The Fed: Not a Ponzi scheme

Investment Analysis Clubs Macro Economic Trends and Risks
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Albaby1 has written two absolutely brilliant posts about why cryptocurrency is not a Ponzi scheme.

Since cryptocurrency companies can “mint” as many “coins” as they want, they represent a “foreign” currency. Buyers who spend USDs to buy the “coins” are making an uncovered bet in this “foreign” currency. The crypto company can offer a high interest rate, covering it with newly issued “coins.” The exchange rate with USDs will drop since the crypto company is not producing any goods or services of value so the “coins” experience inflation against the USD.

This is not a Ponzi scheme, since the crypto company doesn’t need to steal from customer accounts to cover other customers’ withdrawals. They simply “mint” more crypto “coins.”

Thank you, Albaby! You are smart!!

Now, let’s consider what you wrote in light of the Federal Reserve, which creates USDs out of thin air to lend to banks at negative real interest rates.

Let’s consider the relationship between the USD and my very first purchase from my own earnings as a babysitter, when I was age 12: a Hershey chocolate bar. It was a nickel (5 cents) in 1966. (At that time, pennies were solid copper and also had real value.) A Hershey bar is a REAL GOOD. It is tangible and can be duplicated.

The original Hershey bar was heavier than today’s Hershey bar. When Hershey reduced the size of its bar in 1972 to keep the price equal due to inflation, the New York Times reported it as a sign of the inflationary times. “The company announced from its headquarters in Hershey, Pa., that its milk chocolate bar would shrink in size by 8.35 per cent.” Manufacturers are doing the same today: a sure sign of inflation.

https://www.nytimes.com/1972/12/30/archives/hershey-bars-wil…

Take a look at consumer price inflation.
https://fred.stlouisfed.org/series/CPIAUCNS
https://fred.stlouisfed.org/series/FPCPITOTLZGUSA

Now take a look at asset price inflation.
Bonds – remember that the price of bonds increase when interest rates drop. Also these are nominal rates, not adjusted for inflation.
https://fred.stlouisfed.org/series/DGS10

Stocks, Price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted P/E Ratio (CAPE Ratio)
https://www.multpl.com/shiller-pe

Real estate
https://fred.stlouisfed.org/series/CSUSHPINSA

How many USDs are in the system? We have to use M3, the broadest measure of money.
https://fred.stlouisfed.org/series/MABMM301USM189S

Prices are always set by supply and demand. If the supply of money (which fuels demand) is growing faster than the supply of real goods and services (including assets like stocks and bonds) the price will rise.

It is clear that systemic money (which is controlled by the Federal Reserve, government spending and lending by banks and other lenders) has been increasing much faster than the supply of real assets, goods and services.

Ultimately, it’s the Fed that controls the money supply which mostly affects asset prices. The government controls fiscal spending into consumer hands.

The crypto companies are just following the Fed’s example.

The Fed is not a Ponzi scheme. But the effects have been inflationary over decades.

The Fed hates deflation. The Hershey bar will never go back to costing a nickel.

But the rate of inflation in the future will surely rise.

The government has made immense commitments for future entitlement spending which will grow much faster than the growth of supply. Inflation in the service sector – medical care and higher education, etc. – has been growing faster than goods inflation for years. Low-cost foreign labor has suppressed the price of goods. Services must be performed hands-on by American workers and the price is rising. And will continue to rise as the profits are suctioned off by management (as intercst is so fond of reporting).

Wendy

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Albaby1 has written two absolutely brilliant posts about why cryptocurrency is not a Ponzi scheme.

Thanks for the kind words, Wendy.

I do want to clarify one thing. Cryptocurrency generally isn’t a Ponzi scheme. That doesn’t mean that there aren’t specific crypto projects that are complete scams, intended by the creators from the start to steal investors’ money.

Those Ponzi schemes will lack the many specific instances of fraudulent activity that are unavoidable in a ‘traditional’ Ponzi scheme. And they’re not necessarily structured the same way as a Ponzi scheme. So up until the person running the scheme disappears with all the money, they’ve got some arguments they can make to investigators and/or a court. Those features - coupled with the pseudo-anonymity of crypto and the ability to scam people while being safely out of the criminal jurisdiction they’re located in - are reasons why you see so many of these in the crypto space. They may not be classic Ponzi schemes, but they’re still use the lure of unrealistic returns that can never be fulfilled in order to get lots of money under their control.

The specific attributes of crypto allow them to run their Ponzi-type scams without committing a lot of the precursor frauds that are easy to prove in a Ponzi prosecution. But make no mistake - some of these folks are planning to eventually rug pull and run off with all of the investors’ money.

Albaby

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Cryptocurrency generally isn’t a Ponzi scheme

Sure, you point out that it isn’t illegal.

However it shares a couple of rather fundamental traits with Ponzi schemes:

  1. Investors are only paid returns from new investors. There is no inherent income or wealth building process. No asset except any credibility.

  2. Insiders are relentelssly bleeding the system …

  • the exchanges
  • option traders
  • crypto hedge fund fees
  • miners keeping the blockchain intact by selling newly minted coinc
  • In some cases blatant and unlimited dilution by the modern alchemist “entrepreneur” who successfully lures punters in to buy his cheaply made product.

… such leeching has to be paid for by a constant stream of net new investors … … fortunately for the industry, as we have seen, there is a fool born every minute …

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Cryptocurrency generally isn’t a Ponzi scheme. That doesn’t mean that there aren’t specific crypto projects that are complete scams, intended by the creators from the start to steal investors’ money.

Exhibit A perhaps?

https://m.slashdot.org/story/402766

The firm Sky Mavis makes an online video game called Axie Infinity that uses its own crypotokens to reward winners. The tokens DO have some value to customers paying to play the game. The firm had a cyber breach earlier in the year that resulted in the loss of $600 million of these tokens and the firm just recently informed its customers of the breach and the need to suspend redemption of cryptotoken winnings for real cash.

Except its CEO initiated transactions prior to that public announcement to cash out roughly $3 million in tokens. A trade to protect the FIRM’S cashflow to allow it to continue operating and protect its customers’ ability to transact with those tokens, perhaps? Nope. The CEO was trading with his personal accounts.

Use of cryptocurrency as a vehicle for micropayments that settle in real time back to real currencies while isolating in-flight transaction processes exposed to the entire web from the engine room handling “real money” makes perfect sense.

Until a G7 level country begins accepting tax payments via cryptocurrencies, using cryptocurrency for material business transactions (involving more than one comma, say) or as a store of value is essentially entering into a never-ending race to stay ahead of criminals. The party YOU are dealing with using cryptocurrency may be on the straight and narrow but can still be wiped out by one flaw in their security systems. And unless your government has a stake in protecting the integrity of that cryptocurrency, it is likely your beef with the other party will be viewed as a battle of equal fools by the courts, leaving you on your own.

Need an Exhibit B?

https://www.theblock.co/post/160230/babel-finance-crypto-los…

An Asian firm named Babel Finance promotes itself as a crypto-lender. It isn’t clear if that means they

A) make loans denominated in common cryptocurrencies while internally funding those loans with traditional funds sources like any other bank or mortgage operation or

B) they sell loans in regular currencies but leverage internal cryptocurrency “investments” as the source of funds or

C) they lend in cryptocurrencies and internally fund those loans with crypto-centric investments.

The firm apparently had two different types of internal investment teams – a “Trading Team” that executed trades to fund its “retail” lending to its customers with typical reporting and controls and a “Proprietary Trading Team” that operated in parallel playing with the company’s money but apparently without any normal reporting about their positions and trades. It turns out the Proprietary team lost a boatload of money when Bitcoin dropped from $31,000 to $22,500 from June 6 to June 14 of 2022 and those losses so impaired the company’s own account that it starved the firm of liquidity to operate on behalf of its customers.

In other words, the Trading versus Proprietary Trading distinction was completely pointless. It turns out it is impossible to “hedge” bets in the cryptocurrency sector when the entire sector drops like a stone simultaneously. Who knew? In this case, it isn’t even clear if they made attempts to hedge those trades in the Proprietary account.

WTH

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Company X and its usd revenues pays more as you advance. May bankrupt at the end of the day.

The issue is work is done.

Company X gets computers and automates. A lot less work is done.

Company Y is a software company. It automates a lot of things including its own development and production.

Even less work is done.

Company Z is in crypto and some work is done. It is not a Ponzi scheme.

But Company Z is not making false promises. Company X was.

Company Q in DeFi is making false promises. Fraudulent perhaps not a Ponzi scheme regardless.

The bigger immediate issue is fraud. The Ponzi scheme debate is a red herring.

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But make no mistake - some of these folks are planning to eventually rug pull and run off with all of the investors’ money.

But the crypto space is, in general, functionally a Ponzi scheme in that it requires an ever-increasing amount of money to come in to keep the sector afloat and/or grow it.

This is particularly true in “crypto lending”, which is nothing but Ponzi even if the organisers don’t actually intend to run away with the money. The outcome for the “investors” is ultimately the same.

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Just my own case, I offers the NFT and the ability to buy merchandise. Not a word promising anything beyond that. The clean honesty is valuable in itself.

The fraud is in the future promises.

That is why DeFi keeps getting into trouble.

But then again that is why the global financial system eventually gets into trouble as well.

As an artist either your project can sell for value or can not. It can be ultra hard for most artists to understand creating value. Young dreamers put the value into future promises.

Really skip over calling any of this a Ponzi scheme. Watch out for any fraud anywhere.