For many, interest rates are the root of all evil: they drive debtors to ruin, redistribute wealth to the wrong people, and create a permanent pressure for growth in the economy—which I dispute, however.
Historically speaking, it was hardly possible to become rich through the returns on savings accounts or similar fixed-interest, virtually risk-free investments. Many critics of the system, on the other hand, calculate how the compound interest effect allows ever greater fortunes to be accumulated ever more quickly.
With continuous interest, 100 euros will eventually turn into millions, then billions, and finally absurdly high amounts, at which point it becomes apparent that the interest system cannot function in the long term, i.e., it would not be sustainable.
However, at an interest rate of 2% per year, it would take 466 years for €100 to become €1 million, and only after another 348 years would the descendants of the savings account holder become billionaires.
However, there is one crucial factor that is often overlooked in such calculations: inflation – money is becoming less and less valuable! Let's assume that the central bank manages to keep inflation close to its target of 2% per year. In that case, the heirs will indeed be millionaires in 466 years, but they will not be able to buy any more with their million than an investor can buy today with 100 euros. In the year 2479, 1 liter of organic milk will cost 11,000 euros, lunch at a restaurant will cost 100,000 euros, and an annual pass for the Vienna public transport system will cost 3.65 million euros.
This thought experiment is intended to show that interest rates that merely offset the inflation rate are only apparent returns and can therefore be paid indefinitely. The additional money comes from the central bank, which controls inflation with the money supply.
Significantly higher interest rates can be earned with stocks, for example. In recent decades, an average of around 10% per year was possible—if you were able to sit out the temporary high fluctuations in value.
10% per year is significantly more than economic and money supply growth. If returns remained at 10% per year in the long term, there would eventually be no real value and no money left to satisfy the demands of increasingly wealthy shareholders. The system would collapse, as many critics of interest rates and capitalism predict.
But what would actually happen is something else: the increasing surplus of investment capital would cause returns to fall. After all, no one is obliged to take on debt so that the wealthy can earn their interest. Companies only raise capital if they can invest it in such a way that they can repay the money plus interest and still make a profit.
This surplus of investment capital already exists today! Economist Gunther Tichy blames it for the major financial crisis of 2008. It was not (only) the greed of bankers and investors that brought our financial system to the brink of collapse, but the pursuit of returns that cannot be generated in a reputable manner, because there is already more than enough free money in the world for reputable investments.
Even if no one wanted a loan anymore, our interest rate system would not collapse: savings could then be deposited with the central bank. The central bank can credit interest "out of thin air." This leads to the desired inflation.
No matter how you look at it, I don't see how interest rates could be blamed for our unsustainable lifestyle and economic practices.
About the author Mario SedlakBorn in Vienna in 1975, graduated in technical mathematics from the Vienna University of Technology in 2000, technical expert in the electricity industry since 2008.
