A Simple Maths Formula Is Basically Responsible For All Of Modern Civilisation


As a species, we tend to remember inventions as the things that changed history. Fire, agriculture, architecture, the printing press, electricity, all of these led to immense leaps forward for humanity.

But what’s more difficult to get a grasp on is the impact that concepts and ideas had on our progress. 

For instance, a very simple idea — that loans can be made, and periodically interest can accrue on those loans — has been with us since we first began planting seeds in the ground.

As communities became more advanced, so did the underlying idea. As government became more organised, so did the implementation of the idea. 

That idea — compound interest — has had an instrumental impact on the development of civilisation, and it’s about time it had its due. 

Compound interest is a simple maths formula all things considered.

Compound interest is a type of loan where the accumulated interest is added to the principle moving forward.

Depending on what side of this relationship you're on, things have the potential to go either very well or very badly for you.

Compound interest is calculated by multiplying the present balance by 1 plus the effective interest rate per period raised to the number of compounding.

The reason compound interest has is so revered is because the compounding property means you can either profit immensely or owe a massive debt.

For instance, there's an apocryphal and probably joking quote from physicist Albert Einstein where he attributes it as the 'most powerful force in the universe.'

It's easy to see why. Saving $10,000 for 10 years with an interest rate of 5% compounded annually gets you $16,288 after 10 years and $43,219 after 30. Overall, people tend to view free money favourably.

Now, think of yourself on the other side of that debt. It's understandable that people have a certain fear of the concept.

Compound interest made agriculture possible and became a crucial part of humans forming cities.

The origin of interest precedes the development of money.

Loans of seeds and animals were likely the earliest forms of interest.

Seeds yielded increases, and after a harvest they could be returned with interest. Animals could be returned with some of their progeny.

By the earliest recorded historical times, this sort of lending was very common.

The development of money meant that rather than returning grain in exchange for an initial loan of grain, people were able to exchange another item linked to a value.

As a result, there's evidence of interest of around 20% being charged on loans of silver or barley by 3 millennial BC in ancient Sumeria.

Source: A History of Interest Rates

As interest became more sophisticated, so did civilisation.

Grain loans ran interest rates of between 20-50% APR in the earliest recorded history.

What came next -- as the business of lending became more sophisticated -- is that Governments became involved. Indeed, the earliest loan sharks were evidently such a problem that they took significant space in a number of religious texts frowning upon their behaviour.

The Israelites didn't allow interest, the Iranians thought it dishonorable, Indian civilizations set caps on interest rates. The Romans and Babylonians likewise limited interest rates.

Greek civilisation was cool with no credit limits but forbade debts to be paid with personal bondage.

Source: A History of Interest Rates

Compound interest played a role in pulling us out of the Dark Ages and early venture capitalism.

While compound interests -- at this point derided as 'usury' -- was viewed as morally suspect, its re-emergence coincided with the end of the Dark Ages.

Recent research has suggested that the reason that usury was so loathed was a speculative credit boom of the 12th century that resulted from the discovery of silver mines in Germany and the Christian invasion into Islamic Spain.

One fascinating side effect of compound interest being shamed is the advent of the venture capital business.

Usury -- lending to make a profit on compound interest -- took a back seat to giving people money and collectively making a gain from what they do with it.

The idea took root that a merchant wasn't sinning by giving an agent money, and profiting when the agent returned with more money.

Source: Usury and Just Compensation

The people who paid for the Renaissance felt guilty because their money may have come from compound interest.

By the 14th century, a number of international family-based merchant banks had emerged. During the 15th century, this became institutionalized in northern Italy, most notably the de Medici family.

Since a lot of what they did may have skirted on usury, the merchants would avoid the impression that they were taking from the poor by giving back to their city.

They would do this by building a church or hospital or some other act of philanthropy, all of which fuelled the Italian Renaissance. The guilt moneylenders felt due to their relationship to usury funded one of the most significant events in western civilisation.

Source: Usury and Just Compensation

It's important to keep in mind that compound interest was pretty important for the creation of the middle class, too.

The main opposition to compound interest -- usury -- was the notion that it was a way for the rich, who had capital, to indebt the poor, who didn't, and extract egregious sums from that.

That's a pretty valid concern, but pragmatically speaking the concerns of an emerging bourgeoisie quickly began to trump the concerns of the religious who were concerned with taking advantage of the poor.

The rise of Protestantism -- with its additional emphasis on work ethic and capital accumulation -- led to an increased permissiveness from religious bodies in dropping constraints on capital expansion so desired by the emerging merchant class.

This was especially seen during the reformation, especially among Calvinists, who saw business as something to pursue with a concern for morals anyway.

Source: Usury and Just Compensation

In the 16th century, compound interest once again became legitimate along with the Age of Reason.

In England it was illegal to charge any interest until 1545, when an Act was passed which allowed interest of up to 10% annually.

Repealed in 1552 and later re-enacted in 1571, the law legitimized an industry that until then had been carried out by loan sharks.

With interest capped, this was finally the chance for the development of financial sciences during the Age of Reason.

Source: An Early Book On Compound Interest

In 1613 a landmark book in the history of compound interest was published by Richard Witt, setting the stage for the future of the entire financial industry.

Richard Witt, a man whose genius went unrecognised in his own time, published Arithmeticall Questions in 1613. It was the first textbook on compound interest, containing tables and formulae regarding the practical application of compound interest for lenders, landowners and merchants in seventeenth-century England.

It was a practical manual for an ancient process that only recently had become legitimized, and the work is known for its clarity, foresight, and precision.

Modern actuaries consider it a pioneering historical work in their own field.

While Witt was far from the first to write about compound interest -- recall that calculations were one of the reasons our species invented writing -- he was the first to produce a practical text on the subject, laying the groundwork for an English banking system.

Source: An Early Book On Compound Interest

But, if we're being honest, compound interest is also pretty much responsible for communism.

As Karl Marx wrote on compound interest:

(Usury) does not change the mode of production, but clings on to it like a parasite and impoverishes it. It sucks it dry, emasculates it and forces reproduction to proceed under ever more pitiable conditions.

As the credit and debt system became more sophisticated, Marx saw money lending as a force that allowed Capitalists to extend control over others.

In Marx's view utilising compound interest gave capitalists more control than they actually owned as a result of the compounding effect.

Source: Usury and Just Compensation

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

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

Source: ASA

Even if you don't have loans, 70% of Americans own a home. How'd you pay for it? Most Americans did it with a mortgage.

Anyone who has ever taken out a car loan or bought on layaway used the benefits of compound interest.

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

Do you eat food? Most farm expenses are up front and all the profit is after harvest. Farmers finance operations with compound interest loans.

Source: FSA

If you shop at a business, the company probably operates on loans or gives out a loans or has their cash invested in bonds.

Is your savings in bonds or a 401K? You're preparing for retirement by lending with compounding interest through your career.

Government debt is also subject to compound interest. The government spent $360 billion in 2012 on interest alone. That's on taxpayers.

Source; Treasury

One simple maths formula forms the fundamental basis for the human economy. Just remember that in many ways, compound interest is one of the main reasons we're here.

It's no surprise that the power of compound interest has captured the popular imagination.

For instance: On Futurama, time traveller Phillip Fry had 93 cents in his bank account in 2000, which had been accruing interest at 2.25% for the past thousand years, bringing the balance to $4.3 billion when he needed it in 3000.

Futurama Fry's Bank Account 'A Fishful Of Dollars' by luismgochoa

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