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. One penny, put out at our Saviour’s birth at 5 % compound interest, would, before this time, have increased to a greater sum than would be obtained in a 150 millions of Earths, all solid gold. But if put out to simple interest, it would, in the same time, have amounted to no more than 7 shillings 4½d.
In his Observations on Reversionary Payments, first published in 1769 and running through six editions by 1803, Price elaborated how the rate of multiplication would be even higher at 6 percent: “A shilling put out at 6 % compound interest at our Saviour’s birth would … have increased to a greater sum than the whole solar system could hold, supposing it a sphere equal in diameter to the diameter of Saturn’s orbit.”
Rather naïvely, Price suggested that Britain’s government make use of this exponential principle to pay off the public debt by creating a public fund that itself would grow at compound interest (called a sinking fund). The idea had been proposed a half century earlier by Nathaniel Gould, a director of the Bank of England. Parliament would set aside a million pounds sterling to invest at interest and build up the principal by reinvesting the dividends annually. In a surprisingly short period of time, Price promised, the fund would grow large enough to enable the government to extricate itself from its entire debt. “A state need never, therefore, be under any difficulties, for, with the smallest savings, it may, in as little time as its interest can require, pay off the largest debts.”
What Price had discovered was how the exponential growth of money invested at interest multiplies the principal by plowing back the dividends into new saving. Balances snowball in the hands of bankers, bondholders and other savers, as if there always will be enough opportunities to find remunerative projects and credit-worthy borrowers to pay the interest that is accruing.
The moral is that the economy’s ability to produce and earn enough of a surplus to pay exponentially rising interest charges is limited. The more it is stripped to pay creditors, the less able it is to produce and pay as a result of unemployment, underutilization of resources, emigration and capital flight.
In the two thousand years since the birth of Christ, the European economy has grown at a compound annual rate of 0.2 percent, far lower than the level at which interest rates have stood. Yet financial fortunes have crashed again and again — in part because interest payments have absorbed the revenue that otherwise would have been available for new direct investment.
The inability of productive investment opportunities to keep pace with the expansion of credit is the Achilles heel of finance-based growth. How can compound interest be paid? Who will end up paying it? Who will receive it, and what will they do with it? If banks and a creditor class receive this money, will they spend it domestically to maintain balance, or will they drain the economy’s income stream and shift it abroad to new loan markets, leaving the economy strapped by the need to pay interest on the growing debt? If the state accrues this money, how will it recirculate it back into the economy?
“The Magic of Compound Interest” vs. The Economy’s Ability to Pay
1. Neither money nor credit is a factor of production. Debtors do the work to pay their creditors. This means that interest is not a “return to a factor of production.” Little credit is used to expand production or capital investment. Most is to transfer asset ownership.
2. If loan proceeds are not used to make gains sufficient to pay the creditor (productive credit), then interest and principal must be paid out of the debtor’s other income or asset sales. Such lending is predatory.
3. The aim of predatory lending in much of the world is to obtain labor to work off debts (debt peonage), to foreclose on the land of debtors, and in modern times to force debt-strapped governments to privatize natural resources and public infrastructure.
4. Most inheritance consists of financial claims on the economy at large. In antiquity, foreclosure for non-payment was the major lever to pry land away from traditional tenure rights inheritable within the family. (Early creditors got themselves adopted as Number One sons.) Today, most financial claims are on the land’s rent, leaving ownership “democratized” — on credit.
5. Most interest-bearing debt always has been predatory, apart from lending for commerce. Carrying a rising debt overhead slows material investment and economic growth.
6. The rate of interest never has reflected the rate of profit, the rise in physical productivity or the borrower’s ability to pay. The earliest interest rates were set simply for ease in mathematical calculation: 1/60 per month in Mesopotamia, 1/10 annually in Greece, and 1/12 in Rome. (These were all the unit fractions in their respective fractional systems.) In modern times the rate of interest has been set mainly to stabilize the balance of payments and hence exchange rates. Since 2008 it has been set low to re-inflate asset prices and bank profits.
7. Any rate of interest implies a doubling time for money lent out. See the Rule of 72 (e.g., five years in Mesopotamia).
8. Modern creditors avert public cancellation of debts (and making banks a public utility) by pretending that lending provides mutual benefit in which the borrower gains — consumer goods now rather than later, or money to run a business or buy an asset that earns enough to pay back the creditor with interest and still leave a profit for the debtor.
9. This scenario of productive lending does not typify the banking system as a whole. Instead of serving the economy’s production trends, the financial sector (as presently organized) makes the economy top-heavy, by transferring assets and income into the hands of an increasingly hereditary creditor class.
10. The exponential growth of debt shrinks markets and slows and investment, reducing the economy’s ability to pay debts, while increasing the debt/output and debt/income ratios.
11. The rising volume of debt changes the distribution of property ownership unless public authorities intervene to cancel debts and reverse expropriations. In antiquity, royal “Jubilee” proclamations liberated bondservants and restored lands that had been foreclosed.
12. Cancelling debts was politically easiest when governments or public institutions (temples, palaces or civic authorities) were the major creditors, because they were cancelling debts owed to themselves. This is an argument for why governments should be the main suppliers of money and credit as a public utility.
Financial vs. industrial dynamics — and the One Percent vs. the 99 Percent
European and North American public debts appeared to be on their way to being paid off during the relatively war-free century of 1815–1914. The economy’s debt burden seemed likely to be self-amortizing by being linked to industrial capital formation. Bond markets mainly financed railroads and canals (the largest ventures usually being the most corrupt), mining and construction. Wall Street was interested in industry mainly to organize it into trusts and monopolies. Yet most economic writers limited their focus to the promise of rising technology and productivity, assuming that finance and banking would be absorbed into the industrial dynamic.
The threat of interest-bearing claims growing so exponentially as to subvert industrial progress was analyzed mainly by critics from outside the mainstream, many of whom were socialists. Two of the earliest books warning that financial dynamics threatened an economic crisis were published by the Chicago co-operative Charles H. Kerr, best known for publishing Marx’s Capital and Gustavus Myers’ History of the Great American Fortunes. In 1895, J. W. Bennett warned of a rentier caste drawing the world’s wealth into its hands as the inventive powers of industry were outrun by the mathematics of compound interest, “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.”