This understanding of interest and compounding, however, creates an illusory problem at the same time that it hides a real problem. Since finance and economics are such important mechanisms for structuring the way we live, it is worth looking carefully at these fundamentals.
A monetary system can be modeled quite simply. Each person has an account, a single number, their net monetary worth. Some people have positive net worth, other people have negative net worth. Perhaps Fred has a net worth of +10, Sally has +2, and Bill has -12. Adding up these three numbers, the total is zero. The net worth totaled across all people is always exactly zero.
Day to day transactions happen when people exchange goods or services for money. Bill might cut Sally’s hair, in exchange for which Sally pays Bill 3 monetary units. That payment moves from Sally’s account to Bill’s account. So now Sally’s net worth is -1, Bill’s is -9, and Fred’s remains at +10.
Interest payments occur at regular intervals. At the end of each interval, each person’s account is multiplied by some number. Let’s use an interest rate of 1% per time unit. Then when interest payments are made, Fred will have 10.1, Sally -1.01, and Bill -9.09. The sum of these three numbers remains zero.
If there are no other transactions, then interest will simply amplify the differences in net worth more and more over time. But people with negative net worth can also provide goods and services for those with positive net worth, in exchange for money. These exchanges reduce the differences in net worth. The combination of these two effects determines how account balances actually evolve.
It should be clear from this simple model that interest payments are entirely compatible with a steady state or even a shrinking economy. All that is required is that sufficient transactions occur that move money from those with large positive net worth to those with large negative net worth to counter the amplifying effect of interest payments.
This simple observation exposes the real problem with interest payments. What if these exchanges fail to occur? How might they fail to occur? To whose advantage would it be if they failed to occur? Could those who benefit by such failure influence affairs in a way to increase the likelihood of that failure? Could that chain, failure – benefit – influence – failure, then feed on itself to amplify the imbalances?
It is not the simple mathematics of interest payments that leads to accelerating imbalance. Putting the blame in the wrong place means that the blame is not being put in the right place!
It is important to see how money is power, and also how debt is powerlessness. Money gives a person options. Debt reduces a person’s options. The more options a person has, the more they can optimize their behavior and enhance their productivity, their profitability. The fewer options a person has, the less opportunity they have to find ways to be productive and to earn a profit. This connection between money and power is not a property of the simple monetary model presented above. What real monetary systems generally add are rules that restrict transactions for people with large negative balances.
The reality of the world is of course vastly more complex than any economic model. How are prices determined? If the power conferred by money gives a person influence over pricing, this can enable them to acquire more goods at lower prices, further concentrating wealth.