Most of us have heard of Albert Einstein’s “Theory of Special Relativity.” I’ve heard of it. I can even recite the formula. But to be honest – I know I don’t have a full understanding of it.
When Einstein was asked one day by a newspaper reporter what he considered to be his greatest discovery, the genius who revolutionized our view of physics did not refer to his Theory of Relativity. Rather, he said that his greatest discovery was “The Rule of 72.”
Unlike his more arcane theories, the Rule of 72 is quite simple. It is easy for anyone with at least a rudimentary background in basic math both to understand and apply.
During his early career, Einstein held employment as a patent clerk. During a lull in his work, the question occurred to him, “How long does it take for money to double at a fixed compound interest rate?” So he began computing the answer to that question.
He discovered that it took 72 years for a monetary unit to double at a compounded one percent rate of annual interest. He then tried it with a two percent rate and found that it produced a result of about 36 years. (These calculations are not exact but provide a convenient way to approximate the power of compound interest).
Obviously, the higher the interest rate, the less accurate the estimate this rule provides as we can see by inspection. If we were getting a 72% rate of interest, at the end of a year we would see a similar increase – not the 100% that the rule would suggest. But since few of us have the opportunity to obtain those high rates of returns – for our purposes – the rule can provide some excellent insight.
Why are consumers buried in staggering amounts of debt? The answer is that we have spent money that we didn’t have and have simply added our purchases to our credit card balances. We rush out to get that wonderful item that’s on sale at 20% off – and then proceed to give that discount right back to the credit card issuer who is charging us a compounded 18% – 24% rate of annualized interest.
According to the “Rule of 72” our credit card balances will double in either four or three years respectively at those interest rates. At least interest – including credit card interest – was a deductible item on your Form 1040 for those who itemized. But that deduction disappeared years ago.
Meanwhile, the pittance that you are getting on your savings accounts is fully-taxable. The good news is that at one-quarter of one percent, there isn’t much to report. By the way, at that rate of interest, your money will double in a mere 288 years.
We have gotten into a very dangerous mind-set. Instead of asking, “How much will this cost?,” we ask, “How much is the payment?” This is nothing short of an invitation to disaster.
With the Obama-recession still in force – Washington has shown neither the insight nor the courage to address the question of the nearly-insurmountable debt which we have amassed through our overspending. Not all the fault should be laid at the President’s feet. Congress shares as much responsibility as he.
While the official national debt figure is that America owes its creditors about $15 trillion dollars – the truth is that number does not include unfunded liabilities, Medicaid and Medicare (and with the temporary payroll tax-holiday, now Social Security). The true figure has been estimated to be at least twice that amount. That’s just short of $100,000 for every man, woman and child in this land of the free and the home of the insolvent.
I don’t know about you – but I would be hard-pressed to come up with the funds if someone unexpectedly handed me a bill in that amount.
But that could happen. All it would take would be for those who have been willing to buy our T-Bills; T-Notes and Bonds to decide they had enough and were concerned about the safety of their loans. This would include our Japanese friends and the Chinese – who are perhaps not so friendly toward us – but tolerate our over-indulgence because we are a significant outlet for their products.
Think about it this way. A good friend comes up to you and needs one thousand dollars. You have known this person for a number of years and believe him to be an honest individual. He has just gotten a little over his head and needs this loan for one month – so you lend it to him.
At the end of the month he rings your doorbell. Of course, you’re expecting to be repaid on your good faith loan. But instead, he says, “I know I promised you the thousand plus the twenty-five dollars in interest today, but something else came up. If you would just lend me one thousand fifty dollars, I’ll pay you back the one thousand twenty-five that I owe you.” How would you react to that request? That’s exactly how America is funding its debt – or should I say – our debt.
One can only hope that our creditors never heard the Will Rogers quote, “I am less concerned about the return on my money than the return of my money.” And, hopefully, they have never heard of Einstein’s “Rule of 72.”