A Socialist View of Compound Interest

Mainstream economics is adamant against looking at debt as something that can grow exclusive from a society’s ability to carry it. There have been few who have bothered to even conduct an investigation. Usually one has to look at socialists or lunatic fringe rightists to get any kind of questioning. Even then, the rightists tend to be very poor in their analysis. It was Karl Marx who put forth the best work on it. A critique of capitalism is needed to even begin looking at the flaws within it. Mainstream economics has no such desire to do so.

What we do have is a common refusal to accept that financial crisis tends to grow until insolvencies drain away saving that had been poorly invested. A major cause of bankruptcy today is the use of savings placed into real estate, stocks and bonds that end up losing their value. Since our present capitalist system is highly financial in nature, the greatest risks in bankruptcy lie within the hands of the financial sector. A majority of a bank’s holdings are in real estate, stocks, and bonds; not customer deposits as it was in times past. When these investments fail, the consequences are devastating. Banks become unable to pay out people who withdraw cash and for insurance companies to pay out to their policyholders. This poses a great danger to the economic system, one that we saw quite clearly with the Great Recession of 2008. The best defence they have is to hold on to debts long after they would have normally forgiven them – even if it has a negative effect on the economy itself by keeping it insolvent.

Marx foresaw this all the way back in his day. He described money lent out at interest as a “void form of capital.”[i] He saw it as “fictitious capital.” The reason he called it fictitious, was because it wasn’t based on the means of production. Instead, all these interest-bearing activities are claims on the means of production. He saw it as fictitious because the demands for payment could not be met. Marx noted that when you try to services these rising debts, the result has been a deflation in the market for commodities. This caused an oversupply that led to crises where companies scrambled for money, but the banks were short on funds and failed to provide it. When it comes to production, interest is always a subtraction from the profits of an enterprise. As this happens, there is a reduction in reinvestment in production. Instead, that money goes to the creditor, not spent on goods and services which would stimulate demand.

Thus we see the truth: financial capital is antagonistic towards the creation of real value via physical capital. As industry cannot function without credit, that same credit undermines its ability to produce profits. This antagonism is a manifestation of contradiction within capitalism. What it needs to function, is also poisonous to it.

Marx describes the circuit of capital for industrial production as: M – C – M’. M is the money that is put up for production costs, the input which sets the whole process in motion. C is the commodities that were produced that the capitalist then turns around and sells. M’ is the money the capitalist receives from the sale of those commodities which is greater than the amount he began with. Finance capital is described differently: M – M’. Or, money that sells for more money. This refers to credit, all kinds of financial investments that have nothing to do with tangible value creation. These include mortgages, personal loans, credit card debt, trade finance, and government bond financing for war activities. Here we can see why past economists predicted that credit and interest would end up subservient to industrial production. Yet, in our modern society, it has not. It has taken on a life of its own and made industry subservient to it. When a crisis hits and industrial firms go under, financial capital is there to snatch up all the assets held by those companies. When this happened, property and wealth flowed into the hands of the financial capitalists. As we know, crisis is inevitable in capitalism. In hindsight, it is inevitable that financial capital would come to dominate.

When we see debt deflation, what are we witnessing? We’re witnessing a reduction in the ability of businesses and labour to consume commodities. This is also known as a reduction of purchasing power. This takes place when these two groups are subjected to debt service, and when government taxes revenue to pay bondholders as opposed to using the money to invest in public infrastructure. This lack of purchasing power causes the domestic market to shrink which reduces the ability of debtors to pay their debts even further. When the economy starts failing in this way, people have a tendency to save money in the expectation of a possible income loss – which then makes the problem even worse.

Despite having recognised this, Marx failed to place this into his model of the capitalist economy. Most believe he had planned to do so, but he died before he was able to. The absurdity of compound interest, which leads to money-capital infinitely expanding to the point of crisis – Marx saw as being subordinated to the ebbs and flows of industrial capital.

“The commercial and interest-bearing forms of capital are older than industrial capital, but … [i]n the course of its evolution, industrial capital must therefore subjugate these forms and transform them into derived or special functions of itself. It encounters these older forms in the epoch of its formation and development. It encounters them as antecedents … not as forms of its own life-process. … Where capitalist production has developed all its manifold forms and has become the dominant mode of production, interest-bearing capital is dominated by industrial capital, and commercial capital becomes merely a form of industrial capital, derived from the circulation process.”[ii]

Marx’s optimistic view was that industrial capitalism would mobilise people’s savings in a productive direction. In a sense, the problem would solve itself.


[i] Marx, Karl. Capital: A Critique of Political Economy Vol. 3. 1867

[ii] Marx, Karl. Theories of Surplus Value. 1863