The Miracle of Compounding Interest, Part 2

Yesterday, I discussed the wonders of compounding interest and the benefits to an individual investor.  For this post, I want to talk about compounding interest applied to an entire society or civilization.

Just as an individual can accumulate great wealth over time with compounding interest, a society can also accumulate great wealth.  It is the same concept.  If the economic growth of a particular area averages around 4% per year, then that area will be twice as wealthy about every 18 years.  But you have to realize that after another doubling after the next 18 years, then the people will actually be 4 times better off than 36 years ago.  After another doubling, they will be 8 times better off.

Despite the economic growth of the 20th century, the 19th century was actually more prosperous for America, in a sense.  There was great economic growth through most of the 1800's.  We saw the great results in the 1900's, even though growth was lower (as an average) during that time.  The 1900's were so great (at least some of the time) because the wealth was being built off of what was already accomplished in the 1800's.

While technology certainly plays a big role, it is actually capital investment that is the main thing that makes this happen.  People save money and invest their excess capital.  This enables people to be more productive.  This allows them to save even more and invest even more, which leads to even more production with less labor necessary.

If America had the massive government spending, regulation, and bureaucracy in the 19th century that we have today, the people then would have been really poor.  The people of the 20th century also would have been really poor.  And we would be far worse off today.

We are a quite wealthy society now, especially compared to anything a hundred years ago.  This is in spite of the massive government we have.  If we didn't have the massive government, then we would be that much more prosperous.  But most of what we have today is due to the previous capital investment that took place previously over hundreds of years, or more.

It has been said that the American Founders would have had more in common with the people living in the era of Jesus than with us today.  In other words, there was not that much advancement for a couple of thousand years.  Something happened in the late 1700's and early 1800's where the economy got going.  Much of this is due to freedom in Britain and America (at least economically speaking).  The economy was like a car that needed an initial push to get it going.  Once it got going, then it could accelerate.

Even a small 2% growth can add up significantly over time.  People don't notice it unless they look back several years and compare the living standards.

With the tough economic times (due to the massive government and central bank), it is still important to have some economic growth.  It can give us hope that we can get beyond the government interference enough to continue to prosper.  If we ever did get government off of our backs, we could see real growth at 5%, 10%, or more.  Our standard of living would increase at a staggering pace.