A lot of people have asked for a short and simple explanation of the Compound Interest Paradox. I'm planning an updated version my Compound Interest Paradox post, scheduled to be posted in a few weeks. (Now that Blogger offers "scheduled posting", I'm queuing up posts ahead of time. I have 3 months' worth of nearly finished drafts queued up, and I schedule posts a week in advance now.)

There's a fundamental structural flaw in debt-based money. Money is only created when someone takes out a loan. However, only the principal is created and not the interest payments. For example, suppose a bank borrows $1B from the Federal Reserve at 5% interest for 1 year, either directly at the Discount Rate or via the Federal Reserve "monetizing the debt". In a year, the bank must repay $1.05B. The $50M required interest was never created or put into circulation. Therefore, there's a permanent money supply shortfall. Everyone is enslaved under a crushing debt burden.

The key step in the money creation process is when banks borrow from the Federal Reserve to create new reserves. Only the Federal Reserve can create new money, and all the money it creates has debt strings are attached. For each $1 the Federal Reserve creates, the financial industry can create $9 more via fractional reserve banking. This new money is recycled. The interest payments on the extra $9 are recycled as bank profits and expenses. Banks always are "loaned up" to the full reserve ratio allowed by law. Surplus bank reserves are loaned to other banks, or (rarely) back to the Federal Reserve via reverse repurchase agreements. However, the interest payments on the $1 created by the Federal Reserve are *PERMANENTLY* destroyed as the loan is repaid. Total debt is always greater than total money.

When the Federal Reserve creates new money, the Compound Interest Paradox operates with the full force of law. The general public does not have the financial industry's money-printing power, and their access to money is always limited by the Compound Interest Paradox. Banks don't need to collude to cause economic booms and busts, because Fed Funds Rate changes force them to collude. Before the Federal Reserve was created, large banks colluded to create economic booms and busts. The usual "Problem! Reaction! Solution!" scam led to the creation of the Federal Reserve. It was State regulation of banking in the first place that allowed large banks to collude to cause economic cycles, which then allowed them to lobby for the creation of the Federal Reserve.

Consider a quantum mechanics analogy. In quantum mechanics, a proton and anti-proton can be simultaneously created. They later collide and are destroyed, for no net effect. Similarly, dollars and anti-dollars (debt) are always created in matching pairs. However, the anti-dollars multiply via interest, whereas the dollars do not. Therefore, when the dollars and anti-dollars collide and cancel, there always are surplus anti-dollars left over.

In the
USA, monopolies are openly discussed as immoral. The Federal Reserve is the biggest monopoly of all. The Federal Reserve's monetary monopoly is more valuable than the monopoly of the State itself. By delegating its money-printing power to the Federal Reserve, the State has delegated most of its power to the Federal Reserve.

There are a lot of consequences of the Compound Interest Paradox.
  • Boom/bust cycles are not an economic law of nature. They are a consequence of an unfair monetary system. The people who control large corporations love this arrangement, because their smaller competitors are bankrupted during the bust phase; large corporations can withstand the cycle.
  • Boom/bust cycles encourage consolidation of industries. Large corporations are the most common business, because they can most effectively withstand boom/bust cycles and lobby the State for favors.
  • Real interest rates must be negative, to ensure any money is in circulation at all. Negative real interest rates provide a massive subsidy to the financial industry and large corporations, paid by everyone else as inflation. Banks and hedge funds can borrow the cheapest, followed by large corporations. Individuals cannot borrow on favorable terms, or cannot borrow at all.
  • Without a gold standard (sound money), individual savings are stolen by inflation.
  • Income taxes and regulations prevent people from boycotting the Federal Reserve and using sound money instead. If you develop an on-the-books alternate monetary system based on real money (gold or silver), the taxes and regulations make it impractical. Whenever someone works, Federal Reserve Points must be paid as taxes/tribute.
  • Negative real interest rates mean that the cheapest way to finance a business is via the financial industry/State. With fair market-determined rates, growing a business via reinvested earnings is comparable/preferable to borrowing. This places individuals on an equal footing with large corporations.
  • Individuals cannot easily accumulate capital to form their own businesses. Their savings are eroded by inflation. The stock market doesn't earn a positive inflation-adjusted return. Politically connected insiders can start businesses, because their connections allow them to get funding from the financial industry. In a communist society like the USA, connections are more important than talent.
  • Individuals cannot profitably loan each other money. If you loan money to your friends at 6%, that isn't keeping up with inflation. If you make a gold-denominated loan, that has an implied interest rate of 20%-30%; it would be cheaper to borrow from a bank.
  • Individuals don't have the magic money-printing power that banks have. This means that they will always be slaves of the bankers.
  • The financial industry has a unique perk. They get to print the money that everyone else uses to trade. This guarantees that the financial industry will *ALWAYS* be about 10% of the economy.
  • Large banks become "too big to fail". If one is forced into bankruptcy, then a bailout is *NECESSARY*, because otherwise the financial system starts to unravel. In a free market, one business' bankruptcy does not threaten the stability of its competitors, if they are prudently managed. There is no need for financial industry insiders to be concerned about negative consequences of bad decisions; there will *ALWAYS* be a Federal Reserve bailout, either directly as was the case with JP Morgan Chase and Bear Stearns, or indirectly in the form of a Fed Funds Rate cut.
  • With the ability to (literally) print money, the financial industry can lobby the State for perks. They can guarantee that reform will never occur. The insiders bought out all the TV stations and newspapers, guaranteeing their abuses will never be exposed. (The Internet is changing the equation somewhat. I predict that the Internet will enable an agorist revolution.) The financial industry insiders bought control of schools and universities, guaranteeing that only fake economics (Keynesian economics) and fake politics ("Taxation is not theft.") will be taught in schools. The financial industry insiders arranged for everyone else to be educated/brainwashed as slaves ("good citizens/consumers"). (Most politics courses don't even ask the question "Are taxes different from stealing?" It's an undiscussed axiom that taxes are morally acceptable.)
  • With negative real interest rates, the incentive is for banks and hedge funds to maximize their use of leverage, because this maximizes their profits. Only politically connected insiders can start a hedge fund. There is no true "free market" for hedge fund managers; they are merely a group of people highly skilled at lobbying the State for favors.
  • When inflation occurs, wealth is stolen from one group of people and transferred to another group of people, the people who print the new money and spend it first. Most new money is created by the financial industry, rather than by Federal deficit spending. Therefore, the primary beneficiary of money supply inflation is the financial industry insiders and not the government.

If this explanation is still too complicated, let me know. Once you understand the Compound Interest Paradox, a lot of economic problems are easier to understand. The Compound Interest Paradox is a key concept, and I agree that it should be my #1 most popular post by a wide margin.

I try to answer are serious reader questions. Pro-State trolls get annoying after awhile. Fortunately, most pro-State trolls get disgusted and leave. I'm continuing my policy of pointing out and ridiculing pro-State trolls.