Wednesday, 27 October 2010

It's now respectable to call it a Ponzi scheme

Whether one calls it Quantitative Easing (QE), or one uses any other of the multitude of acronyms that have been floated since TARP, the simplest nomenclature for the financial mechanics which constitute US monetary policy is to call it what it really is - a Ponzi scheme. Reduced to its simplest the US Treasury issues bonds at which the principal buyer (or implicit guarantor that indefinitely large quantities of the bonds will always be accepted as collateral) is the Federal Reserve.

Over several years, but especially the two most recent, a number of market commentators, not within the mainstream of "reputable finance", have been gutsy enough to characterize the manner in which the public sector balance sheet has been expanded to prop up asset prices as a Ponzi scheme. But most have been marginalized or considered to be part of the loony blogosphere and dismissed by their more "respectable" and politically correct peers.

In his current commentary Bill Gross from PIMCO has finally uttered the words which give a new respectability and gravitas to this characterization. Here is the relevant section from his current commentary .

It seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time. It is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin. It is a Sammy scheme – you and I, and the politicians that we elect every two years – deserve all the blame.


The only real question is why is it only now that Mr. Gross is willing to publicly acknowledge something which he must surely have known and thought about dozens of times over a very long period? Surely it couldn't be as simple as the fact that in the same letter he predicts that the 30 year bull market in Treasuries is now over. For Mr Gorss to reach this conclusion one is left wondering just how consequential it is for capital markets that he has realized that, even with PIMCO's vast buying power, a monetary policy predicated on QE, like all Ponzi schemes, eventually requires an incommensurately large flow of money from investors to keep the scheme going.

For a graphic image of just how unsustainable this self-reflexivity eventually becomes there is the archetype known as Ouroboros which is a voracious creature that ends up devouring its own tail.

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