Ponzi Schemes

Why Should We Care about Ponzi schemes?
Ponzi schemes are more prevalent in our society than it would first appear. In fact, our entire banking system is one giant Ponzi scheme. Ponzi schemes are certainly unethical, but are they harmful? Why?

What is a Ponzi scheme?
The term “Ponzi scheme” is named after Charles Ponzi, an early 20th century swindler. A Ponzi scheme is a fraudulent investment operation that pays returns to investors out of the money paid by subsequent investors rather than from profit. Here’s how it works. Suppose I offer to pay you 12% on your $1,000 investment. First of all, I am going to offer you a rate that is significantly higher than you are able to make in the open market, which will tend to cloud your judgment by appealing to your greed. You are expecting $120 per year or $10 per month in return for investing your money in my “venture”. But rather than returning you money earned from profits (or interest for your loan), I simply partially return to you your original principle over time! In this example, I can return about 83 payments for a period of nearly seven years before your “investment” runs out – so I have a lot of time to perpetuate the scam before I run out of your money.

How Can This Go On?
As long as you don’t ask for your money back, this scam can be perpetuated for a long time. But eventually I would run out of your money. However I can prolong the illusion by simply getting more investors like you! Suppose you wanted your money back in say 2 years. I would have only $760 to give you, but I spent say $500 of that on myself already. No problem, just get the next investor’s $1,000 and send that to you. I can now stall the new sucker for over two years while I find another “investor”. After all investors usually don’t ask for their money back anyway – not while its “working so hard” for them. So I can effectively live off the strong probability that people will not ask for their money back early on, and when they do I’ll just shuffle the remaining money around from one victim to the next.

Fractional Reserve Banking is a Ponzi scheme
You should by now see some strong similarities between normal banking practices and Ponzi schemes. The only real difference is that one is legal while the other is not. But so what – I don’t want to go to jail and banks can’t go to jail so is there any further harm if just banks practice this?

All Balloons Eventually Deflate or Explode
Unfortunately, there is. Its called the “boom-bust cycle”, or sometimes dressed up as the more dignified term “business cycle”. Inflation causes unsustainable booms, which inevitably bust when reality surfaces. And just like the Great Depression, if enough suckers want their money back at the same time, the entire financial system collapses. Since our banks are allowed to loan up to 90% of your money, which can spiral into a 1,000% false increase in the money supply, and since foreign governments hold a significant amount of our currency it’s not too difficult to imagine a very rough ride ahead.