The Great American Ponzi Scheme
Jan 14th, 2009 | By Bill Bonner | Category: Financial NewsGive us Madoff! Give us Madoff! “Oil rises to $39 on Bernanke comments…” “Asian stocks rise after Bernanke remarks…” When they turned out the lights and closed the doors in New York last night, the Dow had lost 25 points and oil had gone down to $37.
But this morning, investors seem to be feeling better about things. What did Bernanke say to bring about the turnaround?
We find the report on the front page of the International Herald Tribune:
“More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets,” said the main man at the Fed, speaking to an audience at the London School of Economics.
He went on to say that he didn’t necessarily like bailing out Wall Street, but it “appears unavoidable.”
Nothing particularly exciting about that. But then we turn to page 12:
“Bernanke warns that bigger bailouts needed around the world,” is the money headline.
And then, the report gets down to business. The world economy is dangerously ill, says Dr. Bernanke, or words to that effect. We’re going to have to try some experimental drugs to rescue it.
“Beyond buying troubled assets from banks, Bernanke said, another option was to provide asset guarantees under which the government would absorb part of the banks’ losses in exchange for warrants and other forms of compensation. [Of course, if the banks had any means of compensating investors they wouldn’t be in this fix.]…
“Bernanke also expressed support for the idea of creating a so-called bad bank that would allow the government to buy financial assets in exchange for cash or equity.”
Here is where we laughed so hard we thought we might damage our midriff.
Create a ‘bad bank?’ Is he kidding? The world’s full of bad banks already – banks that did just what Bernanke is proposing to do; they bought financial assets, notably mortgage market derivatives, for cash. Now, they turn to the taxpayer, desperate for a handout to keep them from going under.
And the baddest bank of all? Next to the Central Bank of Zimbabwe it’s the US Fed. What’s it doing? It’s buying trash and paying cash. In this way, the mistakes of rich bankers are transferred to the people… via the people’s bank – the Fed. Of course, the people don’t know what’s going on. And they won’t notice either when the Fed eventually unloads these toxic assets – in the dark of night.
We have not checked the gold market this morning. Yesterday, gold held steady at $820 and appeared ready to drop into the $700 range. If gold doesn’t go up this morning, investors are not paying attention.
Let’s go back over the fundamentals. The world economy is correcting. The feds are trying to stop it. They tried their Friedmanite monetary stimulation – cutting rates to zero. And they’re sweating like Sisyphus, trying to make Keynes’ fiscal stimulus work too.
Both will fail – for the reasons we explained in these Daily Reckonings. You can’t help an alcoholic by giving him free hooch. And you don’t do a fat man any good by offering him another dessert.
*** In a broad sense, the social welfare economies of all the advanced Western nations are nothing more than Ponzi schemes. Typical is the Social Security system of the United States of America. It survives only as long as there are enough new contributors to cover the promises made to the old ones. As in any Ponzi scheme, the first ones into the system do very well. The very first beneficiaries put in little and got a lot out – depending on how long they lived. But as time goes by, the deal goes bad. Middle-aged people today would be better off with a private pension system… and the young are unlikely to see any benefits at all.
John Law never lived to see America’s system of public finance at work. Nor did Charles Ponzi. But even without a paternity test, each would have recognized it as his own.
Bernie Madoff is still alive as of this writing. He is the world’s reigning champion… title holder in the Ponzi league. Yet, compared to America’s system of public finance, his scheme was penny ante… chickenfeed. Madoff’s swindle cost investors only about $50 billion. America’s dollar swindle will cost them trillions.
The nature of the scheme is most easily understood by looking forward rather than backward. President Obama announced last week that Americans faced “trillion dollar deficits for years to come.” Already, the estimate of the deficit for 2009 was $1.18 trillion. Some experts predict a deficit over $2 trillion. At least one guesses that it will come in over $3 trillion, if not in 2009 then the following year.
These huge deficits do not seem to disturb the sleep of the homeland bound citizens. A trillion-dollar annual deficit, over 5 years, would add about $50,000 to each family’s burden of debt. But some intuition assures Americans that they will never have to pay it. By instinct alone, they know it’s a Ponzi scheme.
The day is long past when Americans could say “we owe it to ourselves.” A large part of US borrowing is taken up foreigners. There is no way these enormous deficits could be financed by domestic savings. The foreigners have to pony up the dough, or the US will run out of money. They do so in the hope of getting the money back – with interest. But how can the US pay back the money it borrows? It has no earnings. It has no surpluses. Instead, it must borrow more to service past borrowings. It must depend on bad money to come in so the good money can go back out. It is a scheme John Law would love; Ponzi would be proud of; and Bernie Madoff can operate.
As we write, nothing is more remarkable than the credulity and gullibility of the world’s patsies. Bernie Madoff’s oldest friends would come up to him and practically beg him to take their trust funds. People joined his Palm Beach country club just so to get close enough so he could separate them from their money.
And now, investors practically stumble over one another in their eagerness to lend money to world’s biggest debtor. In all the astonishing figures now crossing the big board probably none is more amazing that the current yield on US Treasury paper. At barely over 2% yield on 10-year notes, investors lend money to the feds and ask nothing in return… except their money back.
Of course, every Ponzi scheme must end. And the scheme of US public finance is already reaching its conclusion. As we write, lenders have still not wised up. But they’ve gotten poorer.
Two of today’s headlines from Bloomberg tell the tale:
“China’s exports decline most in a decade…”
“Trade deficit narrows…”
Trenton no longer takes. So Tianjin no longer makes. And Tianjin’s entrepreneurs no longer turn up at the central bank with piles of dollars to exchange for yuan. Which leaves China’s central bank with fewer dollars to buy up US Treasury debt.
The whole system is breaking down. Most likely, it cannot be repaired. But at least Bernie Madoff will know what to do when the end comes.
*** We’re still waiting for the Obama Bounce. Hardly ever has there been such a major sell-off not followed by a major bounce. But we wouldn’t want to bet too heavily on it. What to do? Our old friend Jim Davidson has an idea:
“The great lift to animal spirits that Obama will give the U.S. could well translate into a temporary stock “boomlet.”
“How should you trade it, knowing that the fundamentals remain weak and deteriorating?
“I believe that the solution is to buy MITTS. Not catcher’s mitts but Market Index Target-Term Securities, special purpose trading vehicles on the S&P 500 and the small-cap Russell 2000 Index.
“MITTS allow you to profit if the market rallies while guaranteeing that you can’t lose money on the downside. In other words, you can play the “sucker’s rally” of 2009 without being a sucker.
“How is such a miracle possible?
“The concept is simple. MITTS are a combination of long-term options on stock indexes with zero coupon U.S. Treasury bonds that are guaranteed to return to their issue value of $10 a share of each MITT on the maturity date.
“A brainchild of Merrill Lynch, MITTS have been issued on many underlying products with different maturity dates.
“They are one of the only instruments out there that allow you to make gains on of sucker’s rally with virtually no downside risk.”
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Best-selling investment author Bill Bonner is the founder and president of Agora Publishing. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning and three best-selling books, Financial Reckoning Day: Surviving The Soft Depression of the 21st Century, Empire of Debt: The Rise of an Epic Financial Crisis and Mobs, Messiahs and Markets..
