A (0:00)

Foreign hi, I'm Andy Tempte and welcome to the Saturday Morning Muse. Start your weekend with musings that are designed to improve financial literacy around the world. Today is August 30, 2025. Last week we explored the many faces and facets of return and discovered why different types of return calculations matter for making smart financial decision decisions. We touched on the cagr, or compound Annual Growth Rate, and mentioned that the power of compounding deserves its own deep dive. So today we're beginning a three part journey into what Albert Einstein allegedly called the eighth wonder of the compound interest. While we've covered the moral evolution of interest and basic interest calculations in previous episodes, compound interest represents something far more powerful and mathematically elegant. To understand why this concept has captivated mathematicians, philosophers and investors for centuries, we need to explore its historical development. Now, our story begins with one of America's most ingenious founding fathers, and yes, that is Benjamin Franklin. In 1790, Benjamin Franklin died and left behind one of history's most famous demonstrations of common compounding. Franklin bequeathed 1,000 British pounds each to the cities of Boston and Philadelphia. With strict instructions, the money was to be lent to young TradePeople for exactly 100 years. Franklin calculated that after a century of compound growth from lending to tradespeople and then reinvesting those proceeds, that each fund would multiply substantially. But here's where Franklin's experiment became truly extraordinary. He stipulated that after 100 years, each city could spend part of the money on public works, but the remainder must continue growing for another 100 years. Franklin predicted that those funds would be worth millions after 200 years of investment and compounding his mathematical framework, it proved to be sound, though real world challenges affected the outcomes. When Boston's fund matured in 1990, it had grown to US$4.5 million, or approximately 2.7 million British pounds at 1990 exchange rates. Remember, only 1,000 British pounds was invested at the outset. Back in 1790, Philadelphia's fund reached US$2.3 million, or approximately 1.4 million British pounds, significantly lower than expected due to early mismanagement and periods when the funds weren't being actively lent out to tradespeople. Despite falling short of Franklin's optimistic projections, both funds still demonstrated the substantial power of compound growth over two centuries. Now Franklin understood something that contemporary mathematicians were simultaneously formalizing that compounding doesn't just add growth, it multiplies it. He was essentially conducting a 200 year economic experiment to prove that patient capital, given sufficient time, could transform modest beginnings into substantial wealth. This principle of compounding, where returns generate their own returns, would become the foundation for modern finance. While Ben Franklin popularized compound interest in America, the mathematics were being calculated and developed by European scholars throughout the 17th and 18th centuries. The period following the bank of England's establishment in 1694 created sufficiently stable currency systems for mathematicians to develop more sophisticated calculations about long term growth. So our historical progression of our story here is really important. We needed those stable currency systems to then begin really talking about and developing the math behind compounding. Now, our next historical figure is Edmund Halley. Yes, that's the same astronomer who identified Halley's comet. He made crucial contributions to compound interest calculations in the 1690s. At the time, he was working for the English government. And Halley used compound interest principles to create the first actuarial life tables, which are statistical charts that calculate life expectancy and mortality rates. Why is this important? Because these tables became the foundation for life insurance and annuity markets that still function today. Halley's work demonstrated that compound interest was a practical tool for managing risk and planning for the future. His calculations helped determine fair prices for life annuities, where an individual could pay a lump sum today in exchange for guaranteed income payments for life. Swiss mathematician Leonhard Euler further refined compound interest calculations in the mid-1700s, developing formulas that made complex calculations more manageable. Euler's work laid the groundwork for modern financial mathematics, showing how interest can compound continuously rather than just annually, depending on the terms of the contract. Later on, we'll talk about continuous compounding, daily compounding, monthly compounding, and all that comes from Euler. These mathematical advances occurred alongside growing sophistication in European financial markets. Government bonds, corporate securities and insurance products all depend on accurate compounding calculations. Now, to understand compounding's power, we must also examine its potential for destruction. Now we're going to talk about the Dutch tulip mania of the 1630s, because it provides a really great example of what happens when prices grow exponentially. Now, in the early 1600s, tulips were exotic flowers that were newly imported to the Netherlands from the Ottoman Empire, what is now modern day Turkey. Their vibrant colors and unique patterns made them status symbols among the wealthy. In the Netherlands, as demand grew, tulip prices began rising, slowly at first, but then dramatically. What started as rational price increases based on genuine scarcity became a speculative frenzy driven by compound growth expectations. Expectations, tulip price doubled, and then they doubled again, and then doubled again. At the peak of the mania, a single tulip bulb could cost more than a skilled Craftsman annual salary. The mathematical principle driving tulip prices was essentially compound growth applied to speculation. Buyers purchased tulips not for their beauty, but because they expected prices to continue, continue compounding upward indefinitely. Sellers reinforce this expectation by demanding ever higher prices, creating a self reinforcing negative cycle. When the bubble burst in early 1637, tulip prices collapsed by over 95% in a matter of weeks. Fortunes built on the expectation of compound growth vanished overnight. The tulip mania demonstrated that while compound interest can create wealth when applied to productive investments that actually earn returns, the same mathematical principle of exponential growth can destroy wealth when applied to speculation and asset bubbles. Now, the most significant application of compound interest during this historical period was in government finance. Now, this is not a snooze fest because this is a really important example. Following England's successful model with the bank of England, European nations discovered that they could fund wars and infrastructure projects by issuing bonds that paid interest over time. The French government, struggling with massive debts from various wars, and this is why it's important, including the United States Revolutionary war. While the French issued increasingly sophisticated bonds throughout the 18th century. And these instruments promised to pay holders not just their principal back, but compound interest. Over periods spanning decades, the French national debt grew exponentially as compound interest on previous borrowings added to new debt issuances. We are living this phenomenon today with the explosion of the United States national debt and its corresponding gigantic interest burden, approaching a trillion dollars a year. This expansion of government debt had profound historical consequences. France's inability to service its compound interest debt became a major factor leading to the French Revolution in 1789. The mathematical force that could create wealth for individuals could also bankrupt nations when applied irresponsibly to government spending. Now, the English government, by contrast, managed their debt more carefully and established the credibility that allowed them to borrow at lower interest rates. This virtuous cycle of responsible debt management and lower borrowing costs helped finance Britain's rise as a global power during the 18th and 19th centuries. Now, these historical examples reveal something profound about compounding. It is a force that has shaped nations, funded revolutions, and has created or destroyed countless individual fortunes. The thread connecting all of our stories is time. Compounding requires patience, discipline, and long term thinking. Franklin's 200 year experiment succeeded because he understood that compounding's true power emerges not over months or years, but over decades and generations. Next week, we'll move from these historical foundations to practical applications. We'll explore the basic mathematics that Franklin and Halley used, examine simple examples that illustrate compounding's power and discover why. Understanding these principles is absolutely crucial for anyone early in their career, especially if you're just starting your career in your 20s. Who wants to build substantial wealth over their career? Want to be a millionaire? Tune in next week. So until next week, I wish you grace, dignity and compassion. My name is Andy Tempte. This is the Saturday Morning Muse. You can find the show on all the major streaming services as well as out on YouTube. Please like, subscribe, rate and most importantly, importantly, share this public good with your friends, your colleagues, your neighbors and a family member or two. The show was produced by Nicholas Tempte and we'll see you next time on the Saturday Morning Museum.