decades repeats itself in the next 20 years or proves to be a historical anomaly.
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