Is an interest-based enonomy sustainable in the long run?

Question

I dollar, invested at 5% annual interest invested 1000 years ago would have grown to more wealth than currently existing. How can we continue like this?

Answer 1

Pitirim Sorokin, one of the founders of modern sociology, once asked almost the same question (only his was about a franc invested at the time of Christ). Sorokin's answer to the question was, we don't see enormous fortunes around simply because the human society undergoes periods of massive destruction. Say, you invested an equivalent of $1 in England in 1006. What would you invest in? Probably land, since there was little else to invest in at the time. Now how would your investment perform during the Norman Conquest of 1066, when nearly all land in Britain was given to the Normans?

There are other possible answers as well.

First, your interest income is far from assured. Edward III, king of England, borrowed about 1,500,000 florins from two Florentine banking houses, Peruzzi and Bardi, to finance what has eventually become known as the One Hundred Years' War. In 1345, the king deafulted on the loan, and both houses went bankrupt...

Second, your interest income may be eroded by inflation, including wage inflation. After the outbreak of Black Plague in 1300s, the population of Engalnd decreased by 30-40%; as a result, laborers became scarce and wages soared...

Answer 2

This is a sub-question of a larger question:
can any economy (or part of an economy)
grow exponentially forever?

The answer is that it can't.

The first law of thermodynamics (a fundamental principle
of physics, somewhat like the "law of gravity" is a
physical law) says that there is a finite amount of matter
and energy in the universe and you can't increase it.
The second law of thermodynamics says that you
can't recycle energy.

Since there is an upper limit to the amount of physical
anything (cars, toys, kilowatt hours of electricity, or
anything else) that we can have, our physical consumption cannot grow exponentially forever. (Our population cannot grow
exponentially forever, either.)

You might wonder whether in an "information economy", we could at least keep consuming exponentially increasing amounts
of information (music, video, Yahoo Answers) forever,
but you have to store information physically, and the Heisenberg
Uncertainty Principle says that there is an upper limit to the
amount of information you can store in a finite amount of
matter. Actually, it says that there is a limit to the accuracy with which you can measure things, but since we store information by measuring things (e.g. by measuring the strength of a magnetic field on a hard disk drive), Heisenberg's principle essentially puts an upper limit on information storage. (We're a long way from that limit, but it does exist.)

Thus we can't keep consuming exponentially growing
amounts of anything forever. And since we can't do that,
we can't meaningfully pay ourselves exponentially more
money forever -- whether that payment is in the form
of interest, or earnings on increased productivity, or
anything else.

So the answer is that no economy, or portion of an economy,
including interest earnings, can grow exponentially forever.

Answer 3

Don't worry. Kids like you wouldn't think of actually investing that dollar. So many ipods, so little time.

Answer 4

The dollar keeps going down. Nothing seems to go up.

Answer 5

Don't forget about the mitigating effects of inflation.