In a Ponzi scheme, money is taken from one source to pay for another, without actually having a real foundation or solid guaranteed future store of funds.  The initial returns generate excitement leading to more spending based mainly on reporting of false gains and the continuing propagation of unrealistic ideals.  At some point, the scheme loses its’ viability and fails to deliver as promised resulting in collapse and loss of funds, leaving victims’ scrambling to try to make up in some way for their losses.

The most famous Ponzi scheme of modern day was run by Bernie Madoff from New York City who managed to turn $5,000 saved from a lifeguarding job and installing sprinkler systems into nearly $65 billion of accounts.  During the run of the scheme he was able to amass an impressive list of clients including numerous celebrities and other well-known public figures.  Arvedlund, E. (2018).

His scheme was so elaborate and well-thought out that he was able to keep it running for over two decades while offering ten percent or higher returns.  In addition, his firm, Bernard L. Madoff Investment Securities, at its’ peak was handling five percent of the trading volume on the New York Stock Exchange.  The scheme was exposed when his sons turned him in after he admitted to them that he was running a Ponzi scheme.  Subsequently, he was sentenced to 150 years in prison. Arvedlund, E. (2018).

Perhaps the biggest example of obtaining funds based on future (potential not guaranteed) gain, scarily similar to the workings of a Ponzi scheme, belongs to the Federal Government.  The Federal debt now runs over $21 trillion.  How did it get there?

Federal Reserve critic, John Hussman, views the United States as a country that has over time evolved into a Ponzi economy.  Expansion of debt has become the normal operating platform. Domestic investment has held steadily at a very slow rate of 1.4 percent since 1999 compared with the 4.9 percent rate consistent over the previous five decades.  In addition, recent years have seen the interest of the Federal Reserve lower to stand at zero.  Morgan, J. (2014)

Indirectly, this prompts the average household citizen to take on more debt, rather than storing away savings.  You only need to visit a furniture store to be told that you will not have to make payments for a certain amount of time but you can still have the goods immediately.  When the ‘no payment’ term is up, customers are subject to usually higher than average retroactive interest rates.  Therefore, if it not possible to then pay what is owed, what seemed like a good deal at the time has turned into an even higher accumulation of debt.  Immediate rewards overshadowed any thought as to how things might come tumbling down in the future.

In the same way, the Federal Government may give the superficial illusion of immediate rewards by touting successful programs as the end result of their spending.  The reality, as evidenced by the current $21+ trillion and growing debt, may portray a completely different story – one of unsustainable results – much like a Ponzi scheme.  The question here is where are they planning to obtain the funds to pay off this herculean debt?

In a Ponzi scheme, paying off current debts or investors relies on obtaining a constant source of new funds from payers who hope to benefit from promises.  The Federal Government relies majorly on systematically obtaining new funds from tax payers and has the power to initiate increases as per their discretion.  The general population is seen as a huge pool of funding to draw from without thought as to the consequences of their financial stability or future.  This sort of thinking may well have an impact on weakening the economy by compromising the financial security of the workforce.  The gap between income and consumption increases and debt levels rise.

As spending continues, the situation becomes impossible and as a natural result will collapse, will leave financial losses in its’ wake.

There are certainly parallels between Ponzi schemes and the way that the Federal Government sources, engages and funds their own programs.  The idea that as long as people are there to pay into the system, either voluntarily or involuntarily, it can keep running indefinitely, without worrying about the initial debt-load, is very similar in both cases.

What will happen should it reach the point that the incoming sources of funds can no longer keep up with the continuing debt load of the Federal Government? What happens when the economic system of the so-called Ponzi scheme collapses? We just have to look at recent examples such as Russia in 1998, Argentina in 1999 and currently Venezuela. The fiat system is backed by essentially nothing. As consumers we value a $100 bill just as $100 but it is in essence a federal debt issue that is backed by nothing.

Continual printing of money leads to hyperinflation then most likely an economic collapse. The Ponzi scheme must come to an end as obtaining more funds comes to an end. The winner could be the astute individual who owns gold and gold backed securities. If history proves correct, and if my opinion on the stock market decreasing in late 2019 into 2020 becomes reality, then gold should be the benefactor. I hear a lot of my friends and associates whining that they should’ve invested early in the cannabis sector…to be honest, I am one of those but there is always an opportunity around the corner and in my opinion gold and gold stocks are just warming up. I’m excited to see what will unravel in late 2019 and beyond for this undervalued sector.

Happy Investing!

Dr. Kal Kotecha

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References

Arvedlund, E. (2018).  A decade after Bernie Madoff’s arrest, FBI agents reveal more about his Ponzi scheme.  http://www.philly.com/philly/business/bernie-madoff-fbi-patrick-duffy-paul-roberts-fbi-20181206.html

Hussman Funds (2018). Hussman: Our Entire Economic System is a Ponzi Scheme https://www.hussmanfunds.com/comment/mc180604/

Morgan, J. (2014) Hussman: The US Economy is Becoming a Ponzi Scheme https://www.newsmax.com/finance/hussman-ponzi-us-economy/2014/09/23/id/596356/

 

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