Agreed Greed: The Compound Interest

“Oh, it’s a mystery to me
We have a greed with which we have agreed” — “Society” by Eddie Vedder

What is Wealth Inequality?

Wealth inequality, also known as economic disparity, refers to the vast and often stark differences in the distribution of economic assets, which includes income and property, among a population. It’s a global issue, reflecting not just individuals’ varying access to resources, but also broader systemic imbalances.

In an ideal world, wealth would be distributed evenly among all the people. Everyone would have an equal slice of the economic pie. But in reality, the distribution of wealth is heavily skewed in favor of a small percentage of the population, leaving a disproportionate number of people with very little. This isn’t about someone having more pizza slices than others; it’s about a few people having most of the pizza, while many others are left with mere crumbs.

To visualize this, picture all the world’s wealth represented by a giant pizza. Now, if we were to distribute this pizza equally among everyone, each person would get an equal slice. But in our current world, the wealthiest 1% would receive more than half of the entire pizza. The remaining pizza, less than half, would then have to be divided among the rest of the population, the 99%.

This disparity becomes even more alarming when we consider that the bottom 50% of the population, half of all people in the world, hold less than 2% of all wealth. That’s like dividing a single slice of pizza among half of the people at the party while the wealthiest get the rest of the slices. This kind of division reveals an astonishing concentration of wealth in the hands of the few while the majority scramble for what’s left.

But this inequality isn’t just about numbers and pizza slices. It has real, tangible impacts on people’s lives. Those at the lower end of the wealth spectrum may struggle to meet their basic needs, including housing, food, and healthcare. They may also face barriers to improving their situation, like limited access to quality education and job opportunities.

Contrarily, those at the upper end of the spectrum have a significant amount of influence and power, which can often be used to perpetuate their wealth. They can afford better education, access to opportunities, and financial advice to help grow their wealth further, reinforcing the wealth gap.

In essence, wealth inequality is about much more than just differences in income. It’s a complex and systemic issue that impacts almost every aspect of society, from the opportunities we have access to, to the overall health of our economy. By understanding what it is, we can better work towards solutions that address this significant challenge.

What’s Making it Worse?

The compounding effect of wealth serves as hidden cancer within our society, subtly yet powerfully amplifying inequality and widening the gap between the affluent and the less fortunate. It operates through various mechanisms, intensifying existing disparities and further cementing the privilege of the wealthy few.

Compounding primarily operates by allowing wealth to generate more wealth over time. As individuals or entities amass wealth, they can allocate more resources for investments, facilitating the growth of their assets at an accelerated pace. This compounded growth leads to a dramatic accumulation of wealth in the hands of a few, while the majority of people struggle to make financial headway.

Various investment practices also significantly contribute to the compounding effect. Certain investment vehicles, like stocks, real estate, and other financial instruments, offer significant potential for long-term growth. However, access to these lucrative opportunities isn’t evenly distributed. The wealthy often have better access to exclusive investments or can afford specialized financial advice, giving them a distinct advantage in maximizing the compounding effect.

Intergenerational wealth transfer is yet another vital factor that contributes to the compounding effect. Inheritances, gifts, and trusts are mechanisms through which substantial wealth can pass from one generation to the next. Consequently, a family’s fortune grows over time, creating a snowball effect that escalates the wealth of each successive generation.

How Does Compounding Work?

Compounding is the financial concept where an investment grows based on both the original amount and the returns that the investment has already generated.

Think of it as planting a seed. You plant one seed (your initial investment), and from that seed grows a tree (the returns). The tree bears fruit, each fruit with seeds of its own. You plant these seeds, and now instead of one tree, you have several (reinvesting the returns). Each of these trees grows and bears fruit, multiplying the amount of fruit (returns) you initially had.

Let’s put it in simpler terms with an example:

Suppose you invest $100 with a return of 10%. After the first year, you will have $110. The 10% return didn’t just apply to your initial $100; it also applied to the $10 return. So in the second year, you will have $121. That extra $1 might not seem like much, but as time goes by, this growth becomes exponential. After 10 years, that $100 would have more than doubled to $259.

Now, let’s scale this up.

Imagine instead of $100, a billionaire invests $1 billion with a return of 10%. After the first year, the investment grows to $1.1 billion. In the second year, the investment isn’t just generating returns on the initial billion, but also on the extra $100 million earned in the first year, bringing the total to $1.21 billion. As with the smaller investment, this might not seem huge initially, but over time, this growth is staggering. After 10 years, the original $1 billion would have grown to $2.59 billion, an increase of $1.59 billion.

The concept of the “snowball effect” is a perfect analogy to understand how compounding works in the real world. Imagine a small snowball rolling down a snowy hill. As it rolls, it gathers more and more snow, increasing in size and speed with each revolution. Eventually, the snowball becomes a large, unstoppable force.

The same principle applies to wealth. When wealth is used to generate more wealth, it creates a compounding effect, allowing the initial investment to grow exponentially. This exponential growth means that a small initial investment might not look so significant in the beginning. However, given enough time and the right conditions, the final result can be surprisingly large.

Now, consider what happens when the initial investment is not small but significantly large. The compounding effect can be truly awe-inspiring. A billion-dollar investment, for instance, has the potential to multiply many times over. It illustrates the staggering scale at which the compounding effect can work, leading to colossal wealth accumulation in the hands of a few.

What Does This Mean for Everyday People?

The allure of compounding wealth is potent, creating a sense of urgency and desire that can permeate through all levels of society. For those in lower and middle-income brackets, the prospect of rapid wealth accumulation can present a dangerous temptation.

In societies with large wealth disparities, individuals from lower and middle-income families often find themselves in positions where they observe the tremendous benefits of compounding wealth but lack the means to participate in this form of financial growth. The opportunities to invest and grow their wealth are either nonexistent or come with risks that are too high for their financial safety.

Faced with this reality, some individuals may feel forced into taking desperate measures to attempt to gain access to the advantages of the compounding effect. This could involve participating in corrupt practices, including accepting or offering bribes, engaging in fraud, or even resorting to criminal activities.

Such actions are driven by the desire to accumulate enough wealth to start their own snowball effect. As these individuals see the exponential wealth growth among the higher-income groups, they may become disillusioned and feel as though their only path to financial security lies in these quick-win strategies.

This is not to say that everyone in these income brackets will resort to such measures. Many individuals maintain their integrity and strive for success through legitimate means. However, the system that promotes such extreme wealth disparities can undoubtedly put enormous pressure on those who are trying to improve their financial situation.

The existence of such pressure highlights the importance of addressing the systemic issues at hand. Efforts should be focused on creating an economic system that offers fair opportunities for wealth creation across all income groups, discouraging the inclination towards corrupt practices.

How Does Exponential Wealth Growth Impact Economic Stability?

In order to properly grasp this concept, we need to take into account how money and goods are intertwined within an economy. Money is not just a means of trade; it’s a representation of the goods and services produced in an economy. If the amount of money grows much faster than the ability of the economy to produce goods and services, it can lead to serious imbalances and economic instability.

To illustrate, imagine a billionaire whose wealth, thanks to the power of compounding, is growing exponentially. The money doesn’t merely accumulate in a vault somewhere, it circulates in the economy in various forms — real estate, stocks, bonds, and other investments. Now, if this wealth is growing far quicker than the economy’s capacity to generate goods and services, it can distort the market.

Here’s how: as the billionaire’s wealth grows, they invest more in assets like properties and stocks. This increased demand can inflate the prices of these assets, creating what’s known as an ‘asset bubble’. And as we’ve seen in the past, when these bubbles burst, it can lead to economic crises, such as the housing market crash of 2008, which had devastating effects on the global economy.

Furthermore, if a significant portion of the population can’t keep up with the rising prices, it can result in decreased consumer spending. Since consumer spending accounts for a substantial portion of economic activity, this decrease can lead to a sluggish economy, job losses, and even a recession.

Additionally, this disproportionate growth of wealth can cause social and economic inequality to skyrocket, leading to societal unrest, which in turn can further destabilize the economy. It’s a vicious cycle, where the rich get richer, while the rest of the population struggles to keep up.

This is why it’s not enough for money to grow; the growth of an economy needs to be inclusive. That means ensuring everyone has access to opportunities, resources, and tools to improve their economic standing. This doesn’t mean doing away with compound interest altogether but using financial tools and policies that promote sustainable and equitable economic growth.

How Can We Make Things Better?

Compound interest, with its exponential growth, can seem like an economic superpower. But it’s crucial to consider that this superpower often serves a select few with substantial capital, leaving the rest behind. Transitioning to simple interest can be seen as a way to level the playing field and enhance economic stability, particularly at the micro-level.

Let’s look at it this way: if banks and other financial institutions were to switch from compound interest to simple interest, the appeal of merely storing wealth and watching it grow would decrease. Why? Because simple interest only applies to the original amount of money put in, and not to the interest that money has already earned.

This shift could potentially incentivize individuals, especially the wealthy, to explore other avenues for their money. Instead of leaving substantial sums in bank accounts or bonds, they might be more likely to invest in businesses, startups, or other entrepreneurial ventures. In other words, they would potentially be more likely to inject their money directly into the economy, where it could stimulate growth and job creation.

The direct benefit of this would likely be a boost in the micro-economy, as more businesses could lead to more job opportunities and increased economic activity. This could lead to a more inclusive and sustainable economy, as the wealth wouldn’t just be circulating amongst the already wealthy, but spreading across various sectors and demographics.

It’s important to remember that while this scenario sounds promising, it also requires careful implementation and regulation. Without proper oversight, the wealthy could still monopolize industries, and income inequality could persist. Additionally, it’s critical to have financial literacy programs in place to help the general population understand how to best utilize these changes for their benefit.

In conclusion, while switching to simple interest could be a step towards economic equality and stability, it’s not a magic bullet. It would need to be part of a larger initiative to address income inequality, involving other changes like improved access to quality education, fair wage policies, and tax reforms

Disclaimer: The views reflected in this article are the author’s views and do not necessarily reflect the views of any past or present employer of the author.