COMPOUND INTEREST
by Galen Guengerich
May 23, 2004
By any measure, Albert Einstein possessed one of the great minds of the Twentieth Century, if not in human history. His theories of relativity forever changed the way we understand the physical world. They also developed, early on, an undeserved reputation as being impossible for ordinary people to understand. One reason for is that when the New York Times decided to do a story on Einstein shortly after the First World War ended, they sent their golf correspondent to conduct the interview. The subsequent article was riddled with errors, among them that Einstein had found a publisher daring enough to publish a book that only twelve people in the world could understand. None of this was true—there was no book, nor was there a publisher—but the myth had been created. Some time later, a journalist asked the British astronomer Sir Arthur Eddington if it was true that he was one of only three people in the world who could understand Einstein's theories. Eddington thought deeply for a moment, and then replied, "I'm trying to think of who the third person is."
Briefly stated, Einstein's genius was in understanding the universe not in terms of fixed bodies and constant forces, but rather in relational terms. After all, he is famous for his theories of relativity. Whether the entity in question is an object, a force, or a human being, who or what you are fundamentally depends on your relation to other forces and things.
This principle applies to everything, even the laws of finance. Einstein is widely rumored to have once said that the most powerful force in the universe is compound interest. While this rumor lacks any verifiable basis, he is documented to have said something almost as compelling: that compound interest is the greatest mathematical discovery of all time.
How so? Let's say you earn 7% annual interest on an investment of $1,000. With simple interest, the total value of your investment grows by $70 each year. On the other hand, if the interest is compounded each year, the interest is added to the principal, and the interest payment is calculated on the current value of the investment, not the original value. The interest paid at the end of year two, for example, would be 7% of $1,070, or about $75. Over an extended period of time, the difference between simple and compound interest is dramatic. If one of our graduating seniors were to invest $1,000 at 7% simple interest this June, upon her retirement in fifty years the investment would be worth $4,500. If the same amount was invested at 7% but the interest was compounded daily, the total would be more than $33,000.
If you plot these investments on a graph, the line that represents simple interest looks like a Canada Goose taking off from the Central Park reservoir: you wonder if it will even clear the fence at the other side. Compound interest, on the other hand, looks like a Lear jet. It also starts slowly, but then it takes off like a rocket. Over time, compound interest adds much more value much more rapidly.
My interest in interest, so to speak, is not to make us all wealthy—though I cannot think of a group of people who would spend money more wisely. My interest, rather, is how the difference between simple and compound interest can serve as a useful lesson for how to create value in the rest of our lives. This lesson has two points. The first is that all value is created by relationships. The second is that compound relationships have the potential to create more value more rapidly than simple ones.
First, let's examine how relationships create value. This principle is certainly true in financial markets. In fact, the term interest itself derives from a Greek verb interesse, which means "to be between." An economy based on the private ownership of property and capital requires something to stand between and connect those who own capital and those who need it. Financial instruments and markets are the principal means whereby an owner delegates control of capital to others. In financial terms, these interest-bearing relationships make it possible to use capital to create value.
The same principle, however, applies to more than just money. Another great mind of the Twentieth Century, the philosopher and theologian Alfred North Whitehead, believed that everything in the universe is constituted by its relationships to other things. Whitehead is the source of what has come to be known as process thought. Before Whitehead, most thinkers conceived of the universe in what I call billiard ball terms. The conventional wisdom was that everything is made of substances much like billiard balls. Some of these balls are tiny (electrons, atoms, and molecules) and some are vast (planets, solar systems, and galaxies). But whatever its size, each of the billiard balls that make up the universe is its own entity. It is what it is within itself.
Whitehead believed that the billiard ball view did not adequately explain how value is created in the universe. The best way to illustrate Whitehead's view is by describing a person; let's take me as an example. In billiard ball terms, I am an organism made up of about 195 pounds of organic material that constitutes roughly 50 trillion individual cells. These cells are differentiated into various tissues and organs, which together make up the ten major systems in the human body. I am sixty percent hydrogen hydroxide, also know as water. Is this an adequate explanation of my value to myself and the world? Not even close, Whitehead insisted.
In Whitehead's understanding, I am best described in rather different terms. What gives value to my life is the collection of relationships I represent. I was born on a dairy farm in a Mennonite community in central Delaware, grew up in the late Sixties and early Seventies in south Arkansas, and attended a Mennonite High School in Lancaster, PA. I studied classics at Franklin and Marshall College, theology at Princeton Seminary, and religion and ethics at the University of Chicago. My father is a Mennonite minister, as are six of my eight uncles and about twenty of my first cousins or their spouses. My niece Krista died of a brain tumor at age eleven. My daughter Zo‘'s mother and I are divorced. I came to All Souls ten years ago, Zo‘ was dedicated on this chancel, and Holly and I were married here. These experiences, and countless others besides, make me who I am—not in the way a potter applies steady pressure to shape a bowl, but in the way flour, butter, sugar and other ingredients go together to make a cake. If you take away the relational ingredients that make up my life, what remains has little value—certainly not as Galen Guengerich. I am made up of, or constituted by, those relationships. This is the first insight: all value is created by relationships.
The second insight is that compound relationships have the potential to create more value more rapidly than simple ones. Let me clarify how I understand the difference between simple and compound relationships. Whitehead once said that the goal of civilization is the evocation of intensities. By this, he means that relationships become more valuable as they become more intense—that is, more substantial and more profound. Your relationship to your best friend, for example, is more valuable than your relationship to the lady who calls at dinnertime about phone service. Aside from your understandably-strident rebuke, your relationship to her is trivial.
In addition to an intensity differential, there is another difference between simple and compound relationships. If my identity is constituted by my relationships, I need to take other people and other things seriously. In part, they make me who I am. Simple relationships are those in which I deny this fundamental reality and act like everything is about me. Compound relationships, on the other hand, are ones in which I recognize the truth: my life is indeed about me, but it's also about other people and other things as well. Value comes from relationships that are both substantial and reciprocal.
In terms of our everyday experience, simple relationships focus only on how useful or obstructive others are to helping us get what we want. Each person in our lives has a functional role: customer, sibling, competitor, parent, employee, investor, teacher, friend, boss, teammate, or subordinate. We also view the elements of the natural world in an instrumental way: air is to breathe, water is to drink, land is to develop, trees are to harvest, oil is to drill for, and crops are to engineer. When our national interest is defined one-dimensionally, other nations are either with us or against us, friend or foe, loyalist or traitor.
The problem with this approach is that it severely limits the value we can create. This has become painfully clear to our nation in recent months. We are learning the hard way that much of what happens in the world is not about us and what we want. If democracy eventually comes to Iraq, it will come because the people of Iraq long for it, not because our military insists on it. Our mistake as a nation is not that we want freedom from tyranny for the Iraqi people. Our mistake is in believing that our view of things is the only one that must be taken into account. I am deeply troubled by the disdain for human dignity shown in the Abu Ghraib prison. But I am also troubled by how those actions mirror with appalling clarity our wide-ranging disdain for other interests and other points of view. Value comes from relationships that are substantial and reciprocal. We will always be better off when we understand the truth: our interests are compound.
I also think of the interests that are engaged in the debate over gay marriage. The primary opposition to gay marriage involves what to my mind is a simple-interest argument. According to the Bible, marriage was ordained by God for the propagation of the human species. Since gay couples cannot procreate, gay marriage is against both God's law and nature's will. The interest of this viewpoint is one-dimensional: to defend the authority of the Bible as the divine rule book for living.
If the biblical proclamation on marriage is indeed the final word, should fertility tests therefore be required for heterosexual couples before they are permitted marry? Should marriages expire if they remain childless after, say, three years? What about the interest of society in doing everything it can to support committed relationships? Does it not strengthen the institution of marriage to extend its domain rather than diminish its relevance?
Last Sunday afternoon, Holly and I had brunch with a gay couple and their daughter, a delightfully spirited girl named Alice. The male couple had adopted Alice from Peru when she was three weeks old. They recently celebrated Alice's first birthday. Holly and I had a wonderful afternoon with them. We came away thinking that Alice is one of the truly fortunate children in the world. Her parents love each other, and they love her too. The simple-interest view would not have the three of them together at all, much less flourishing as a couple and a family. Through their life together, each contributes much more value—to themselves individually, to each other, and to society as a whole—than they would as individuals alone. This is compound interest at work.
My bottom line, as it were, is this: go and nurture in your life relationships that are substantial and reciprocal. That is where the value lies. Take yourself and your own needs seriously, but take other people and the world around you seriously as well. Knowing that our interests are compound doesn't always mean that everyone wins. But it does mean that we are working in harmony with, and not in opposition to, the fundamental nature of the universe.