Ponzi schemes

A Ponzi scheme is a fraudulent investment scheme which pays unnaturally high returns to investors using the funds received from increasing numbers of new investors who are lured into the scheme. Ponzi schemes can maintain such unnaturally large returns for a limited period of time, but are completely dependent on the number of new investors perpetually increasing. The greater the number of investors already in the scheme, the greater the required influx of new investment to keep on paying the unnaturally high returns promised by this fraudulent scheme.

A Ponzi scheme is inherently unsustainable because, as we all know, the number of new investors simply cannot keep on increasing perpetually. But yet, our economic systems of today show many disturbing resemblances to a Ponzi scheme. The examples discussed below can probably not strictly qualify as Ponzi schemes, but they share a very similar nature: Unnaturally large returns are paid out to people already in the system on the fundamental assumption that the scheme will keep on growing forever. Take good notice of this last sentence, for it describes the very nature of our economic system today.

While a standard Ponzi scheme runs on money, our economic system runs on production. In a standard Ponzi scheme, investors get unnaturally high returns because the amount of new money flowing into the scheme keeps increasing exponentially. And in the heydays of our exponentially expanding economy (roughly over the second half of the 20th century), people enjoyed unnaturally large amounts of consumption because production kept increasing exponentially. 

This exponential increase in production was facilitated by three major factors: rapid population growth, cheap and abundant fossil fuels, and rapid technological progress. These three compounding factors really allowed for astronomical increases in production and easily facilitated Ponzi-scheme-like growth. Roughly since the turn of the century, however, these factors have been simultaneously waning at a very rapid rate. Population growth is no longer exponential (population is actually declining in several developed nations), fossil fuels are becoming expensive and technological progress has run into the law of diminishing returns. In addition, we are starting to face some serious resistances from our fundamentally finite planet

In spite of these numerous and compounding resistances, however, our debt-based growth-dependent economic system has remained unchanged and the obvious economic problems we are facing today should therefore come as no surprise whatsoever. And yes, these problems are fundamentally guaranteed to stay with us (gradually getting worse and worse) until our system gets a fundamental overhaul (either by our own initiative or though a system-wide collapse).

The really worrying thing is that we in the developed world seem to be totally oblivious to the fundamental limits to growth in production discussed above, even though these factors have been gradually growing right under our noses for the past three decades or so. Instead of making the fundamentally enforced changes, we have chosen to keep this inherently unsustainable system going by raking in more and more consumption from the future, primarily through totally unsustainable levels of debt. In essence, debt is nothing other than future consumption taken today and our absolutely skyrocketing debt levels are therefore a clear indication that we have been consuming or futures at an ever-increasing rate.

The one and only reason why we have been able to keep this up to this day is because the vast majority of us participating in this mother of all Ponzi schemes have not yet identified this fraudulent system for what it is. You see, a Ponzi scheme can only continue existing for as long as it can keep on fooling ever increasing numbers of people to invest in the scheme. The moment that investors become aware of this trickery, new investments dry up and the scheme simply cannot keep on paying those who are already invested in it. Soon after this realization, the scheme collapses and a lot of people lose a lot of money.

It is crystal clear that the global Ponzi scheme we call the world economy is slowly starting to unravel. More and more people are waking up to the fact that many governments will simply never be able to pay back their debts. This is nothing other than a loss of trust in the ability of this Ponzi scheme to keep on generating further returns and yes, this is usually the stage when things start falling apart.

The practical effect of a Ponzi scheme is that it facilitates a large redistribution of wealth from those investors who got in last to those who got in first. Since the investors who got in first have been drawing on these unnaturally large returns for a very long time, they would have easily made back their initial investment (plus a large profit) by the time the scheme collapses. Those investors who got in last, however, have only been drawing returns for a very short time and will therefore incur great losses when the system collapses and they lose their investments.

This is exactly what is happening at the moment in the developed world. Older people have been drawing on the unnaturally large returns made possible our Ponzi scheme economy for a long time. In essence, one can say that they are the fortunate Ponzi scheme investors who got in first. Younger people, on the other hand, are now in a situation where this fraudulent system is being exposed at a time when they are still extremely vulnerable. They are the unlucky Ponzi scheme investors who got in last.

In practice, this is manifested as very high youth unemployment and debt. EU periphery countries seem to be the first members of the developed world who are feeling this. Youth unemployment in countries like Greece and Spain is now rising above 50%. Even in the USA, only 51% of those who graduated from college since 2006 have full-time jobs at a time when the student loan bubble is fast approaching its zenith. In addition, a lot of young people who have been fortunate enough to have found work have been duped into using their income to secure a massive home loan in the buildup phase of one of the world’s multitude of housing bubbles. It is therefore clear that the youth of today are in very deep trouble, especially if the economy keeps on deteriorating as many feel it must.

But perhaps the best manifestation of our Ponzi scheme economy is Social Security. The government has been able to promise lavish retirement benefits (in order to win votes) on the false assumption that the system will keep on expanding exponentially forever. As a result, those who are already retired are getting a lot more value out of the scheme than they paid in. For example, the very first recipient of US Social Security, Ida Mae Fuller, received $20,993 in benefits while playing in only $44. Now, however, as the number of active workers per retiree is rapidly decreasing and the economy is weakening, this situation will rapidly reverse with people having to pay a lot more money into retirement funds while they are still working than they get out when they finally retire.

At the moment Western governments are still postponing this fundamentally enforced correction by borrowing ever more unsustainable amounts through government bonds. But it will not be long before it finally dawns on investors that our global Ponzi scheme economy is inherently unsustainable and they will never get back the vast amounts of money they are now lending to the governments of many developed nations. When this happens, loans will dry up and governments will have no other choice than imposing painful austerity measures such as those being imposed in some European countries at the moment.

The honest truth is that the years ahead will definitely not be as much fun (here the word “fun” is used under our idiotic modern definition of ever-increasing amounts of consumption”) as the previous half-century or so. Greeks, Spaniards and Italians can protest all they want, but the fundamental truth remains that we have been using our Ponzi scheme economy to live way beyond our means for many decades and, now that the scheme is unraveling, we will obviously have to start living well within our means. The more we resist this fundamental fact, the more painful the collapse will be.

People should know that there are some very hard times ahead. But unfortunately, as we will see on the next page, the vast majority of us are not prepared for this at all.

6 thoughts on “Ponzi schemes”

  1. Actually, I don’t like this at all. This has now superseded Clive Hamilton’s Requiem for a Species as the scariest thing I have ever read. However, like someone stopping to look at a road accident, I feel compelled to read on… I have never seen students as unwitting investors before; but young people persuaded to buy mortgages – yes – that has concerned me ever since the first big crash in house prices…

  2. Irrespective of whether aspects of modern society resemble Ponzi schemes or not, and I am deeply sceptical of the proposition made here, the graphs shown leave a lot to be desired. That is because the scale of the graphs, especially the first three, are extreme in the x axis. Plus the scale used for those graphs should be the same for all three graphs in order to make an accurate comparison.

    For example, the figures for US debt the period 2000 – 2011 while increasing over the period, bear no relationship to the shape of a Ponzi scheme which has an exponential increase over time.

    Take world population. The growth rate peaked at 2.2% in 1963 but had declined to 1.1% by 2011. Total annual births were highest in the late 1980s at about 138 million, and are now expected to remain essentially constant at their 2011 level of 134 million. Again, no similarity to a Ponzi scheme.

    I honestly think that millions of people around the world understand that growth can not be sustained indefinitely and there are signs from all over this world that changed attitudes and changed behaviours are underway. Eventually, even the politicians will get it!

    1. Thanks for that critical feedback, Paul. Please consider the following points to help me improve this post:

      As I see it, the fact that the graphs are no longer expanding exponentially is exactly the reason why the global economy is failing and many pundits predict lots of economic hardship ahead. For example, if the US debt could keep on expanding exponentially between 2000 and 2011, we would still be happily building the bubble and this Ponzi scheme-like growth would still be continuing today. It is because the scheme gradually ran out of new investors (and eventually gave loans to very irresponsible “investors”) that it eventually collapsed and caused massive wealth transfers from those who got in last to those who got in first – something very typical of a Ponzi scheme.

      The same can be said for the world population. It is because population growth has stopped in the developed world that things like Social Security and Medicare are starting to eat up more and more of the tax-revenue, forcing governments to take on ever greater amounts of debt in order to at least live up to some of the totally unrealistic promises they made in their election campaigns. Again, if population in the developed world could keep on expanding exponentially, we would not be having these problems and this Ponzi scheme would still be happily rolling along, making us all feel very rich.

      I appreciate your optimism about the world beginning to understand the exponential growth problem, but when you look at the two major vehicles through which this Ponzi scheme-like economy is maintained now that planetary boundaries and the law of diminishing returns are making real economic growth progressively more difficult (debt and welfare) it appears that this transition is happening all too slowly.

      Investors are still lending to countries like the US at ridiculously low rates even though the chances of the US ever repaying their debts without massive devaluation of the dollar are virtually zero. Economists predict that the coming fiscal cliff of tax hikes and spending cuts (which would slice the US deficit from something like 9% to 4.5% of GDP) would send the economy into a deep double-dip recession, taking out lots of GDP from under the massive debt burden, thereby increasing the already massive debt/GDP ratio even more.

      The moment that investors realize this and start demanding greater interest on the money they lend to large developed nations (the moment they start to realistically price the risk involved), the game is up. The total debt of countries like the USA, Japan and the UK is in the same range or even greater (as a percentage of GDP) than that of countries like Greece, Spain and Italy. The only difference is that they are “too big to fail”. One has to wonder how long this market perception (which really is the only thing keeping this system afloat) will last.

      With regards to entitlement spending, EU periphery countries are currently demonstrating how the electorate responds to austerity cuts in entitlement spending. Imposing the required austerity (which is implicitly demanded now that the Ponzi scheme is no longer growing) will be politically impossible since any politician who tries it will be voted out as soon as possible.

      To me, the rapid evolution of our unthinking culture of consumerism (through debt) and entitlement (through total welfare states) is clear proof of the Ponzi scheme-like nature of the global economy. I think that such a mindset of living way beyond one’s means (and accepting that as totally normal) can only develop within a Ponzi scheme sustained over a number of decades.

      1. Aren’t western government, especially in the EU trying to keep their Ponzi scheme economies going with internal and inward migration?

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