The Rot Within, Part I: Our Ponzi Economy

Depending on blowing the next bubble to temporarily prop up the economy is the height of foolhardy shortsightedness.

All the conventional policy fixes proposed by Demopublican politicos, technocrats and the vast army of academic/think-tank apparatchiks are the equivalent of slapping a coat of paint on a fragile facade riddled with dryrot. All these fake-fixes share a few key characteristics:

1. They focus on effects and symptoms rather than address the underlying causes, i.e. the dryrot at the heart of our government, society and economy.

2. They maintain and protect the Status Quo Powers That Be–no vested interests, protected fiefdoms or Financial Elites ever lose power as a result of these policy tweaks.

3. They are politically expedient, meaning they assuage the demands of vested interests rather than tackle the rot undermining the nation.

4. They ignore the perverse incentives built into current systems and the incentives of complicity, i.e. to cheer another coat of paint on the dryrot rather than face the costs of real reform.

The financial underpinnings of the economy and society are rotting from within:finance, higher education, defense, healthcare, law, governance, you name it.

This week I want to highlight a few key causes of this pervasive and eventually fatal systemic rot.

Let’s start with Our Ponzi Economy. There are three primary examples of our Ponzi Economy: pay-as-you-go social programs (Social Security, Medicare, Medicaid, etc.); housing and the stock market. All are examples of financial Ponzi schemes.

All Ponzi schemes rely on an ever-expanding pool of greater fools who buy into the scheme and pay the interest/gains due the previous pool of greater fools. Ponzi schemes fail because the pool of greater fools is finite, but the scheme demands an ever-expanding pool of participants to function.

All Ponzi schemes eventually fail, though each is declared financially sound because this time it’s different. The number of greater fools required to keep the scheme going eventually exceeds the working population of the nation.

Here’s why Pay-As-You-Go Social Programs are all Ponzi schemes:

1 retiree consumes the taxes paid by 5 workers. 
Those 5 workers when they retire consume the taxes paid by 25 workers. 
Those 25 workers when they retire consume the taxes paid by 125 workers. 
Those 125 workers when they retire consume the taxes paid by 625 workers. 
Those 625 workers when they retire consume the taxes paid by 3,125 workers.

You see where this goes: very quickly, the number of workers required to keep the Ponzi scheme afloat exceeds the entire workforce.

The only way to keep the Ponzi scheme going is to keep raising payroll taxes on the remaining workers, which is precisely what welfare states (i.e. every developed economy on the planet) has done.

But raising taxes merely extends the Ponzi scheme one cycle. Eventually, taxes are so high that the remaining workers are impoverished. Right now, the U.S. has reached a ratio of 2 full-time workers for every retiree. As the number of retirees rises by thousands every day and the number of full-time jobs stagnates, the ratio will slide toward 1-to-1:

The Problem with Pay-As-You-Go Social Programs: They’re Ponzi Schemes (November 5, 2013)

Estimates are even worse in other developed nations. In Europe, the ratio of retirees over 65 to those between 20 and 64 will soon reach 50%–and that’s of the population, not of people with full-time jobs paying taxes to fund social welfare programs. (source: Foreign Affairs, July/August 2014, page 130)

As the percentage of the working-age populace with full-time jobs declines, the worker-retiree ratio will become increasingly unsustainable. The taxes paid by each worker are nowhere enough to fund the generous pension and healthcare benefits promised to every retiree.

In the U.S., the number of people of working age who are jobless is 92 million; the number of full-time jobs is 118 million. This chart of labor participation includes almost 30 million part-time employees who don’t earn enough to pay substantial taxes and millions of self-employed people making poverty-level net incomes.

Courtesy of STA Wealth Management, here is a chart that shows full-time workers are less than half the labor force:

Housing is also a classic Ponzi scheme: prices can only go up if there is an ever-expanding pool of greater fools willing and able to pay even more for a house than the previous pool of greater fools.

As I have explained many times, the only way the Status Quo has been able to expand the pool of greater fools is to lower interest rates to near-zero, drop down payments to 3% and loosen previously-prudent lending standards.

The Housing “Recovery” in Four Charts (May 27, 2014)

These tricks extend the Ponzi for a cycle by artifically expanding the pool of greater fools, but that pool is not infinite. (Foreign buyers are currently enlarging the pool, but their participation is dependent on the Ponzi schemes in their home economies not blowing up.)

The stock market has been made the official metric of the nation’s economic health; too bad it’s a Ponzi scheme. Financial bubbles are what economist Robert Shiller calls “naturally occurring Ponzis” because the psychology of ever-rising prices and profits fuels an inflow of greater fools that sustains the bubble until all available greater fools have sunk their cash and credit into the bubble.

Here is what a market that is increasingly dominated by Ponzi bubbles looks like: this is the S&P 500 (SPX):

 
(source: Gordon T. Long, Macro Analytics)

Depending on blowing the next bubble to temporarily prop up the economy is the height of foolhardy shortsightedness. Yet that’s our Status Quo, increasingly dependent on inflating bubbles to evince “economic strength” when the Ponzi paint will soon peel off the rotten wood of the real economy. 


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  • mmckinl

    Social Security, Medicare, Medicaid … Are not Ponzi Schemes … The problem is the bulge in population of the Baby Boomers. As soon as the “pig is through the snake” these programs are sustainable and are completely necessary unless of course you want people dying en masse in the street due to sickness or old age. Oh … and collapse the health care system for everybody …

    The problem is our military spending and the effective tax rates on the wealthy and corporations. Thanks to tax loopholes for trusts, charities and other carve outs for big money tax avoidance not only do we lose tens of billions in revenue and increase wealth disparity but we also pervert the economy around government largess to the rich in the form of these tax giveaways.

  • JEHR

    mmckini, you have it right. It is too bad that this article links Social Security to Ponzi as that is so misleading. A sovereign government cannot run out of money for the benefit of its citizens–the government can pay for whatever it feels is important and Social Security is one of those benefits.

    • not authorized

      I think you are half right. The second half of your statement is true. The first part.. I have questions.

  • Jeff Matthews

    That’s one (negative) way of looking at it. Everything in life is subject to cycles – at least everything of interest. We are full; we are hungry again. It is raining; tomorrow, the sun will shine. Cycles of ups/downs and booms/busts make life interesting, challenging and mysterious. Too many critics are under the delusion that life would be better if it was stagnant and dull. Nobody really wants pain, but painful experiences are what make people appreciate those times when they are pain-free.

  • Jeff Matthews

    That’s one (negative) way of looking at it. Everything in life is subject to cycles – at least everything of interest. We are full; we are hungry again. It is raining; tomorrow, the sun will shine. Cycles of ups/downs and booms/busts make life interesting, challenging and mysterious. Too many critics are under the delusion that life would be better if it was stagnant and dull. Nobody really wants pain, but painful experiences are what make people appreciate those times when they are pain-free.

  • Jim G

    Wash, how can you talk about ponzi schemes without talking about DERIVATIVES? Isn’t it derivatives that broke the economy? Isn’t all the manipulation of the markets done so we don’t lose our shirts in the derivatives market, including using war to keep the dollar strong? You are an economics expert. Tell me what would happen to US bank derivative exposure if the stock market crashed, gold doubled, energy prices doubled, and the mortgage market collapsed? If the Fed is calling out German banks for their derivative exposure, which side are they on – the guarantee side or the insurance side? Which side our our banks on? IS THE US BANKRUPT, AND IS THAT WHAT ALL THE WAR AND THREATS ARE ABOUT?

    Really, we need to know.