Compound interest is a prime example of exponential growth. Two terms you may hear thrown around from time to time, but what do they really mean? Well exponential growth means that something increases, but at an ever-increasing rate, so to clarify, just because something gets bigger, that does not make it exponential, but if it gets bigger at a larger rate each time, then that is exponential. So how does this relate to interest?

Well that has everything to do with the ‘compound’ part. Interest, as you probably know, is a percentage that is paid on top of a set amount of capital, such as a loan or savings, that is paid out at regular intervals, whether daily, monthly, yearly and so on. Let’s say you put £10,000 in a savings account for a year, that was to pay a yearly 5% interest rate. Well, assuming the money was left in the account without interruption for the year, at the end of the year an additional 5%, or £10,000 multiplied by 1.05 which equals £500, would be paid to you as an interest payment. Simple enough.

Now we know that 5% of £10,000 each year is £500, so if we multiplied that by 10, you’d be forgiven for assuming that the total interest over 10 years would be £5,000, however because of compounding interest, that’s not the case.

For example what happens if say, you left the £500 interest payment in the account for another year at the same rate? Now you would be leaving £10,500 in your savings account for the second year instead of £10,000, so at the end of the year you would be paid £525 (£10,500 x 1.05) and now have a total of £11,025 after the second year. Your initial £10,000 has actually increased more than the sum of 5% over 2 years. At first the ‘bonus’ compound interest is small, but as with anything exponential, over time that small bonus, becomes a much larger one.

If we left the money in the savings account for a total of 10 years, we would have a total of £16,289 (£10,000 x 1.05 x 10.5 x 10.5 x 10.5 x 10.5 x 10.5 x 10.5 x 10.5 x 10.5 x 10.5). This is an additional £1,289 or 13% on top of the already generous 5% yearly interest rate. This is a huge increase from the second years additional £25, or 0.25% ‘bonus’ compound interest, infact it is 49 times more. If that money was left for 50 years, the £10,000 would now be £114.674 and after 100 years £1,315,013!

This sounds great for the individual trying to put a nest egg away for later years and is the way in which most pensions are run, but it also enables the banks and the super-rich who have been hoarding money for decades and centuries to now have such a vast incomprehensible wealth, all because of this exponential growth and compound interest effect, and it only ever widens the gap in wealth the longer it is left. For doing absolutely nothing, except profiteering at others’ expense.

The more money you have, the more money you can save, the more you can save, the more you get from compound interest, which means the more you can have, which means the more you get and so on. In our opinion this is not only not good for society or the overall economy, but also immoral.

Where there are winners, there are losers, so who is losing out here? Well apart from the obvious ever-widening chasm between the rich and poor, anyone who has a credit card for example suffers the same fate as money in a savings account, but in reverse. Let’s say for example you have a £5,000 on a credit card and your yearly interest rate is 12%. Well as 12% of 5,000 is 600, so you might imagine you would be paying back a total of £5,6000, however with credit cards, the interest is charged monthly, so with APR that is just 1% compounded interest per month.

Well, after just 1 month, the interest due would be 1% of £5,000, or £50. But say you have just lost your job or the government has introduced more restrictions on your freedoms and work due to coronavirus, so you can only afford the minimum payment of £25. So now next month you now owe 1% interest on £5,025 instead, or £50.25, a mere additional 25 pence, barely worth mentioning right? Well what about if this kept on going for 3 full years of struggle, now you would owe £6,077 in credit card debt and already would have paid £900 in minimum payments. And if this was left for 10 years, it would total £10,751 still owed, not including the £3,000 already made in minimum payments. This person will more than likely never clear that debt.

In 10 years, someone who started with £10,000 in savings, now has £16,289 and the person who had £5,000 on their credit card, in now down £13,751! Some may argue that they worked hard for their money or were more frugal or sensible with their money, and that’s a valid point, but nobody worked hard for their interest, or the compounded interest and let's be honest, many people with large savings accounts didn’t even work hard for the money in the first place.

And that person who has £5,000 is hardly taking advantage, especially if they can only afford the minimum repayments, the only difference is with compound interest, they are even more in debt 10 years later than the day they took on the debt.

If a pre-determined finite interest was used instead, keeping with the 12%, but this was instead a total interest amount, not compounded, then even at minimum repayments, after 10 years the debt would only be £2,600, or in other words, the person repaying the debt would actually be paying off the debt and would be £8,000 less worse off than with compounding interest. Meaning that the person might be able to get additional credit if in need 10 years later, but with compound interest and over £10,000 in debt, if that person falls into trouble again, they may not be able to get more credit, or a housing, or car, or whatever they need.

So compounding interest is exponential, which is great for all the savers getting money for nothing, but for everyone else all compounding interest is doing, is compounding misery, compounding life’s difficulties and compounding inequality.