Can Compounding Go On Forever?
Exploring the limits to growth
The salient question we are going to explore in this article is: Is there any limit to compounding?
When we consider the exponential function, it has become almost a law of the universe, like gravity.
Every year we've come to expect computers to get 50% faster, smaller, cheaper, and more efficient.
Every year we've come to expect investments to grow 9% or maybe even more.
Every year we've come to expect the economy (GDP) to grow 3% or so.
But can that go on forever? How much longer can it go on?
There's an excellent YouTube video that tackles the topic of limits to growth and argues we have only one decade left:
But what are the real constraints, and how soon can we expect to hit them?
First, let's look at stocks. What is a stock? It is a partial share of ownership in a company. In aggregate, the 500 companies in the S&P 500 index have been growing at a rate of about 8% per year the last 50 years.
What accounts for that growth?
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Expansion in the money supply, perhaps surprisingly, accounts for as much as 7% out of the 8%. The remaining 1% is due to increased efficiency, from globalization, including lower wages leading to higher profits. It is also partly explained by the increased productivity per worker since the 1970s.
So, as long as total money in circulation is expanding, which is a law in a fiat currency regime, we're guaranteed to see at least 7% growth. That growth is merely an artifact of money supply expansion. Nothing actually physically grows, just digits in computer systems. The process by which this occurs is through banks giving out loans, thus expanding the money supply in the process.
In precious metals, we see slower exponential growth, around 5%, because as mines became more efficient, more and more metal got produced. In fact, close to 60% of the precious metals ever produced were produced in the last 50 years alone. That is a staggering fact, and one that is unlikely to continue, due to simple physics. You can't keep producing more and more efficiently from ever-depleting mines forever. Eventually you hit diminishing returns.
What is argued in the YouTube video is that most natural resources are running out, and extracting them will get harder in a decade. The result is that assets backed by physical things, like metals, lumber, oil, land, etc., could become increasingly more expensive. We already are seeing unprecedented levels of soil and aquifer depletion in North America, which spells doom for agriculture in perhaps as little as a decade.
On the opposite side, you have increasing energy abundance (solar) and artificial intelligence, which are expected to drive down costs. Furthermore, as futurist Tony Seba points out, precision fermentation will likely replace most animal proteins by 2030. This means that land will be freed up, and food prices will go down significantly, as most food will be synthetically produced through fermentation. As land gets freed up, cheaper housing will be built, and the price of real estate would fall as well.
The only things we can't synthesize currently are inorganic elements like copper or gold. I'm on the side that those commodities will get more expensive in the near future (5-20 years), but that eventually we'll figure out a way to synthesize even gold.
I believe that within as little as 100 years, with super-abundant energy and processes we can't even imagine, synthetic gold will reach price parity with mined gold. Currently it costs over a trillion dollars to synthesize a gram of gold in a particle accelerator. Source here.
But over decades, the exponential curve will apply to this process. It will get easier and easier, until eventually we'll all be buying synthetic gold. This has already been achieved with diamonds.
What other physical constraints are there? Surprisingly, not many. Most businesses now operate in cyberspace, and trade virtual goods - data. In the area of artificial intelligence, currently it uses a lot of energy, but in the future efficiency will increase (Moore's Law) by 50% per year. The result is that by 2050, artificial intelligence that we have today will use an insignificant amount of energy and may be distributed across users' devices.
The future is bright in terms of resource constraints over the long term. In the shorter term (10-20 years), inflation could push prices higher.
The key takeaway from this article is that money supply (the supply of US dollars) expands at about 7% per year, and has been doing so since the 1930s.
This is why investing is so important - the dollar is constantly losing purchasing power. Some people choose to invest in Bitcoin to preserve their earnings for the future, while others choose gold, and others choose the S&P 500.
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I believe that a diversified approach is the way to win in investing.
The US dollar supply expansion can go on forever theoretically, or it can have a tragic end in the form of hyperinflation. In no case, however, can the dollar gain value on any timeline longer than a couple of years, unless we go back to the gold standard. The developed world hasn't been on a gold standard since 1971.
In our next article, we will discuss how you should budget in order to get ahead of 78% of people.
We will take a look at how to change how you view money, and how you should partition your earnings so that you can save some money every month.
Until next time, happy compounding.