Einstein’s General Theory of Investment

“The most powerful force in the universe is compound interest”

Albert Einstein

   “Not any more…”

Ben Bernanke

Einstein was a genius known for his simple elegant expressions of complex natural laws.  Indeed, what is simpler than E=MC2? While it may be urban legend that Professor Einstein was reputed to have said that compound interest was the “eighth wonder of the world and the most powerful force in the universe”, the point is well taken. 

“Compound interest is the eighth wonder of the world.
He who understands it, earns it … He who doesn’t … pays it”

Albert Einstein

Einstein’s observations were perfectly accurate back then as he noticed that the universe was expanding.  Because growth is a natural phenomenon, the human race, in general, and any man, in particular, can take advantage of natural law by putting off consumption today and investing in the future.  This is the force behind compound interest.  A seed of corn not eaten but planted will multiply into a thousand seeds at the future harvest; an acorn nurtured and planted can produce a mighty oak; an olive grove cultivated now may take 40 years to mature but it will take care of future generations. Thus, the moral of the story is always the same:  Save today, invest for the future, and reap fabulous rewards.  If you can invest at 7.2% for ten years, your wealth will double! 

The mathematics of finance should be incredibly simple and elegant to watch in motion but they’re not, thanks to the efforts of the Federal Reserve. 

Einstein came to America during a time of great turmoil in Germany and Europe. Germany was turning into a National Socialist Party with a dictator and command economy. In a command economy, interest can be fixed by the government at zero or even negative, and savings accounts can be stolen and used to fund the wishes of the state. The river of investment that runs forward creating capital can be forced by state-created inflation to run in reverse, destroying capital.  In other words, seed corn rots if it’s not eaten, and investment dries up because saving is for suckers.

Ah, welcome to 2012 America.  The Fed has decreed interest rates at zero for four years, and promised to keep them there for at least another two.  The Fed is still printing money out of thin air as well as buying long term treasuries.  By locking the yield of the 10-year Treasury at 1.6%, it’s well below the rate at which staples like food, energy, utilities, transportation, education, and health care, are rising in cost.

Today, and as far as the eye can see, real inflation is well above interest rates.  Instead of savers being rewarded they are being taxed, mugged, and systematically destroyed by continued low interest rates with no return on capital as the Fed tries to get people to spend and not save to stimulate the economy.  Where capitalism in our country as Einstein knew it used to flourish, we’re now a land dedicated to eating its seed corn, and encouraging people not to waste their time planting acorns for the future.

Is it any surprise that pension funds that assume they will earn an 8% return are all headed to insolvency?  It is now a simple mathematical fact that with spending encouraged and savings taxed and given a negative return, only the superrich can set aside sufficient resources to take care of themselves as they age.  The average American is destined to be a ward of the state.

Einstein understood physics and natural law. He knew that if interest rates are set at zero and well below the rate of inflation, capitalism would die. Trying to run an economy without real interest rates is like trying to run the universe without gravity.  It doesn’t work. 

Whenever I fly or take public transportation and hear the government announcement “if you see something, say something”, it reminds me of Einstein because he came to America to honor and support our capitalistic system, and would have stood up to Ben Bernanke today by insisting he stop printing, before the train of capitalism crashes.