The Perils of Ponzi Politics

Western governments are currently running the largest Ponzi scheme in history. For the past 30 years, debt has been stacked upon more debt. Governments have perpetually financed the present through the promise of future prosperity, with politicians mortgaging away the lives of future generations in order to avoid making tough decisions. They can only paper over the cracks for so long, because the one thing that you can be sure of with a Ponzi scheme is that it will eventually collapse – it’s just a matter of when.

Image courtesy of Don Kennedy, © 2011, some rights reserved.
Image courtesy of Don Kennedy, © 2011, some rights reserved.

A Ponzi scheme is a fraudulent investment operation which pays returns to existing backers by using the money pledged by subsequent investors. The scheme is utterly bankrupt and entirely dependent on a never-ending stream of new investors, lured in by promises of unrealistic returns. So long as confidence remains high and people remain gullible, the life of the scheme can be prolonged – but not indefinitely. Around the world, governments are turning to increasingly desperate measures to extend the life of their Ponzi scheme. In order to keep up with interest payments on existing debt and to sustain enormous budget deficits, governments have opted to take on new debt. The problem is that the number of willing creditors is evaporating.

With international demand for US debt shrinking, the US Federal Reserve has taken to propping up the American economy by buying back US Treasury securities from the world market. The Federal Reserve now purchases an exasperating 61% of net Treasury securities, meaning that America’s central bank now owns more American debt than China [1]. While it is illegal for the Federal Reserve to buy bonds directly from the Treasury, it is not against the law to purchase them from the secondary market. Thus, all the interest payments paid on the debt is paid back to the Federal Reserve as profit, creating an interest-free loan and sustaining demand for treasury bonds. Lawrence Goodman, former Treasury official, observes that, “this not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.” [2] This practice of monetising the debt in the short-term allows the US to keep interest rates low and mask the true extent of the crisis, but in the long-term will rot the economy. Germany chose to monetise its debt during the First World War, which contributed to its eventual economic collapse and rampant hyperinflation.

However, it is not the US which is in the worst economic shape. In Japan, the debt to GDP ratio reached 211.7% in 2013 – the worst in the world [3]. It is inconceivable that the Japanese will ever be able to pay back the money they owe. Yet the government has unveiled a new plan to keep its economy limping on – in addition to doubling the money supply in the space of year, they are introducing Japanese compensation bonds – which US hedge fund manager, Kyle Bass, has warned is the equivalent of “adding a Ponzi scheme to a Ponzi scheme” [4]. With this counter-intuitive move, Tokyo can acquire new debt leveraged against the promise of speculative funds raised by future tax reform. This is not the act of a government with a clear plan for economic recovery, but a desperate stalling tactic to delay the inevitable implosion of the Japanese economy under the weight of its own colossal public debt.

We now even have Eurobonds being touted as a way out of the Eurozone crisis, where heavily-indebted states would be able to access to cheaper credit based on the strength of their neighbouring countries, allowing them to borrow even more money to keep up with their debt repayments. Just when will it end? Bernie Madoff, the man responsible in 2009 for carrying out the largest Ponzi scheme in US history, famously remarked that he couldn’t believe he got away with it for so long. When the debt time bomb finally does explode, people all over the world will be wondering the same thing.

But surely this is just basic Keynesian economics? Is it not conventional wisdom that deficits are beneficial in times of recession? Indeed, John Maynard Keynes believed that in times of economic contraction it was sometimes necessary to increase public spending to limit the severity of the recession and aid recovery. But what he also understood was that capitalism was inherently a system of boom and bust. He believed that in times of prosperity, governments should maintain budget surpluses in order to counteract these temporary periods of high spending and to avoid unhealthy accumulations of debt. Western governments have seldom been able to balance their budgets in times of prosperity, let alone produce surpluses. Consequently, politicians masquerading under the guise of Keynesian economics to justify their astronomical deficit spending have betrayed his economic theory by refusing to accept this inconvenient truth.

It is clear that we are standing on borrowed time, but is there anything that can be done to manage the crisis? The first step is for people to acknowledge that there is a problem and that, unless we act now, the social consequences are going to be calamitous. We have already seen a tearing of the societal fabric in Greece and Spain. On a global scale, we are going to see entire generations left destitute by the reckless behaviour of their parents’ governments.

Governments need to accept that they cannot print their way into salvation. Politicians need to be prepared to take deeply unpopular decisions and to cut public spending drastically. While there is an urgent need to administer the bitter medicine that our ailing economy so desperately needs, we also need to be mindful enough to pursue austerity measures that work. All too often, the only politicians willing to take the tough decisions are ideologues who forget that austerity measures are a means to an end, and not ends in themselves.

To put this into practice is not going to be easy, because decades of high public spending have had the insidious side effect of breeding cultures of entitlement. When a population is used to ample social security and copious government spending, it is difficult to convince them that they are going to have to lead lives considerably less comfortable than that of their parents. The anger is going to be palpable, but it should not undermine the resolve of those in power to take the tough decisions necessary. It is precisely this fear of making unpopular decisions that bore fruition to the Ponzi scheme in the first place. We can not keep deferring our problems to the future, and we can not keep looking overseas for more credit, because as economist Nouriel Roubini warns, when the day of reckoning comes: “there’s not going to be anyone coming from Mars or the Moon to bail out the IMF or the Eurozone”. [5]


[2] Ibid.




One Reply to “The Perils of Ponzi Politics”

  1. I was sad to see that this article is built on common misconceptions. Governments should now be spending a lot more than they are, not less. The US, the EU, Japan, Greece and Spain (and Weimar Germany?) are all very different cases, but they all have one thing in common: none was bankrupted by runaway government spending. For the sake of time, just consider the US. The US government can now borrow money at historically low rates that are negative in real terms, and as the country is in a liquidity trap (i.e. traditional monetary policy is ineffective because high savings rates continue despite interest rates that are at or near 0%), fiscal multipliers (i.e. the effect, expressed as a multiplier, that government spending will have on national income) is certainly greater than one and perhaps higher than 3 (the relevant literature is reviewed well, and generally endorsed, by the IMF here: For example, if the US borrowed $1 trillion now, it would pay less back in real terms in the future while investing the money to grow the economy by, depending on your estimates, anywhere between over $1 trillion to more than $3 trillion. Higher GDP would also push up tax revenues, making the effects of government borrowing even more minimal.

    There is a lot else to comment on here: one person’s debt is another person’s asset, so not everyone can be bankrupt at once; high debt-to-GDP ratios have traditionally been lowered by boosting growth rather than cutting spending; there is no evidence that high debt-to-GDP ratios have adverse economic effects, particularly in countries that control their own currency; austerity ignores and worsens the fundamental lack of aggregate demand that is plaguing rich economies; and governments since the 1980s have largely not been Keynesian. There’s also the irony that the markets that people arguing for austerity apparently deify don’t even reflect their arguments: Treasury bond yields are historically low (and were even before Quantitative Easing), and every time the Federal Reserve even hints that it might begin to taper its bond-buying the markets react negatively.

    This article is also strangely timed given the extent to which the case for austerity has collapsed in both experience (countries adopting austerity have seen their debt-to-GDP ratios go up rather than down) and academic debate (beyond just Reinhard-Rogoff and Alesina-Ardagna). Unfortunately it still dominates political rhetoric to a disturbing degree, and that salience should be challenged.

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