Financial Stability, + Website

CHAPTER 14 Mathematics: (1 + i )x > (E = mc ²)

At a press conference when Albert Einstein retired, a journalist asked the great physicist to identify the most important mathematical formula in history. Einstein’s theory of relativity led to the nuclear and thermonuclear bombs that Einstein warned against, as well as thousands of peaceful applications. Yet he smiled and said: “One plus i to the x.” Einstein observed that the formula for compound interest had had more impact on humanity than any other equation. ¹

The theory of financial stability minimizes both i and x in the formula when applied to the assets and liabilities of financial intermediaries. That is how equilibrium in finance achieves the maximum level of equity and productivity growth for all sectors of an economy. Using that same formula, moreover, we can calculate the precise impact of changes in i on the investment value of any given level of cash flow that an economy produces. That result is illustrated in Table 9.1.

Financial stability minimizes the burden of finance on production and maximizes the efficiency of investments that generate productivity. It does so, however, by minimizing the margin that financial firms often use to fund compensation paid to financial managers.

It is easy to demonstrate the long-term growth benefits to financial institutions from minimizing margins that maximize the growth of their customers’ wealth and thus their needs for financial intermediation—the business of banking. It ...