"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, January 21, 2011

David Stockman, Former Reagan Budget Director, Describes the Ponzi Trap

In my previous post, The US Debt Ceiling and Modern Monetary Theory, I gave a justification for growing the debt.  That is, we face a choice between immediate deflationary collapse, and eventual currency destruction.  Personally, if I were a politician I would be a deficit spender.  I wouldn't be proud of it though.

But most people don't understand that debt backed money in a post industrial economy that relies on ever increasing asset valuations needs a certain level of debt growth to sustain itself.  That's the crazy world we live in.  And this type of economy has also influenced our trading relationships with other countries - we consume what they produce, and we give them an IOU in return.  Thus, if the US were to stay within the debt ceiling, it would trigger an immediate deflationary depression, taking down the rest of the global economy with it.  That's the ugly truth. There would be less money in the system to service all existing debts, public and private, and the system would collapse on itself in a deflationary death spiral.  So as a politician, I would unfortunately vote for more debt.  To do otherwise would be a career ender.  Why?  Because most people don't understand our monetary system and would think I caused the deflationary collapse on my watch.

So we're stuck in a Ponzi Trap.  Get out of the Ponzi, it collapses today.  Keep it going, and there is a .0001% chance of getting out of it.  Well maybe I'm being optimistic.  All Ponzis collapse, no?

Which brings me to David Stockman's recent interview, which I posted the link to earlier this week.  Here's something he said that puts the situation in perspective, emphasis mine:
"If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months." 
Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth. 
"When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said. 
"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."
So there you have it.  Another public admission, this time from a former high level White House official, that those in Washington believe the system needs to grow or else face collapse.  I think that threat is very real.

So what do you do?  I visit many financial sites which have their own "solutions", and I am still not convinced.  Some bloggers believe in a combination of solutions.  Many harp on what I call the "Morality" issue I recently wrote about.  They say that if we prosecute the villains, if we re-regulate the system, all will be solved.  Sorry, I don't buy it.  And it's not that I am anti morals, or that we shouldn't prosecute fraud - I'm just admitting that mathematically, the system needs immorality and loopholes to function.  Ponzi systems, by their nature, are reliant on con men and naive suckers as well as impossible mathematics to function.  Unfortunately, Ponzi systems, as Nicole Foss has put it, are "self limiting;" they self destruct.

Other bloggers say we must stop spending.  Well, we have just addressed that.  Stopping spending now kills the mathematical growth the Ponzi system relies on to exist.

I'm not going to give you a "solution" if by "solution" you expect a return of the status quo - that is, the year 2005 and beyond.  Why?  It doesn't exist.  We are faced with a debt bomb of historic proportions that can not be diffused.

So what can you do?  You take care of yourself and your own.  You try to get the hell out of the way as best you can, given your own unique circumstances.  You adjust your own lifestyle - whatever that means for your situation.  You prepare for the worst, yet try to live business as usual.  It's a difficult balancing act.  That's the best "solution" I can come up with.

I'm not going to say all will be fine if we just "do this."  It won't.  We are facing a massive correction and global rebalancing that could even involve war.  Look, I'm just an anonymous blogger.  I'm not some public figure analyst or bank CEO or employee - I don't have to worry if CNBC doesn't invite me back, or if I lose clients, or if what I say affects my career or the stock price of a company.  I have none of those worries.  I have the freedom to speak my mind in my own little corner of the internet.

Best of luck,



Rajiv said...


You may want to see the Lecture by Dr. Bill Mitchell: What Is Fiscal Sustainability? and also his blog

The whole lecture is well worth watching, as is the whole teach-in.

The critical thing to remember is that a Government is not a household or a firm, and it is the supplier of currency, and not its user. Households and firms are the users of the currency, and demand it for conducting their day to day business. Deficit spending is necessary to compensate for the decision on the part of households and firms to save.

Misthos said...

Rajiv, I agree 100% with you on the basics of MMT. A government that controls its own currency can never go bankrupt.

Now that we don't have the private sector debt growth we used to, the US government needs to step in. But how long can this continue?

There is still a bond market out there... there are interest rates... there are trading relationships in a world of scarce resources...

All of these things impact a nation economically, even if it can print at will.

So no, the US government will never technically go bankrupt. But the numbers still need to "look" sustainable. That's how we will be judged by the markets and by our trading partners. Now that each additional dollar of debt is producing an ever diminishing amount of gdp, we're in trouble.

Not technically from a solvency perspective, but from a viable currency perspective. We will have a bond or currency crisis, regardless of our non "operationally constrained" abilities.

Rajiv, what is your opinion on MMT and how world reserve currency status affects it, if at all?

OKL said...

as per my post on pragmatic capitalist; http://pragcap.com/deficit-hysteria-the-debt-ceiling


wow this got really long… i’m still a little befuddled by MMT, but i am getting the basics of it, i think.

i think the crux of the issue is whether or not deficits matter;

regardless of which school of thought you are, the answer is that deficits do matter- not how it is created, but how it is spent. if it is spent on non-productive things, which is a tendency of lousy politicians, then ultimately the country will not benefit in the long term, which will cause interest rates to rise.

now, if i’m not wrong- in MMT, interest payments too does not matter because the govt can just print to make the payments or with a central bank, it can create an interest rate for the govt bonds.

however, and this is what MMT folks advocate as well (i think), even if the govt does not run into bankruptcy- the erosion in moral values, societal ethics, proper legal enforcement- will ultimately cause the people to abandon the usage of the currency by overthrowing the govt… regardless of and perhaps because of, the govt subsequently chooses to enforce “legal tender” by force of arms.

inflation forces interest rates to rise and after reading the 2 main camps- Austrian and MMT, i realize that they really have the same definition;

Austrian; Too much money chasing too little/same number of goods.
MMT; production of goods does not keep up with demand.

while they differ on the cause, i think both are pretty much the same; “inefficient/excessive govt spending” and the end result is the same- hyperinflation, govt failure.

the main difference i think, is that the Austrians want to limit govt’s ability to spend through a commodity based currency (for good reasons, i might add), while the MMTers see absolutely no need to- but that DOES NOT MEAN THAT MMTers AGREE ON INCESSANT GOVT SPENDING.

the main issue surrounding MMT, as i see it, is that whether we like it or not, it has two main political effects;

a) it gives govt unlimited powers to spend
b) it causes to people/groups of people to demand “spend on me”

these are true, but we have to remember that these are choices, not definites.

given today’s context, the most important thing is that the govt had the choice NOT to bailout the banks, they had the choice not to have super-sized militaries, they had the choice not to invade foreign countries… etc; but they did.

OKL said...

part 2...

i guess what i’m trying to say is that; if you are angry at all of these nonsense going on with the govt, you must direct your anger at the bureaucrats, not the system. the MMT system merely gives the people more choices and leeway;

for example, it was generally acknowledged during the 2008 crisis that if it was allowed to spread, main street would’ve faced issues far greater than what we have today. yet, rather than choosing to protect main street from that, the govt chose to bailout the banks, which causes moral hazard by encouraging them to do what they had done before and further more, by doing so the govt lost the opportunity to reduce their influence in Washington (regulatory capture).

worst of all, they incurred the wrath of their own people.

for us who can see what is going on, what happens next? the govt now cannot touch the banks because they don’t have a “handle” on them, the govt wants to help its people through spending, but the people has no confidence in them to do it properly in their interests.

and this is where i differ from most people in looking at the deficit hysteria; it is not so much that people do not understand MMT, in fact i think it is irrelevant. it is a political issue, it is a crisis of public confidence; i view the deficit hysteria as a “no” vote to the govt’s ability to spend wisely.

in fact, because NO ONE HAS BEEN PUNISHED (except Madoff) and Main Street is pretty much in the same situation/worse off, the public now views a “yes” vote to raising the debt ceiling as condoning everyone who caused the crisis and that is not what they want. put it simply, they want to see “heads rolling”- it has been entirely unacceptable for them to see none.

yes, the public might not understand that because of the accounting identity, they themselves will be worse off than before, but i personally think that if that is the way people will “wake up”, then it might not be such a bad thing… though it will be really messy by then…

in addition, right now is a good time for anyone who wants to change things and believe that it is possible to do so; if the USA continues down this path, the pain will be much worse. heck, even if you think that it is inevitable that the USA will continue down this path, if you think that it is worth saving, then i think smarter folks should step up and prevent the pain from being worse.

at the end of the day, its the people that matters; they must be honest, upright and frank. if they are not, then i will just end this with Mark Twain’s quote;

“History never repeats itself, but they rhyme.”

OKL said...

another thing i'd add here is that by being the reserve currency, the US is almost obligated to run deficits- more than what is required of the US economy- year after year.

i can almost hear the rest of the world screaming bloody murder if the US runs surpluses on a continuous basis.

the next level would be to have multiple currencies coming together to serve as one single reserve currency; this requires political unity that i just don't see happening... not now anyway.

Jim Slip said...

Misthos, while you have said many times that the system is going to collapse, you haven't explained sufficiently why it is going to collapse, or how it is going to collapse. We know for example that the previous monetary system ended when the US simply pulled out. How is it gonna happen this time?

I thought on occasion about the inflationary effects of a big national debt on an economy that issues it's own currency ,not in the form of the debt itself, but in the form of increased interest payments.

I quote from an article by James K. Galbraith:

"Bonds owed by the government yield net income to the private sector, unlike all purely private debts, which merely transfer income from one part of the private sector to another.

Nor is that interest a solvency threat. A recent projection from the Center on Budget and Policy Priorities, based on Congressional Budget Office assumptions, has public-debt interest payments rising to 15 percent of GDP by 2050, with total debt to GDP at 300 percent. But that can't happen. If the interest were paid to people who then spent it on goods and services and job creation, it would be just like other public spending. Interest payments so enormous would affect the economy much like the mobilization for World War II. Long before you even got close to those scary ratios, you'd get full employment and rising inflation--pushing up GDP and, in turn, stabilizing the debt-to-GDP ratio."


It makes sense, in theory.

Anyway, my questions are:

- I understand that bond issuance is a way to control the interest rate, which if I'm not mistaken works like this: selling bonds > drain reserves > interest rate up; or: buying assets > pump reserves > interest rate down. Still, we know that government deficit spending is not financed by bond issuance, so what would happen if it just stopped?

- Why isn't the USA government pursuing even bigger deficits so that it does something about what are surely catastrophic unemployment levels for US standards?

- MMT says that government deficit spending yields net income to the private sector. That is correct but not worded properly. In a globalized world, and in account deficit economies, it yields net income to the private sector of OTHER countries. Not so?

Misthos said...


Re: "as per my post on pragmatic capitalist; http://pragcap.com/deficit-hysteria-the-debt-ceiling"

I often visit PragCap as well. Cullen Roche has done a great job with explaining MMT, but I don't think he is as critical as he should be or could be. The only other person that I think has been somewhat critical in the financial blogosphere, is Ed Harrison of Credit Writedowns.

But you bring up a few points, the main thing, if I can summarize your comment, is that governments misuse MMT. I'll agree with that to an extent. But I addressed this in my post on Mathematics and Morality.

I believe that the government reacted to the crisis, began the wars, etc... because IT HAD TO. It had no choice.

We live in an energy dependent post industrial society. It's one thing to have a society where most people are leaving the agrarian lifestyle, and entering a manufacturing lifestyle, and another when they have arrived at the post industrial stage.

So what does that post industrial society do to maintain economic growth that relies on a debt driven monetary system?

It creates the FIRE economy. It creates an economy that becomes increasingly reliant on debt fueled asset valuations. When Greenspan recently said the Stock Market IS the economy - he was right. Hence, another reason for QE.

And what type of economy is a debt fueled asset valuation driven economy? Due to increasing asset values (real estate, stock markets, etc,..) that need increasing debtloads to drive that growth... guess what else that's called?

A Ponzi, or Pyramid, by any other name, which inherently relies on both (usustainable) mathematics and unsustainable (im)morality.

It's the nature of the beast. Yet it's unavoidable. It ends on its own.

Misthos said...


Re: Reserve Currency

I agree. It's called the Triffin Dilemma. I created a label (tag) found on the right margin of the blog with articles that mention the Triffin Dilemma.

In global banking circles, everyone is aware of this. Yet the common man, still wants US politicians to say we will once again become an exporting powerhouse.

This too is unsustainable. The years are approaching when no one nation has the reserve currency. And as you point out, political unity is lacking. Just look at the ongoing currency war.

I see a systemic breakdown, and a resurgence of a gold standard of sorts. It's the only replacement that everyone would (reluctantly) agree on. Gold by default, not by organized transition. It will get chaotic.

Misthos said...

@ Jim

I should start a series of posts describing the various threats to the current system. Notice I said threats - as there are many.

The world is an extremely hypercomplex system and no mathematical model can ever take into consideration all the human, technological, and geopolitical factors into consideration.

But at the end of the day, the global system is trying to rebalance itself. A system, even a human designed one, requires some sort of balance. I view the meltdown of 2008 as the system saying it can't continue as is... there are too many unsustainable imbalances.

And what did policymakers do? They shifted the debt around. They have not addressed these imbalances. They are trying to keep the system alive - as it exists. Arguably, the US economy, or even the Greek economy, are merely zombies - just look at my recent post on the US Banking system by Randall Wray. And I don't even have to explain the Greek situation to you - you know that better than me. They are not fully functioning on their own. The numbers don't add up.

Look at the dangerous precedent Ireland has recent engaged in. The Irish Central Bank printed 51 billion Euros. No debt sale, no tax revenue - just pure electronic seignorage. A few keyboard strokes, and voila - 51 Billion Euros entered the system.

A collapse can be anywhere from a hard crash to a smooth transition.

1971 was a collapse of a monetary system. The end of Bretton Woods. The inflation of the 1970s was a symptom of that.

When FDR confiscated gold, that too was a collapse, of sorts, of a monetary system. He "watered down" the gold standard by making it illegal for US citizens to own investment grade gold. And then he devalued the dollar against gold. He took the citizen's wealth.

1929 was a different collapse - not guided by government, but it was the system itself saying that it can not sustain the inherent imbalances anymore.

And so, I guess we need to define collapse, which I will do in the near future.

But I can't tell you when, or how, the collapse will happen. I can only say that the current system will not last and it will be replaced. There will be political, social, and economic repercussions. Severe.

Misthos said...

@ Jim

"- I understand that bond issuance is a way to control the interest rate, which if I'm not mistaken works like this: selling bonds > drain reserves > interest rate up; or: buying assets > pump reserves > interest rate down. Still, we know that government deficit spending is not financed by bond issuance, so what would happen if it just stopped?"

We currently have negative real interest rates - they are below inflation. The existence of the bond market allows this manipulation. Take that away, and you have a dollar crisis, IMO. You will also have interest rates skyrocket. The question is, do bond vigilantes exist, and if so, how powerful are they? I think we will eventually find out. The price of gold is a symptom of this. We'll see.

"- Why isn't the USA government pursuing even bigger deficits so that it does something about what are surely catastrophic unemployment levels for US standards?"

There are political constraints - the US debt ceiling is one example of political football.

"- MMT says that government deficit spending yields net income to the private sector. That is correct but not worded properly. In a globalized world, and in account deficit economies, it yields net income to the private sector of OTHER countries. Not so?"

True, it depends on who owns your debt. I have read some commentators predict that the US, in a currency crisis, could just tell its foreign creditors to bug off, and only pay US bondholders.

OKL said...


looks like we're pretty much on the same line. i also think that just like the old saying "too much of something is bad enough", we've pretty much reaped all the benefits we can from the current global monetary system.

the overall political situations have changed too much for this to continue along this line. although i agree somewhat that a "global central bank" would make things better, i just can't help but think that it is not much different from today other than countries in the future becoming like today's banking elite.

besides, it doesn't directly solve the global income inequality issue either... while some people might say that "unless you're a communist/socialist, inequality is not a problem", the thing for me is "if i wanted the law of the jungle in human civilization, i might as well live in the wild"

in other words, i also have a nagging feeling that democracy and capitalism in its current form is not very compatible... but that's a political opinion, not a mathematical formula.

in any event, if the US does retreat in its global influence, i really hope its not going to be like USSR... but that's a big "if" and a big "hope"...

digressions, digressions... lol

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