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A MOST POWERFUL READ:Compound Interest

November 23, 2011


“The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview Part II”

April 24, 2001
…Today’s academic curriculum teaches models that fail to recognize how the economy’s debt overhead mounts up to produce financial shocks. Also ignored is the degree to which wage-earners and industrial investors find a rising share of their incomes diverted to pay debt service.
…The neglect of debt is curious, for the subject was placed at the center of economic and indeed, religious policy for most of civilization’s past four thousand years. The mercantile debts and rural usury of Bronze Age Babylonia and classical Greece and Rome saw the accrual of interest double and redouble the sums due, leading to expropriation of indebted families and forcing them into bondage. From feudal Europe’s papal bankers to the emergence of large-scale Dutch, English and French finance capital, the expansion path of public as well as private debts has soared off the charts toward infinity. Money is saved and reinvested to grow without end, regardless of the economy’s ability to pay. Yet the mathematics describing the growth of interest-bearing debt on an economy-wide basis are missing from today’s macroeconomic policy models.
…This idea that doubling times were determined by the rate of interest was well enough understood to be given a popular imagery. “If wealth is placed where it bears interest, it comes back to you redoubled,”
…The soaring curve of wealth addiction became the natural counterpart to the exponential growth of debt. As individuals obtained more money and property, they desired yet more, becoming insatiable.
…It was in reference to Britain’s war debts that one of Adam Smith’s contemporaries, the Anglican minister and actuarial mathematician Richard Price, graphically explained the seeming magic of how debts multiplied exponentially. His 1772 Appeal to the Public on the Subject of the National Debt described how “Money bearing compound interest increases at first slowly. But, the rate of increase being continually accelerated, it becomes in some time so rapid, as to mock all the powers of the imagination.
…Bennett’s Breed of Barren Metal (1895:87) described a hereditary rentier caste threatening to draw all the world’s wealth into its hands as the inventive powers of industrial enterprise were outrun by the inexorable mathematics of compound interest, “the foundation stone on which our industrial system is built. . . . It is the principle which asserts that a dollar will grow into two dollars in a number of years, and keep on multiplying until it represents all of the wealth on earth.”
Spelling out what Bennett’s analysis meant, John Brown (1898:81f.) explained: “At ten per cent the principal is doubled every seven years, so that in less than a century the interest is 16,384 times the principal, and after that the principal increases at such a stupendous rate that the figures soon become unmanageable.
The mathematics of compound interest also explained “the extremely rapid accumulation of wealth in the hands of a comparatively few non-producers,” as well as “the abject poverty of a large percentage of the producing masses” (p. 80). As Bennett elaborated (p. 102): “The financial group becomes rich more rapidly than the nation at large; and national increase in wealth may not mean prosperity of the producing masses.”
…A syndicate of less than one hundred American capitalists, if allowed to collect interest on their capital at a low rate and re-invest for 150 years or less, would at the end of that time own the earth and all real and personal property thereon. This is a simple mathematical proposition, capable of exact demonstration, and any one who doubts the truth of this statement may set all doubts at rest by computing compound interest on one and one-half billions of dollars for one hundred and fifty years, at five per cent per annum.
It seemed that in the long run economies would have to succumb, but how could they get by without credit? These financial critics went beyond orthodox economists by pointing to the problems created by debts mounting up at interest and showing that interest-bearing debt grew by its own mathematical laws rather than economic laws. But they were unable to propose a way in which the two expansion paths – physical production and interest-bearing claims – might co-exist despite their inherent disequilibrium in the short run. Hence, their reforms were not pragmatic. The idea of a credit-free (or at least, interest-free) system simply was too radical for most people to contemplate. It was easier to think of general strikes and even outright revolution to seize the means of production and expropriate the proprietors – or at least to tax them – than to set about designing a financial system that, in theory, could avoid credit crises even in the short run.
One of the most popular expositions of compound interest was developed by Flürscheim, who criticized George for refusing to address the issue. “It is true that the employer is the sponge which sucks up the profit, the greater value (Mehrwerth, as Marx calls it) of labor’s product,” he wrote (A Clue to the Economic Labyrinth [1902]:116), “but only to yield it to the rent and interest lords, as well as to the middlemen, who together press it out of him as quick as he gets it, barely leaving him on the average the hard earnings of his own work, and, what is worse, taking the power from him of increasing production to its full potentiality.” Contrasting finance capital to physical capital, he called on labor and industry together to attack “the real enemy,” the financial rentiers who ended up with most industrial profit as well as the rent collected by landlords.
Pointing out that claims for financial tribute constituted the bulk of the world’s capital (p. 347), Flürscheim explained that, “When an orator or writer has to reply to a socialist’s attack upon capital as the oppressor of labor, he points to what orthodox economy calls capital, and speaks of our wonderful progress due to our improved means of production and distribution, whereas his antagonist thinks of Government bonds, of land monopoly, of mining rights, of all kinds of tribute claims selling at Exchange for certain amounts, and not at all falling under the orthodox definition of capital, though representing that capital which people principally have in view when they use the term.”
Flürscheim elaborated that “All exertions, all improvements in the methods and tools of labor, the strictest economy, the severest self-denial, are powerless to compete with the rapidity of self-increase possessed by capital placed at compound interest, and they cannot keep up with its demands.” To illustrate the dynamic at work, he composed an allegory (pp. 327ff.). Many ages after man was driven from Paradise and told “to earn his bread by the sweat of his brow, mercy began to prevail. A loving angel was sent down by the Great Master, charged with the task of lightening the burden. The angel’s name was Spirit of Invention. He began his work by teaching man to make useful tools” and tame animals, and in time to mobilize water power, air and wind power, fire and steam power to drive machinery.
“It seemed that at last the golden era had come of which men had dreamed for ages past,” but “that envious spirit, that fallen angel, Satan,” was jealous that his own empire would soon be over for ever. Among the follies of man, one little imp, called Interest, managed to attract his attention. “‘What is the matter with you, Interest?’ he asked the saucy imp. ‘You don’t seem to be so dejected as your comrades are?’”
“‘Why should I be dejected, master?’ replied the spirit, ‘Am I not one of your favorite soldiers? Haven’t I always been victorious under your august guidance?’”
But Satan answered sadly, “Alas, You are no match for the Spirit of Invention.” The Interest imp, however, volunteered to demonstrate his prowess in a dual, helped by his son, Compound Interest.
At this point, Flürscheim introduced an image that Napier had suggested at the outset of his second book on logarithms in 1617, the Robdologia, likening the principle of geometric increase to that of a chess-board on which each square doubled the number assigned to the preceding one. An old Persian proverb told of a Shah who wished to reward the inventor of chess, a subject, and asked what he would like. To the Shah’s surprise, the man asked “as his only reward that the Shah would give him a single grain of corn, which was to be put on the first square of the chess-board, and to be doubled on each successive square; which, to the surprise of the king, produced an amount larger than the treasures of his whole kingdom could buy. It is this kind of chess-game which capital is continually playing with labor.” The remarkable growth of compound interest soon swallowed “products, capital, the earth and even the workers.”
This was in essence the ploy that Flürscheim’s Compound Interest demon used. “Look at this chess-board,” he told the angel against whom Satan had pitted him. “It seems just like any other chess-board, with sixty-four squares,” but it “had the peculiar quality of extending the dimensions of the squares, so as always to be large enough” to hold whatever was placed on them. Instead of asking for grains of wheat to be placed on them, the Interest Imp asked for soldiers. “Now, listen well to what I propose,” he said to the angel, pointing to the latter’s huge army.
I enter the first square with my son, and you match one of your warriors against us. We enter the second square doubled in number; you send two more warriors – and so on every succeeding square. . . . When we arrive at the last square, and you have a single soldier left after occupying the same, we shall declare ourselves vanquished, and Satan with all his troops will leave this world for ever. If I win, you and your army are to be at the commands of my master. Are you agreed?
The angel agreed, expecting his horde of soldiers to easily exceed the number that the Interest Imp and his son, Compound Interest, seemed likely to accrue.
In the beginning the angel laughed, for, though twenty squares were passed, no noticeable diminution of his forces was perceptible. Demon Interest said nothing, but attended to business, quietly doubling his army on every succeeding square. At the thirtieth square the angel ceased to laugh, and soon saw he was lost.
‘I despised you, little fellow,’ he signed despairingly, ‘and I am punished for my vanity. I see there is no use fighting against you. Demon Interest is more powerful than the Spirit of Invention. I am your slave. Command your servant!’
‘I am the only servant of my great master,’ dryly replied the demon. ‘Here I see him coming. He will give you his orders.’ (justaluckyfool’s tipping point)
And Satan gave his orders. He commanded that the angel was to continue in his work with all his troops, which were to be increased with all possible exertion, so that humanity – which did not know the nature of the antagonist it had to fight against – would always keep in fresh hope of final successwhen the new troops were forthcoming. But as fast as they appeared, Demon Interest was to send forth a larger army to capture the new forces, to enslave them, and – instead of their benefiting man – make them increase the slave-chains which weigh him down.
justaluckyfool says,
Please note that I believe that as Hudson states that interest is a nessesary part of economic,as well as its bothersom brother,compound.But there is a tipping point in the story where Satan could have been vanquished and a greatter good for mankind could have resulted.The Interest Imp could have used this “most powerful force in the universe” against his old Master for a better Master,one of the people,by the people,for the people.
Endorse “The All Inclusive Solution. The Federal Bank of America.”

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