Comradeship // Freechat

The reason for using compound interest is that the economy moves exponentially rather than linearly. Well, the shape is actually an s-curve, but standards tend to be set on the basis of the initial exponential part rather than the slowing down part.

Since population, especially in an early capitalist economy grows exponentially, the labor-value of the capital stock also does. The growth of capital stock represents the growth of wealth for capitalists, so when they give out loans, they do so against a baseline comparison of exponential capital stock growth.

Whenever it comes to capitalist economies, you should always start your thinking with population and its growth. That tends to be a key determiner of long-term capitalist dynamics.

I think it will help to see money as a relation, rather than a static thing. Then I'll give some examples. I'm no expert but I think working through some examples will be helpful.

If I had $1000 in my bank today, I could buy $1000 worth of stuff today. In a year's time, I could maybe buy $900 worth of stuff, because prices are going up. Meaning, $1000 might still be called $1000 and look like the same $1000. If it were under my mattress, it may even be the same 20x$50 notes. But it isn't the same $1000; what I can use it for depends on a wide range of factors, including inflation. The number in the account may be static, but the number only means something as a relation.

If I lend you that $1000 at 3% for one year, you pay me $1000 plus $30. By the time you pay me, prices have gone up. You've only really paid me back $900+$30 worth of stuff ('ish', because the $30 isn't worth as much, either).

I could charge simple interest at the rate of inflation and break even, more-or-less. But what if you take two years to pay? Do I charge compound interest at 10%/year or (if my maths are correct) simple interest at 21%/biennially? Do I adjust the simple figure if you pay me back early?

Compound interest seems to be a more straightforward way of working out how much the borrower needs to repay to actually repay what was borrowed (relationally, i.e. what the money can buy) rather than the initial sum (e.g. the static $1000). You only actually pay interest on interest if you borrow too much and can't pay off more than the yearly addition. People don't always have a choice, of course, house prices being what they are, for example.

When you borrow money from a bank as a loan, you get both figures. Or an approximation (because interest rates fluctuate and debtors can make overpayments). Consider a mortgage. You get e.g. the '5.7%/year (compound)' and you get a typical estimate of the overall interest, e.g. $75,000 on a mortgage of $100,000 if you take 35 years to repay.

Not everyone who borrows that money will actually repay the $75,000. You could borrow the $100,000 at 75% but then you risk losing out if the base rate or inflation go down or if you get a pay rise that would let you make overpayments.

Compound interest can work in the borrower's favour as well as the lender's. It's perhaps easier to see with commercial loans, where the borrower and lender have more equal bargaining power. Maybe the borrower has more bargaining power. Compound interest is not always 'unfair' in a straightforward way.

Compound interest is monstruous, don't get me wrong, and compound interest is a factor in prices going up, but it has a certain logic to it. As for the bourgeois rationale, it's going to be something like the above but without the words 'relational' and 'static'.

"Compound interest pleases the Economy."

I'm not sure if this answer provides a root explanation for the question, but in a competitive (but not prestigious) undergrad business program the answer provides is https://en.m.wikipedia.org/wiki/Time_value_of_money

Interest paid is offered as compensation for the opportunity cost the lender experiences by lending rather than immediately spending. I still don't see why this implies compound interest, except that vaguely the opportunity cost increases faster than the passage of time.

it's something that can be traced since Babylonia. Michael Hudson has a book specifically about this subject, the collapse of antiquity i think. I haven't read it tho but i remember him promoting the book once in a ben norton podcast.

IMO it adds pressure to pay the loan, a simple interest does not generate pressure. in typical fashion, banks pay bondholders simple interest (depends), but they charge compound interests on their loans.

From what I recall in investment class in college it's all about risk vs reward. If you don't provide enough reward with the compounding interest then no one would be silly enough to take on the risk of loaning the money because it would take too long to get a worthwhile return.

But fuck the system tbh. Life shouldn't be about accumulating the most, it should be about everyone living well together.

1. Personal failure

2. Simplicity of tracking the balance owed

3. Compound interest is more powerful than simple interest, so of course we use it for everything

I see the personal failure one used more often and in multiple forms. "Pay off your debt each month and your credit card won't charge interest," or "If you didn't understand the terms of the loan, you shouldn't have signed it/read the fine print."

I don't know why certain types of loans use simple interest instead of compound interest other than as an alluring alternative that is often offered after someone is already trapped in a cycle of credit card debt. Since there is a period before simple and compound interest meet, I assume they have calculated that profits will be higher for simple interest in that case, but it could just be marketing after someone was burned by compound interest.

An important point I noticed in the third paragraph of your question that you didn't explicitly ask about is the difference between bank finances vs personal finances. Access to money for banks is far different than for individuals. This may be too much for your students, but you may find it interesting. I definitely will not be able to explain all of this sufficiently:

Banks do not need to keep enough money on-hand to pay off all of their debts at once. There is a set minimum they must keep. Everything else gets invested/leveraged elsewhere, including the debts that are owed to them. This is something individuals can also do to manipulate interest in their favor (to a lesser extent), but banks are also insured by the state and in some ways operate as issuers of the states money. This last part is explained within modern monetary theory and allows them to do fucky things with money.

When you have access to what are essentially unlimited streams of money, the rules for borrowing and lending don't affect you the same as when your financial streams are limited.

That is an interesting question. It is taken as an axiom so I never even questioned it until now.

Since money-lending is a practice with long history, I wonder if interest always was compound or if it was linear before a certain period of time.