Confidence Games and Ponzi Schemes: No Way to Run the World's Largest Economy

After hearing a lot of talk in recent days about hopeful signs for the U.S. economy and how it is vital that consumers regain their confidence in order for a recovery to truly take hold, it struck me once again that the U.S. economy, more so than most other economies around the world, is really just a "confidence game".

As in ... a hustle.

As in ... Paul Newman.

As in ... not a good long-term plan (unless, of course, you're the one running the swindle) because, at its foundation, the game is fraudulent.

From Merriam-Webster:

confidence game
noun
a scheme in which the victim is cheated out of his money after first gaining his trust

Now, this is not some short-term hustle where some guy standing on a street corner signals his partner with a tap on his nose - this is a multi-generational scam that has as much to do with flawed concepts about how economies should operate as it does with fading empires and their tendency to transition from manufacturing powerhouses to centers of finance and money shuffling where, over time, the masses are duped into borrowing and spending their way to oblivion and the government does much the same simply because it thinks it has no other choice.

That's kind of where we are now. Let me explain...

The "Engine" of U.S. Economic Growth

Last week's report on second quarter economic growth was notable for its lack of participation by consumers, the group that, heretofore, had been considered the "engine" of U.S. economic growth and, by extension, global growth.

Personal spending made a negative contribution to GDP for the fourth time in the last six quarters and policymakers and economists all across the land continued to pray for consumers to once again open up their wallets and go buy something for the greater good.

In a sign of how times really haven't changed all that much from earlier in the decade when, in 2001, Federal Reserve Governor Laurence Meyer prodded Americans to "go out and buy an SUV" to help pull the economy out of the recession, today we have the wildly popular "Cash for Clunkers" program where, after spending like drunken sailors over the last few years leading the world into the current mess, the solution to our current economic woe is to borrow and spend even more.

You see, consumption is not necessarily a bad thing. In fact, it is very necessary - people have to buy stuff. But, like most everything else, it is best done in moderation, something that hasn't exactly been a hallmark of the American consumer experience in recent years as the personal saving rate (after-tax income minus spending) went crashing from 10 percent to zero over a period of two-and-a-half decades.

click to enlarge
It's now rising like a phoenix and, while that may be a good (and very necessary) thing for one's personal finances, it is definitely not a good thing for the economy in the short-term.

When the local travel agent doesn't spend money at the restaurant down the street, the owners don't pay to have the place remodeled by a contractor who might have bought a new car from the auto dealer around the corner who might then have booked a vacation with the local travel agent who now eats at home.

After years of spending freely - much of it funded not by income, but by taking on record levels of new debt - consumers are now pulling back.

This makes sense.

But, what doesn't make sense is when we are told that an enduring economic rebound will require these now-thriftier Americans to "regain their confidence" in a system that has failed them so miserably over the last few years and, during a period of declining incomes and rising unemployment, go out and spend more money.

In this instance, the "victims" of the confidence game are not so much "cheated" out of their money as they are coerced to spend it when doing so works against their best interests - in a few months' time, after the thrill of driving a new car has worn off, many "Cash for Clunkers" buyers will wish they could swap their monthly car payment for their old clunker.

The U.S. Government as a Confidence Game and Ponzi Scheme

Nowhere is confidence more important than at the Treasury Department and other government agencies that manage the nation's money. Come to think of it, "managing the nation's money" is probably not a good way to characterize what exactly is going on there since there is very little money to "manage" - it goes out as fast as it comes in and the process is better described as "directing the flow" of money rather than "managing" it.

Here, the U.S. government is playing a very high-stakes confidence game with its foreign creditors, many of whom must realize by now that something is seriously wrong as they grow tired of the endless cycle of American borrowing and money printing in order to make ends meet (is that still considered "making ends meet" if you have to borrow and print money to do so?).

The Chinese have been particularly vocal in this regard as they've lent us an enormous amount of money that, someday, they figure they'll want back and they'd prefer it hold onto as much of its purchasing power as possible between now and then. Whether they realize it or not, their confidence is sorely misplaced because the IOUs keep getting piled higher and, despite assurances to the contrary, there is no viable plan to reverse this process.
Stateside, the government's finances - dominated as they are by entitlements such as Medicare and Social Security - appear to be much more of a Ponzi scheme than a confidence game, though, there are surely some characteristics of both.

Once again, from Merriam-Webster:

Ponzi Scheme
noun
an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks

Let's face it, when you and your employer each have 6.2 percent of your wages sent directly to Uncle Sam and deposited into the social security "trust fund", you are "investing" this money in the biggest Ponzi ever perpetrated because your money goes directly back out to recipients and, to make things even worse, what's left over is spent by the government.

Though it didn't start out that way - when the plan was conceived, the average life expectancy was right about the same age that recipients could start collecting payments - the fact that there have been no substantive reforms to make this program into a sustainable system leaves it in a current condition that would make Charles Ponzi green with envy.

If not for our current fiat money / fractional reserve banking system, where there are virtually no limits on the amount of money and credit that can be created "out of thin air", this confidence game/Ponzi scheme run by the U.S. government would have ended long ago.

The Nirvana of Rising Asset Prices

But the biggest deception currently being carried out that directly affects the American public and, for that matter, billions of people around the world in our new globalized economy, has to do with asset prices and, here too, there are characteristics of both a confidence game and a Ponzi scheme.

Centuries ago, equity markets began playing a vital role in building industries and fostering commerce. In return for a "share" of the company's future income stream, mostly in the form of dividends, investors would pay the going rate for a "share" in the company, taking on the added risk of the value of that share fluctuating in price, soaring or sinking as companies prospered or faltered.

In recent years, however, fewer and fewer companies have paid substantial dividends and "investors" have been trained to seek "capital appreciation" instead. That is, when some new investor pays more than they did for the same share, making their share worth more.

Property markets have made a similar transition.

It used to be that real estate was just another depreciating asset, oftentimes requiring very expensive maintenance, and, under a best case scenario, home values wouldn't rise much faster than prices in general.

But here too, over the last few decades, a staid asset class was transformed into a superstar investment sector as money and credit flowed freely from the U.S. government and its banking system, luring millions of "investors" looking to make big "capital gains".

The housing bubble that burst back in 2006 was a near perfect Ponzi scheme that came to an abrupt halt after the last of the new buyers could be found - subprime buyers provided that last push for the late-great U.S. housing bubble.

In both stocks and housing, it was rising asset prices that maintained confidence and attracted new money as prices rose. Of course, as we've come to learn, asset prices don't always go up.
In fact, that peak you see above in 2007 may represent a generational high in asset prices since so much of this increase was fueled by a massive expansion of credit enabled by lax lending practices that have now unraveled over just the last couple years.

It was a credit expansion of monumental proportions that pushed asset prices as far as they could be pushed and then things just kind of fell apart.

But, sadly, this won't stop policymakers from trying to push asset prices back up again. To see a shining example of just how effective this can be, one has only to look at China today to see what wonders a few hundred billion dollars in new credit can work on a slumping stock market and real estate market.

The entire world has been duped into believing that asset prices can continue to rise indefinitely and that we'll all eventually grow wealthy as a result. Even in the aftermath of last year's financial market melt-down most still believe that if only governments around the world create enough new money and credit, drawing in many more confident new buyers, the lofty asset prices seen in recent years will be restored.

Ultimately, they will be disappointed.

Confidence games and Ponzi schemes never end well and they are certainly no way to run the world's largest economy.

Comments

[Mark Bern:]

Great article! It is an excellent summary of how we got into this mess and how, even though our leaders are telling us otherwise, we continue to dig our hole deeper and deeper.

I liked many of the comments, but one especially got me thinking. We are not on the deck of the Titanic. Those who were are already in the water trying not do drown having lost their homes, cars, credit, jobs (not necessarily in that order). The rest of us are still below decks, most are asleep (apparently), and our government is trying to get the bank to collect their instruments and start playing again. They believe that if they can just get people to start partying again, dancing to the music, that the ship can float forever. The real problem for them now is that they haven't figured out how to steer the ship with the rudder and propellors sticking out of the water.

In the end, the leaders will ask us all to row harder (pay higher taxes) and tell that everything is okay. And (for the life of me I can't understand why) some people will believe them (probably those that are not paying any taxes).

Once again, a really provocative and well-written article. Thanks!

Aug 07 07:13 PM

[Sober Realist:]

As long as the banking cartel remains out-of-control and holds a stranglehold on Washington, the economy will continue to slide downward and the wealth transfer will continue. Milktoast regulation won't do; the big banks need to be broken up.


On Aug 07 10:26 AM Leftfield wrote:

> This corrupt system has increasingly distributed rewards irrationally.
> It is rule-based and, from the Fed's funny money and beyond, has
> increasingly hidden real market signals.
> It is not new that your status in the hierarchy of rules usually
> governs your rewards more than a rational measure of one's contribution.
> Being a lawyer or accountant or getting a good government job depends
> on more rules to interpret or to administer which sap real production
> when in excess. They have long been in excess.
> The financial system is so bad it needs no elaboration.
> The Chinese, unborn non-voters and everyone who doesn't really count
> or even vote is being tapped and swindled. Rational ideas and solutions,
> long marginalized, are not treated seriously. That is the nature
> of our decadence and corruption today.

Aug 07 09:53 PM

[DavyJ:]

As I was reading I highlighted this paragraph and was going to say that this says it all:
"But, what doesn't make sense is when we are told that an enduring economic rebound will require these now-thriftier Americans to "regain their confidence" in a system that has failed them so miserably over the last few years and, during a period of declining incomes and rising unemployment, go out and spend more money."

But the more I read, the more I realized I was mistaken. I can't narrow it down to a single paragraph.

Great article!

Aug 07 09:55 PM

[Boxed Merlot:]

From Merriam-Webster:
confidence game
noun
a scheme in which the victim is cheated out of his money after first gaining his trust

Rather:

From Wikipedia:

Confidence game
verb
the act of extending credit and selling notes on that credit to imaginary entity using printing press to fabricate additional notes to extend to those using said credit to pay for all debts both public and private.
See also: US Congress, US Treasury Dept, SEC and US Federal Reserve

Aug 07 10:01 PM

[Mei Shee:]

Excellent!

Also check this out
video.google.com/video...

Aug 07 10:17 PM

[David in D:]

Zmartmoney, perhaps you should take another look at Tim's graphs. You will note that it has been the supposed "conservatives" who have expanded the deficit most aggressively. Are you for more "trickle down" economics? It is precisely the wealth gap, generated under conservatives, that has contributed most decisively to the American economic meltdown. So yes, we need the pendulum to swing back towards sanity a bit after the last 30 years... but of course, no one on Fox News is going to tell you that.


On Aug 07 11:22 AM Zmartmoney wrote:

> The liberal/socialist agenda emanating from Washington requires that
> we be awash in easy money. How else will they pay to have most of
> the people sitting in the wagon, and the remaining few pushing?
> The liberal mindset seeks to have wealth for all, taken from those
> with "too much" and generously distributed by an all-knowing, wise,
> benevolent government master to those with "too little." Along the
> way, it wouldn't hurt if the wise masters were able to corner the
> market on power, which would allow them to spread their wisdom that
> much further. Liberals love to castigate conservatives for their
> "stinginess." In truth, that stinginess is actually self-preservation
> - the ant storing harvest for the coming winter, instead of the foolish
> grasshopper who wants to party till the snow comes. Children's stories
> are still quite useful for demonstrating enduring truths of life.
> There is no free lunch - there is only that one taken from someone
> else. Who are you going to take yours from? Welcome to socialism.
> This party can't stop - Washington can't afford for it to, as there
> are way too many things they want to spend money on first, remaking
> America in their image. BTW - don't mistakenly assume that Liberal
> means Democrat and Conservative means Republican. Look at the last
> decade that was run by Republicans and show me Conservatives in leadership
> positions. Party on dude...

Aug 07 10:25 PM

[nova:]

Michael Clark wrote:
" Wall Street is just another form of Caesar's Palace, without the naked women."
No, it could not be.

Aug 07 11:08 PM

[realold:]

And anyone who voices their concern is called racist, right-wing extremist, Nazi and other taboo labels. Listen to Nancy Pelosi. or Dr. Strangelove Obama at a town hall meeting. The country is following these people over a cliff, having been placed there by George W. Leaders have their own personal agendas that seem different but are basically the same - get what I can for my cronies, be they "corporations rule" Republicans or "keep them dependent on us" Democrats.

America, wake up and stop putting these egotists in office. Stop drinking their kool-aid. Think logically for yourself and vote for people who tell the truth and offer plans involving hard work, sacrifice and no handouts. If what they are saying sounds like you are being "saved" and "changed" watch out.


On Aug 07 10:26 AM Leftfield wrote:

> This corrupt system has increasingly distributed rewards irrationally.
> It is rule-based and, from the Fed's funny money and beyond, has
> increasingly hidden real market signals.
> It is not new that your status in the hierarchy of rules usually
> governs your rewards more than a rational measure of one's contribution.
> Being a lawyer or accountant or getting a good government job depends
> on more rules to interpret or to administer which sap real production
> when in excess. They have long been in excess.
> The financial system is so bad it needs no elaboration.
> The Chinese, unborn non-voters and everyone who doesn't really count
> or even vote is being tapped and swindled. Rational ideas and solutions,
> long marginalized, are not treated seriously. That is the nature
> of our decadence and corruption today.

Aug 08 12:25 AM

[User 357705:]

Just keep depositing my SS checks and paying my Medicare claims!

Aug 08 01:41 AM

[PainfullyAware:]

Tim Iacono - Great Insight And Wisdom !!!

The Hungry And Homeless Do Not Make Very Compliant Citizens.

More and more are feeling the "Disconnect" from the media and DC. The "Sunshine Story" is not correlating well with what is discussed in friend and family circles.

"Free Time To Consider" Grows With Unemployment And Desperation.

Fear Has Driven The Populous To "Allow" Many Abhorrent Incursions On Sovereignty And Liberty. One can only stay fearful for a limited time before "Numbness" returns cognitive thought; even though adversity has not subsided.

There are many "Events" regarding the citizenry as of late that give me hope for recourse ("Town Hall" Dissent, Continued Tea Party and Campaign For Liberty Events). There are also many that relate to "Representatives" that instills the opposite. ( Do We Need More Private Jets For DC As Treasury Auctions Are "Unstable"?)

Disclosure: Long On Humanity, Short On Government.

Aug 08 02:53 AM

[PainfullyAware:]

"America, wake up and stop putting these egotists in office." - realold

Look into "Electronic Voting". Germany recently OUTLAWED its use in their election process - Why?

All The Documentation I Have Been Exposed To About This Subject Gives Great Cause For Concern.

To Assume Benevolence Is Foolish.


On Aug 08 12:25 AM realold wrote:

> And anyone who voices their concern is called racist, right-wing
> extremist, Nazi and other taboo labels. Listen to Nancy Pelosi.
> or Dr. Strangelove Obama at a town hall meeting. The country is
> following these people over a cliff, having been placed there by
> George W. Leaders have their own personal agendas that seem different
> but are basically the same - get what I can for my cronies, be they
> "corporations rule" Republicans or "keep them dependent on us" Democrats.
>
>
> America, wake up and stop putting these egotists in office. Stop
> drinking their kool-aid. Think logically for yourself and vote for
> people who tell the truth and offer plans involving hard work, sacrifice
> and no handouts. If what they are saying sounds like you are being
> "saved" and "changed" watch out.

Aug 08 02:58 AM

[climbera5:]

Excellent post and comments. What irks me with the cash for clunkers program is that most of the car purchases are foreign made, so we are subsidizing foreign manufacturing with our tax dollars. The second round of subsidy came out of the alternative energy allocation of the stimulus package, money that should have been spent on furthering a promising technology and industry for our nation.

Also, the White House is now sending up trial balloons on the idea of increasing taxes on everyone, not just the 'rich'. So instead of making the tough decisions and exercising fiscal discipline, we now face tax hikes to pay for this reckless spending. Not a big surprise but it will happen sooner than later.

Thanks for a great post 'I need more' - hits it on the head

Aug 08 03:01 AM

[EEB:]

When you say that "it's a confidence game", what, exactly, are you referring to by "it"? Life? The whole economy? Social security? The stock market? It wasn't clear from your comments what you were talking about. Vagueness was the problem with the original article, and you continued that fault in your comments.

I completely agree with you that the financiers, in general, are making out like bandits. But they aren't profiting from social security. In fact, they wanted to privatize it so that they could profit from it. The surest way to stop the financiers would be with some serious regulation of the financial sector and raising their taxes, but, of course, that will be "political." Nearly everything is political in some way or another. Even advocating completely free markets is political. I don't see how getting off of the "politics wagon" is going to help, or is really even possible.


On Aug 07 09:36 AM ebworthen wrote:

> Dude.
>
> Get off the politics wagon; it goes nowhere but in circles.
>
> The right/left, Republican/Democrat ping pong match is just to keep
> you from waking up to the fact that you are being robbed and none
> of them give a sh*t about you.
>
> It's like the lawyers who have lunch together at their clients expense
> and laugh it up; then in the courtroom act like they hate each other
> and really "care" about you.
>
> It's a game. It's a confidence game. The game is being played with
> the savings, investments, retirement and pension funds, and hearts,
> minds, and souls of generations all for the sake of McMansions, fancy
> cars, gold-plated toilets, and retiring on a tropical island where
> the mobs of people you robbed can't get to you to lynch your sorry
> neck onto the nearest street lamp.
>
>

Aug 08 10:05 AM

[realold:]

Great analogy


On Aug 07 07:13 PM Mark Bern wrote:

> Great article! It is an excellent summary of how we got into this
> mess and how, even though our leaders are telling us otherwise, we
> continue to dig our hole deeper and deeper.
>
> I liked many of the comments, but one especially got me thinking.
> We are not on the deck of the Titanic. Those who were are already
> in the water trying not do drown having lost their homes, cars, credit,
> jobs (not necessarily in that order). The rest of us are still below
> decks, most are asleep (apparently), and our government is trying
> to get the bank to collect their instruments and start playing again.
> They believe that if they can just get people to start partying again,
> dancing to the music, that the ship can float forever. The real problem
> for them now is that they haven't figured out how to steer the ship
> with the rudder and propellors sticking out of the water.
>
> In the end, the leaders will ask us all to row harder (pay higher
> taxes) and tell that everything is okay. And (for the life of me
> I can't understand why) some people will believe them (probably those
> that are not paying any taxes).
>
> Once again, a really provocative and well-written article. Thanks!

Aug 08 11:35 AM

[RiskReturnO...:]

Very interesting analysis.

Suggest adding a chart of "Household Net Worth" (taking your Asset chart and subtracting Personal Liabilities) ... you will see a much steeper decline as Liabilities (Mortgage and Consumer Non-Mortgage Credit) didn't drop much in past 3 years ...

Drop in Net Worth is the factor that will determine how high the Savings Rate will eventually go ... now that unemployment rate increases have moderated .... government spending as we've seen will go directly to Savings as opposed to increasing consumer spending ...

of course, if banks starts doing mortgage modifications with principal reduction, then that's a whole different story ....

Aug 08 12:36 PM

[PainfullyAware:]

"When you say that "it's a confidence game", what, exactly, are you
referring to by "it"?" - EEB

You should do some research into "Fractional Reserve Banking"; "Fiat Money", "Derivatives", "Dark Pools", "The Presidents Working Group On Financial Markets", "The SEC Red Book". These tend to be the most disturbing when grasped.

I believe that the "Misunderstanding" that is evident in your comment derives from the fact that you see "Big Biz" and "Government" as separate. This is no longer the case.

Mutually Beneficial Arrangements Only Happen Due To Confidence. Consider this statement when you review the many forms of human interaction.

The "Who" doing the regulation causes me to have less confidence. If you believe that "Congress" has written the egregious legislation that has passed recently (Or About To) you are misled. The President and our "Representatives" Did Not Read What They Signed Into Law.

The More You Know The Less Certain You Will Be.


On Aug 08 10:05 AM EEB wrote:

> When you say that "it's a confidence game", what, exactly, are you
> referring to by "it"? Life? The whole economy? Social security?
> The stock market? It wasn't clear from your comments what you were
> talking about. Vagueness was the problem with the original article,
> and you continued that fault in your comments.
>
> I completely agree with you that the financiers, in general, are
> making out like bandits. But they aren't profiting from social security.
> In fact, they wanted to privatize it so that they could profit from
> it. The surest way to stop the financiers would be with some serious
> regulation of the financial sector and raising their taxes, but,
> of course, that will be "political." Nearly everything is political
> in some way or another. Even advocating completely free markets
> is political. I don't see how getting off of the "politics wagon"
> is going to help, or is really even possible.

Aug 08 02:08 PM

[JGPCSEP:]

It has been many years since the American "engine" has created any new wealth. American ingenuity and innovation, along with the manufacturing muscle to make it happen, enriched a generation or two of Americans by creating something that the rest of the world wanted to buy. The second wave of innovation, less tangible but equally valuable, came as America let the way in technological and information advances. The third wave has never materialized, and the rest of the world has caught up. Without presenting anything of value to the rest of the world, we have seen and will see our standard of living decline to closer to the rest of the world's level. There is only so much wealth in the world.....not everyone can be a millionaire. Wealth cannot be created out of thin air. I requires a willing buyer. And we have very little left to sell.

Aug 08 09:46 PM

[Dan in mpls:]

I just gave JGPCSEP a thumbs up in spite of his coment that there is "only so much wealth in the world". Wealth can be created, its just getting more difficult to do so here in the USA and easier to do so in much of the rest of the world. I suspect that after the next market crash people will begin to understand that the party really is over and we can begin to work for real change - back to a system more like what we had in the 1950s before the major social programs of the 60's began to put what has grown to be a majority of the US population on the government dole.

Aug 08 11:09 PM

[Anthony Alfidi:]

Right on, Tim. The only caveat is that the U.S. won't be the world's largest economy for much longer. Many Americans unaccustomed to second-rate status will be shocked and angry when Chinese consumers in 2019 can outspend them.

Aug 09 02:59 AM

[RiskAverseA...:]

"You see, consumption is not necessarily a bad thing. In fact, it is very necessary - people have to buy stuff. But, like most everything else, it is best done in moderation..."

Mmmm... How about it is best done with utmost intention at raising one's productive purpose? Such consumption could, indeed, become quite prolific. Yet if one were to moderate this, then might not one's productivity be compromised? So, your call for moderation is much too vague and easily misconstrued...

"After years of spending freely - much of it funded not by income, but by taking on record levels of new debt - consumers are now pulling back."

And that is THE MAJOR ISSUE underlying many problems we presently face. This issue has been largely ignored for far too long. Now that debt can no longer be expanded to mask THE problem, we are returned to the very reason the United States of America was formed in the first place (i.e. in opposition to tyranny). I am speaking specifically of the INCOME problem. While INCOME was being robbed we were allowed to go into debt under the false premise income would recover. Bzzzz. WRONG. And now comes either one of two things: revolt (demanding a return of our capacity to generate abundant income) or fascism (which underlies most calls to consume less).

"Nowhere is confidence more important than at the Treasury Department and other government agencies that manage the nation's money."

Agreed. And those Mars rovers have yet to find benevolent alien life willing to backstop Treasury's profuse bleeding of debt. BIG PROBLEMO.

Your attack on Medicare and Social Security smack of fascism. To call these programs a "Ponzi scheme" without addressing the INCOME ISSUE is a fraud.

"The entire world has been duped into believing that asset prices can continue to rise indefinitely and that we'll all eventually grow wealthy as a result."

Well, I believe the Dow Jones Industrials Average could fall to 3600 TOMORROW and still remain in a long-term uptrend, so there's some truth to the idea that "we'll all eventually grow wealthy." However, sometimes the "long-term" does not match up with one's lifetime, so I generally agree with your premise.

No, confidence games and Ponzi schemes never end well ... but I do know of one REVOLUTION (1776) that ended FABULOUSLY (and thank God for Alexander Hamilton)...

Aug 17 11:05 PM