Best of the Week
Most Popular
1. Five Charts That Show We Are on the Brink of an Unthinkable Financial Crisis- John_Mauldin
2.Bitcoin Parabolic Mania - Zeal_LLC
3.Bitcoin Doesn’t Exist – 2 - Raul_I_Meijer
4.Best Time / Month of Year to BUY a USED Car is DECEMBER, UK Analysis - Nadeem_Walayat
5.Labour Sheffield City Council Election Panic Could Prompt Suspension of Tree Felling's Private Security - N_Walayat
6.War on Gold Intensifies: It Betrays the Elitists’ Panic and Augurs Their Coming Defeat Part2 - Stewart_Dougherty
7.How High Will Gold Go? - Harry_Dent
8.Bitcoin Doesn’t Exist – Forks and Mad Max - Raul_I_Meijer
9.UK Stagflation Risk As Inflation Hits 3.1% and House Prices Fall - GoldCore
10.New EU Rules For Cross-Border Cash, Gold Bullion Movements - GoldCore
Last 7 days
Silver As Strategic Metal: Why Its Price Will Soar - 21st Jan 18
Stocks, Gold and Interest Rates Three Amigos Ride On - 21st Jan 18
Why Sometimes, "Beating the S&P 500" Isn't Good Enough - 21st Jan 18
Bunnies and Geckos of Sheffield Street Tree Fellings Protests Explained - 21st Jan 18
Jim Rickards: Next Financial Panic Will Be the Biggest of All, with Only One Place to Turn… - 20th Jan 18
Macro Trend Changes for Gold in 2018 and Beyond - Empire Club of Canada - 20th Jan 18
Top 5 Trader Information Sources for Timely, Successful Investing - 20th Jan 18
Bond Market Bear Creating Gold Bull Market - 19th Jan 18
Gold Stocks GDX $25 Breakout on Earnings - 19th Jan 18
SPX is Higher But No Breakout - 19th Jan 18
Game Changer for Bitcoin - 19th Jan 18
Upside Risk for Gold in 2018 - 19th Jan 18
Money Minute - A 60-second snapshot of the UK Economy - 19th Jan 18
Discovery Sport Real MPG Fuel Economy Vs Land Rover 53.3 MPG Sales Pitch - 19th Jan 18
For Americans Buying Gold and Silver: Still a Big U.S. Pricing Advantage - 19th Jan 18
5 Maps And Charts That Predict Geopolitical Trends In 2018 - 19th Jan 18
North Korean Quagmire: Part 2. Bombing, Nuclear Threats, and Resolution - 19th Jan 18
Complete Guide On Forex Trading Market - 19th Jan 18
Bitcoin Crash Sees Flight To Physical Gold Coins and Bars - 18th Jan 18
The Interest Rates Are What Matter In This Market - 18th Jan 18
Crude Oil Sweat, Blood and Tears - 18th Jan 18
Land Rover Discovery Sport - Week 3 HSE Black Test Review - 18th Jan 18
The North Korea Quagmire: Part 1, A Contest of Colonialism and Communism - 18th Jan 18
Understand Currency Trade and Make Plenty of Money - 18th Jan 18
Bitcoin Price Crash Below $10,000. What's Next? We have answers… - 18th Jan 18
How to Trade Gold During Second Half of January, Daily Cycle Prediction - 18th Jan 18
More U.S. States Are Knocking Down Gold & Silver Barriers - 18th Jan 18
5 Economic Predictions for 2018 - 18th Jan 18
Land Rover Discovery Sport - What You Need to Know Before Buying - Owning Week 2 - 17th Jan 18
Bitcoin and Stock Prices, Both Symptoms of Speculative Extremes! - 17th Jan 18
So That’s What Stock Market Volatility Looks Like - 17th Jan 18
Tips On Choosing the Right Forex Dealer - 17th Jan 18
Crude Oil is Starting 2018 Strong but there's Undeniable Risk to the Downside - 16th Jan 18
SPX, NDX, INDU and RUT Stock Indices all at Resistance Levels - 16th Jan 18
Silver Prices To Surge – JP Morgan Has Acquired A “Massive Quantity of Physical Silver” - 16th Jan 18
Carillion Bankruptcy and the PFI Sector Spiraling Costs Crisis, Amey, G4S, Balfour Beatty, Serco.... - 16th Jan 18
Artificial Intelligence - Extermination of Humanity - 16th Jan 18
Carillion Goes Bust, as Government Refuses to Bailout PFI Contractors Debt and Pensions Liabilities - 15th Jan 18
What Really Happens in Iran?  - 15th Jan 18
Stock Market Near an Intermediate Top? - 15th Jan 18
The Key Economic Indicator You Should Watch in 2018 - 15th Jan 18
London Property Market Crash Looms As Prices Drop To 2 1/2 Year Low - 15th Jan 18
Some Fascinating Stock Market Fibonacci Relationships... - 15th Jan 18
How to Know If This Stock Market Rally Will Continue for Two More Months? - 14th Jan 18
Everything SMIGGLE from Pencil Cases to Water Bottles, Pens and Springs! - 14th Jan 18
Land Rover Discovery Sport Very Bad MPG Fuel Economy! Real Owner's Review - 14th Jan 18
Gold Miners’ Status Updated - 13th Jan 18
Gold And Silver – Review of Annual, Qrtly, Monthly, Weekly Charts. Reality v Sentiment - 13th Jan 18
Gold GLD ETF Update.. Bear Market Reversal Watch - 13th Jan 18
Stock Market Leadership In 2018 To Come From Oil & Gas - 13th Jan 18
Stock Market Primed for a Reversal - 13th Jan 18
Live Trading Webinar: Discover 3 High-Confidence Trade Set-Ups - 13th Jan 18
Optimum Entry Point for Gold and Silver Stocks - 12th Jan 18
Stock Selloffs Great for Gold - 12th Jan 18
These 3 Facts Show Gold Is Set to Surge in 2018 - 12th Jan 18
How China is Locking Up Critical Resources in the US’s Own Backyard - 12th Jan 18
Stock futures are struggling. May reverse Today - 12th Jan 18
Three Surprising Places You See Cryptocurrency - 12th Jan 18
Semi Seconductor Stocks Canary Still Chirping, But He’s Gonna Croak in 2018 - 12th Jan 18
Land Rover Discovery Sport Panoramic Sunroof Questions Answered - 12th Jan 18
Information About Trading With Alpari And Its Advantages - 12th Jan 18

Market Oracle FREE Newsletter

6 Critical Money Making Rules

Is Compound Interest Friend Or Foe?

Interest-Rates / Social Issues Jun 07, 2013 - 07:18 PM GMT

By: Raul_I_Meijer

Interest-Rates

Amid all the superficial up and down rumblings of stocks and bonds, and hyped up analysis thereof, none of which makes you any wiser (hey, I told you Abenomics can't work..), it's a good idea to look at some of the more profound workings of the financial system. I saw an interesting take on an angle into this, even though unfortunately it was by itself also superficial.

The angle in question was provided by Walter Hickey for Business Insider, in an article (originally) entitled " Compound Interest Is Responsible For Modern Civilization " (it later turned into "A Simple Math Formula Is Basically Responsible For All Of Modern Civilization", but that’s not even true: just because something can be expressed in a math formula doesn't mean it turns into that formula). It's interesting, and it's not bad, but, sorry Walter, with all respect, I don't think it's good enough.


And it made me wonder what people make of the whole compound interest notion, what they know about it, how they see it, what their intellectual or even emotional reaction is. I'd love to hear that from you. We've all grown up with it, to the extent that we probably don't give it enough thought; we view it as some kind of natural law - which it isn't - .

My own take is that while Hickey presents an interesting summary, the buck doesn't stop where the article does (at only the positive take on it); it reads too much like an Ayn Rand history lesson. In my opinion, you can't really talk, these days, about compound interest merely as "look at all the glorious things it's done for us", no more than you can talk about only the benefits of the oil industry, car manufacturing, GMO crops, nuclear energy or suburbs without providing a balancing part of your story that touches on the negatives as well. We got the brains, might as well use them.

I find it hard not to ponder the idea that even if compound interest is responsible for the civilization we know today, you can still read that in two very different ways, positive as well as negative. Or you can suggest that compound interest, even if it has perhaps been instrumental in building civilization, will inevitably also be responsible for the demise of that civilization. No compound interest story can be considered well written if it doesn't - also - touch on that part of the equation.

Or you can for instance state that compound interest is responsible to a large extent for the existence of the banking and financial sector, and it's by no means a given that they are a positive segment of our world. We live smack in the middle of a period of time in which you simply can't ignore that. Even simpler, you can say things like: "What happened to the 4-day work week? Compound interest did."

Let's start with a few examples of how Walter Hickey sees the topic, and I'll provide a few short comments:

Compound Interest Is Responsible For Modern Civilization

Compound interest made agriculture possible ...

Well, perhaps modern agriculture, but you can't very well make the point that agriculture itself is a direct consequence of compound interest. The mega farm, sure, and Monsanto, but they're not identical to agriculture.

Today, nearly everything we do financially is tied to the idea of compound interest in one way or another.

That makes me think about the 59.8% of young people in Greece who are unemployed today. How would they read this?

70% of Americans go to college and 60% use loans. The reason capital is available is lenders make money from compound interest.

Yeah, but isn't that then also, , the reason so many students are up to their necks in debt? Or that they perhaps need all the loans because compound interest allowed the lenders to create a situation in which students could only get an education if they applied to said lenders for a loan in the first place? I could go on here, referring to student loans until very recently, how there was never a question of a nation's brightest young people having to dig a very deep hole for themselves just to get an education. I could even talk about what it means to a nation if and when many of its brightest fall off the selection divide not on abilities but on wallet size, but I think I'll instead digress for now.

70% of Americans own a home. How'd you pay for it? Most Americans did it with a mortgage.

Now we must ask, if we want to or not, by how much compound interest has raised home prices - labor, taxes, materials, lenders' fees- or in other words how much cheaper a home would be if not for compound interest. People typically pay 2-3 times the principal on a 30-year mortgage, and it's hard to think of that as a good thing.

Do you have a bank account? It's low-cost or free because the bank is using your money to give out those loans.

I think we can safely discard the idea that the way modern banks operate is through lending out the money you deposit with them.

Also, if Einstein ever called compound interest "the most powerful force in the universe", it’s safe to assume, in view of other comments he made about the world in general, that he meant that as a warning, not a recommendation. The financial world doesn't seem to have quite gotten that, there are people out there who suggest he said "Compound interest is the eighth wonder of the world", "The greatest mathematical discovery of all time", or "Compound interest is more complicated than relativity theory". Maybe they're confused with Johnny Carson, who said "Scientists have developed a powerful new weapon that destroys people but leaves buildings standing — it's called the 17% interest rate."

Here's a short take on what I think is the essence of compound interest:

Compound interest means charging a borrower principal (p) + interest (i). If the borrower in turn also wants a profit, he'll have to charge p+i+i2 (i2 is larger than i). Eventually, you arrive at p+i+i+...n. Which is a simpler version of this math formula Walter Hickey provides:

Somewhere along this line, problems arise: one man can only produce so much. The "solution" of course has been the use of external energy sources (wood, slaves, hydro, coal, gas, oil, nukes). They enabled more production "per capita", and therefore the continuation of the p+i+i+...n sequence. What is mostly ignored is that this sequence requires ever more energy to keep the flow going; there is no satisfaction point.

Can we find ever more energy? Doubtful, and even if we could, thermodynamics (2nd law) would still halt the sequence: an increasing amount of energy is needed to clean up the waste produced by the use of energy (no matter how "clean" it is).

That’s how and why we now have compound(ed) crises: financial, energy and environmental. From this point of view, it looks like compound interest inevitably breaks our world. After making it first, perhaps, but still; and there doesn't seem to be a way out. Compound interest doesn't just only "allow" for growth (which sounds quite benign), it demands perpetual growth. And since perpetual growth is not possible, at some point you will see either entire societies or parts of them become poor(er), often in dramatic fashion, because compound interest knows no limits.

Of course we could have parties default on their debt, and that would deflate the compound bubble a little, but at present that doesn't happen: debts are merely transferred from the private to the public sector. So no escape there either.

I'll stop here, because, as I said, I'm interested in hearing what you think about all this. Please share you views in The Automatic Earth comments section.

By Raul Ilargi Meijer
Website: http://theautomaticearth.com (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)

© 2013 Copyright Raul I Meijer - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Raul Ilargi Meijer Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules