Last week we heard the announcement of Allen Stanford’s arrest for perpetrating a ponzi scheme that defrauded investors of billions of dollars. Last year we saw the arrest of Bernie Madoff who purportedly instigated an even larger ponzi scheme. But of course, the largest ponzi scheme of all lies right in front of our eyes in full view. It’s the US government welfare scheme set up years ago. The ponzi nature of it is described nicely in Robert Samuelson’s piece today in the WP titled “Welfare in a Bad Way” .

What’s required of all ponzi schemes is that positive returns to early investors are financed with contributions of later investors. As long as one can induce a larger and larger contribution from later investors (typically by increasing the number of contributors), one can maintain high returns for the earlier investors. Of course, using the term “investor” here is inappropriate since nothing like investing is taking place. Instead it is merely a transfer from one group of people to another. What is most curious about the US government ponzi scheme is that everyone who looks at it can see exactly what it is and yet it seems to be almost impossible to do anything to dismantle it. We decry and prosecute private ponzi schemes but sit back quietly as we watch the largest one in history gather steam before our very eyes.

Ponzi schemes can last a very long time as long as the new source of contributors rises sufficiently fast and/or if the returns paid to previous investors is not too large. But deviate from these requirements and the ponzi scheme will break apart by it’s own internal logic. Changes in the US fiscal budget in the past year have clearly moved forward the time when the US government ponzi scheme will fail. To sustain the scheme for longer will require a reduction in current payouts (too hard to do politically!), or an increase in contributions, either by increasing the number of contributors (but that’s too hard since it requires a higher birth rate or more immigration), or by increasing contributions per person (i.e., higher taxes, … also not popular).

Since none of the changes that would be needed to sustain the government ponzi scheme are popular enough to allow a politician to even propose them seriously, we should expect the system will indeed break apart at some point in the future. If you’re lucky you’ll get out (meaning you’ll die) before the collapse and thus receive your better than fair share. If you’re not lucky though, ( that is if you don’t die soon enough) you’ll receive a set of broken promises and dramatic drop in your standard of living sometime in the future, just like the Madoff and Stanford investors will face today.

Any suggestions??