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Einstein's relativity theory and finance

The life and works of Albert Einstein have long fascinated me and reading a book on his famous theories over the summer break, brought out my inner physics geek. As I delved deeper into his Theory of Relativity, I wondered, could any metaphorical parallels be drawn with money and finance?

The theory, simply put

Einstein concluded that because the speed of light is absolute no matter one’s frame of reference, then time and space are relative concepts.

For example, if I am at rest and a friend flies past me in a rocket at 90% of the speed of light, both of us will measure the speed of an oncoming photon of light to be the same. That speed being a universal constant and upper limit on the speed of any physical particle in the universe at 3.0 x 10^8m/s. How can that be?

When Einstein realised that the speed of light was absolute, it set him on a path towards his theory of relativity. Which basically infers that the invariance of the speed of light is such that time and space must compensate. That they are malleable and can vary depending on an observer’s relative motion. That time and space are intertwined.

How does Einstein’s theory align with money and finance?

Just like time and space, money is relative. Both in terms of perceived value compared to others, and in individual terms at various stages in life. A million dollars may be of huge value to most of us, but to an elite cohort, it may just be a rounding error in their high-life transactions. And money that may be frittered away with gay abandon in one’s youth, suddenly becomes far more protected in retirement.

The constancy of the speed of light to all observers in relative motion might be comparable to the importance of financial concepts that are also constant over time. Such as supply and demand, and risk and reward. Just as space and time are inextricably linked in Einstein’s world, so too are risk and reward in the world of finance, and supply and demand in economics.

Consequences of relativity theory are time dilation and length contraction. An object moving at a constant velocity experiences time more slowly than if it had been at rest. And as time and space are interdependent, then a reduction in time must be accompanied by a reduction in space, known as length contraction. This also ensures the speed of light remains constant, no matter the frame of reference.

Note that only at speeds of a significant fraction of the speed of light, does time dilation and length contraction become material. This is shown here diagrammatically for the brave.

Just as speed squeezes time, so too does the speed with which the price of goods and services rising in the economy, squeezes money. This has never been more evident than in recent times, with inflation reducing the purchasing power of money within a short space of time. The value of money today can be very different to that in the past and in the future.

And the length of time required to achieve financial goals, contracts with compounding interest. Einstein once said, “compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it”. Invested wisely, time grows money. Time can lengthen money.

Relativity equations map space and time coordinates in one frame of reference, to a different set of coordinates in another relatively moving reference frame. Similarly, financial modelling and economic forecasting may map to different outcomes on for example, movements in regulatory or geopolitical settings, and market shocks such as pandemics and wars, which may severely impact supply chains and monetary settings.

Finally, depending on one’s motion according to Einstein, observations can be relative. Perspectives on certain asset types can similarly be relative and influenced by factors such as risk appetite, investment horizon, and market conditions.

There you have it. Physics and finance may not form quite the continuum that space and time does, but sometimes trying to align underlying principles on unrelated topics can inspire new thinking, reinforce concepts, and offer insights into sometimes complex issues.

 

Tony Dillon is a freelance writer and former actuary. This article is general information and does not consider the circumstances of any investor.

 

5 Comments
George Bijak
January 28, 2024

Great analogy, Tony! While the laws of physics can be tested repeatedly with the same result, the world of investments is less predictable and repetitive. The dynamics of investment returns are also cyclical, meaning the driving forces carry varying weight at different stages of the cycle. The cycles themselves are not fixed in length and amplitude. It appears, in order to outperform the market, investors need more intellectual power than rocket scientists :)

richard goers
January 28, 2024

popup thinking here, as getting mind around this is extremely stretching to my intelligence, but in the investment space, HFT that makes small change or cents per trade but in continuous time and reinvests those 'cents in fractions of time' into the capital for trading makes significant more than Buy - Hold investment time line [years / so reinvestment of profit into the equity curve must be exponential to the linear return of long term passive - given also the HFT mathematics suggest it is most improbable you lose money in any 1 day even with a 50% win rate [a document on Virtue Financial IPO shows the math] = 50% win, 25% loss, 25% scratch = with thousands of trades per day [diversified portfolio] - effort : reward [+ cost]

Steve
January 25, 2024

There is another analogy between a physics concept and people which can clearly apply to finance. It is called the Dopeler effect (analogous to the well-known Doppler effect), which is the ability for someone to appear brighter the further away they are! I'm sure we all know someone with this trait....

Allan
January 26, 2024

"[..]" ...the ability for someone to appear brighter the further away they are! [..]" Would that be 'the further away they are, 'from the truth', Steve? Then there's the 'Dunning-Kruger effect' for one to ponder upon. 

Pradip
January 26, 2024

Fact of the matter is that even if you look at the most beautiful person or thing under a microscope, you will see the cells and molecular activities - all the beauty would seem to disappear. And, furthermore, under the microscope, all will appear to be the same. Ask all the ex's of Liz Taylor and they will be able to elaborate on this with first hand experiences

 

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