It's apocryphal, but the urban legend goes that Albert Einstein was once asked for his opinion of mankind's greatest invention, to which he curtly replied "compound interest." Compound interest, the underpinning of economic exponential growth and an utterly necessary device for the proper functioning of any economy hardwired for exponential growth, the simultaneously simple and devilishly complicated instrument that is the beating heart of the industrialized world.
Every economic transaction we make is colored by compound interest. We borrow a couple hundred grand to buy a house, make a two grand a month payment on it, yet still owe more than a two grand difference between this and the last payment. Why?
On a happier side (and in happier times), we look at our retirement accounts and notice the balance in them double about every decade -- even if we don't put a dime of new money into them. Why?
"Every economic transaction we make is colored by compound interest."
Compound interest, again.
It's the grease in the armature of our civilization. The thing that makes everything else work. Utterly vital. We can't imagine getting along without it.
But what if we had to?
Before contemplating that, let's think of what alternatives exist to the compound interest economy. I'll get the bad out of the way: stagnation and decline. That's pretty much what happens in a fishbowl during our periodic recessions and depressions (like this one) where the economy not only slows, but actually contracts. Almost always a Very Bad Thing, such as during Japan's "lost decade" where, for a little while at least, that nation's central bank had to resort to making loans with negative interest.
I'll give you a hamburger today if you let me pay for it, tomorrow.
You got that right, they were paying people to borrow money from them in a desperate attempt to get people to borrow at all. It didn't work, which tells you a bit about just how much trouble they were in.
We're pretty close to the same level of trouble here in the United States. While the Federal Reserve hasn't moved interest rates below the magic "zero bound" (0 percent interest), as Japan did two decades ago, it's close enough to make you wonder.
"The great polymath John Stuart Mill regarded the linear growth economy the only sustainable and sensible method of economic order."
About the only good thing about all of this is that, with interest rates as low as they are, it's very cheap for our government to borrow money to help fund the economic recovery. As economist Paul Krugman put it, the market is sending a very strong signal that there is still something of substantial value in the world, and that thing is the debt of the United States.
Next onto the not-so-bad: a steady-state economy, one based not on the exponential growth model of a compound interest economy, but one that instead relies only on linear growth. Sure, returns in your investment portfolio would stop doubling every year but, on the other hand, you'd pay off your home mortgage in half the time.
This is nothing new, of course. The great polymath John Stuart Mill regarded the linear growth economy the only sustainable and sensible method of economic order. More recently, people like William Catton have made convincing arguments of the necessity of enabling a "steady-state" economy in order to avoid the inevitable consequences of any system subject to exponential growth, namely sudden and devastating collapse.
The nation and the world are at an inflection point right now. This is not your mother's recession -- it may not even be your grandparent's depression. Even optimistic forecasts regarding the economy don't show any kind of tangible recovery in the important things like unemployment and total factor productivity occurring for at least a half decade (because, as another economic wag put it, "five years isn't a calculated value, it's simply the standard length of time in which everyone says things always recover").
And we've seen a substantial reversal in the pace of exponential growth, towards what might be exponential contraction. Oil consumption, perhaps the most telling metric of all, is down nearly 9 percent over its peak, and there are a lot of people saying that, even if we do have a recovery, that consumption is forever dampened.
Steady as she goes?
In fact, we may already be in a steady-state economy, or at least partially, and not even be aware of it. Population growth in the developed world is flat or contracting and, with the exception of a couple famous bubbles over the past few years, the stock market and equities in particular have been absolutely flat, mirroring periods of similar doldrums in the 1960s and 1970s, for over a decade.
"We may already be in a steady-state economy, or at least partially, and not even be aware of it."
The stock market crash of the 1930s was preceded by a great run-up in the prices of stocks, a bubble if you will, so great that even three years after the crash of 1929 stock values were above those of five years prior. The great unacknowledged secret of our current predicament is that our own stock market crash was preceded by no such run-up.
Instead of falling off a mountain, we simply walked into a canyon. In terms of asset destruction, we're far ahead of what our parents' parents experienced in the 1930s. Nobody likes to talk about it, but it's true.
Paul Volker, the chairman of the Federal Reserve whose tough-love approach to monetary policy in the 1970s and 1980s is credited with shocking our country into "Morning in America", recently suggested that none of the complex and fancy new financial instruments that emerged in the 1990s and early 21st century had any material effect on growth, noting that the nation performed better in the 1960s long before anyone had ever heard of a "credit default swap" or "collateralized obligation." Witheringly, he told a group of bankers and Wall Street smoothies that the only thing of real value their industry had produced in the last quarter century was the ATM machine.
I'm suggesting that in adversity we may find opportunity. It will be painful and particularly destructive if done wrong, but if done right a move toward a steady-state, or linear growth, economy might be just the opportunity afforded us in this time of crisis and, perhaps, an opportunity we don't want to let pass.
Gregory Travis can be reached at email@example.com.