The US Government’s Great Ponzi Scheme

Hyman Minsky was an economist who pioneered analysis of debt bubbles. Charles Ponzi was an Italian businessman turned con-artist in the US. Barack Obama is a ‘community organiser’, also turned con artist in the US. The US debt ceiling debacle is the story of what you get when all three go into the opium business together…

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OK, let’s get back to the Markets and Money. President Obama made two interesting admissions during the debt debacle over in the US.

First he suggested that Social Security payments would not be processed on time. That’s interesting because Social Security is supposed to be funded independently. It’s supposed to have assets that it sells to fund payouts to retirees and others. So why would it struggle during a government shutdown?

This is a great example of the type of switcheroo the government plays on people. And the same is about to happen here with our Super system, so pay attention.

What the US government did was invest the Social Security system’s funds into government bonds. It turned an asset of the people, who pay taxes into the fund like you pay Super, into a liability of the government. For Social Security to pay out, the government has to be paying out on its debt. So in the end, those relying on Social Security are relying on the government’s budget.

That’s precisely what Social Security was supposed to avoid in the first place. It was supposed to establish a fund to draw down on so the government didn’t have to borrow to pay retirees. But those funds were spent by the government when it issued the bonds. They’re gone. The net effect is to make the asset of people’s savings disappear into a government spending black hole.

Terrible, isn’t it? Unless you’re the politician who got the windfall funding. That’s why Australia’s brains trust is looking to copy the idea for Superannuation. Ken Henry and the Cooper review noted the lack of bonds held by Super savers. Fair enough; holding bonds is a good idea for retirees.

But if they end up investing in government bonds as part of a government program to secure funds for the government, the situation will be the same as in the US. A private savings vehicle will end up relying on the government budget in the end anyway, with their savings spent by politicians in the meantime.

The second interesting slip by Obama was that he argued the US government would default on its debt if the debt ceiling was reached. That’s nonsense. Unless Congress decided paying the US government’s interest bill was less important than funding the thousands of ridiculous projects it pays for, like the Panda Cam we keep mentioning in the Daily Reckoning.

But here’s where Minsky and Ponzi come in. Minsky argued that debt financing becomes ‘Ponzi finance’ – named after Charles Ponzi and his clever way of paying off old investors with new investor’s funds – when the borrower needs to raise fresh capital just to cover interest on existing loans. In other words, when you borrow to pay off your existing debt.

If Obama reckons the US government has reached the point where it needs to borrow more money to pay its existing debt bills in order to avoid a default, it has reached the Ponzi finance threshold.

Minksy, Ponzi and Obama aside, it’s kind of a bizarre position to take in the first place. If you need to incur new bills in order to pay your bills, aren’t you just increasing the size of your bills, not paying them off?

Anyway, the problem with reaching the Ponzi finance threshold is that you are doomed from that point on. The system will eventually fail when you run out of new lenders. Not that anyone knows where that point is. It should be the moment you hit the Ponzi threshold, if the lenders are clued in and make a run for it. But there are other factors at play when it comes to the US. More on that in a moment.

All this assumes Obama has it right on the risk of a default in the first place. Which he doesn’t. But it’s interesting to note his rhetoric. Acknowledging that you’re running a Ponzi finance scheme is a remarkable achievement. Very few organisations live to tell the tale.

The Americans will eventually reach the actual Ponzi finance threshold on their current trajectory anyway. So why are its creditors still happy to lend the money?

Perhaps America is unique because of its military. That sounds bizarre at first, but the appropriately named Max Boot at Commentary Magazine reckons the US military is all that’s preventing China from pulling its funding support to the US government:

Thankfully the U.S. armed forces are still strong enough-for the time being anyway-to prevent the Chinese military from showing up on our shores to collect the trillions we owe them.

The irony is of course that the Chinese are the financiers keeping the US military afloat in the first place.

The Chinese are hinting they’re aware of all this. Here’s the Chinese news agency Xinhua’s take on the new debt ceiling deal:

‘[P]oliticians in Washington have done nothing substantial but postponing once again the final bankruptcy of global confidence in the U.S. financial system… [The debt ceiling deal] was no more than prolonging the fuse of the U.S. debt bomb one inch longer

The Chinese strategy for dealing with foreign empires has always been ‘grit and bear it’. Over time they will see the Chinese way is better, say the philosophers. It worked rather well on the Mongolian conqueror Genghis Khan and his successors, who ended up gradually assimilating over several generations after invading China. Far more effective than the Great Wall was.

The British stiff upper lip did much better against the Chinese strategy of absorbing foreigners. Its commercial empire made the most of China, swapping valuable stuff like silk and tea for addictive opium out of British controlled India in the mid-18th century. But eventually the Chinese had enough of the raw deal and started the Opium Wars. The Brits were a superior fighting force and ended up with Hong Kong and trade deals after the dust settled.

But what do the Opium Wars have to do with today? Well the situation is similar. Only the US is in the position of the British Empire. The Chinese have been very patient with America. But the fuse is fizzling. At some point, the Chinese will be sick of the raw deal they’re getting – sending valuable stuff overseas in exchange for paper US dollars, which you can’t even smoke. Perhaps there is something to the idea of the strong US military after all.

The Chinese have a long memory, so all of this is relevant. That’s why you might just hear about it again in more detail at our coming conference. The theme deals with the coming version of the Opium Wars. At least that’s one angle. You can sign up for advance notification here if you’d like to express your interest. The speakers list is a thriller.

Back to the paper US dollar, which the Chinese are still begrudgingly accepting for their export goods. It tumbled overnight after Federal Reserve board member Dick Fisher opined that the debt ceiling debacle has ‘swamped’ QE taper prospects.

Remember the taper? It was last month’s crisis that failed to eventuate. Anyway, now it may be delayed even further. Fisher is known as a ‘hawk’ who favours less stimulus, so if he is saying QE should continue past October (which he did), chances are it will. Especially with the debt ceiling debate to return in three months time.

Gold surged on the news of no tapering, the US dollar tanked and the Aussie dollar jumped. And the American stock market reached a new high. Of course, all this is the opposite of a few days ago, so in the end the moves aren’t that big.

That’s the story of the last few years really. All sorts of remarkable events, but not much happening in the markets themselves. But as financial guru and philosopher Nassim Taleb likes to point out, stability breeds instability. Something big is coming.


Nick Hubble+
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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