Friday, February 20, 2009

The Pyramids of Egypt Got Nothing On Us

On a scale of one to ten, what I know about financial markets is a minus two. Talk about derivatives and hedge funds and futures, and I can't even begin to follow. But even I understand pyramid schemes -- to keep them from collapsing, you must constantly bring in new capital, you must keep growing. Pyramid schemes work great in the beginning -- the guys at the top get rich, the guys in the middle get promises of getting to the top, and the guys at the bottom believe they too will get their day. But eventually all pyramids reach the limit of their growth potential and the poor schmoes on the bottom get crushed in the implosion. That's why pyramid schemes are illegal. That's why Madoff is in soooo much trouble.

But, hey, wait -- isn't that how our whole financial system is structured? Isn't it all one giant Ponzi scheme? Isn't that why we're desperately pumping more money into the pyramid to keep it from imploding? Like I said, what I know is a minus two, so I could have this all wrong.

What led me to this conclusion was an article by Chuck Burr, also known as culturequake. To quote from his article:

Total world derivatives are $1000 trillion or 19 times the total world GDP of $54 billion. Over-the-counter derivatives total $684 trillion of which 67 percent are interest rate swaps. Exchange-traded derivatives total $344 trillion. Interest rate swaps are the largest derivative powder keg waiting to blow the world financial markets to supernova.
Our capitalist global casino is a house of cards. If the economy continues to sink, credit default swaps will be the first to blow as we move from hundreds of billions to trillions in corporate quarterly losses. This triggers more deficit spending, which ignites more inflation which lights the fuse to the interest rate swaps supernova.

Greater financial risk plus plummeting earnings per share pushes stock markets lower, which increases pension deficits and defaults (S&P 500 Corporate Earnings chart). As mentioned in my previous essay, America’s 500 largest companies have a deficit of $200 billion in their pension plans. If the Dow hits 4,000, pension deficits would rise to $400 to $500 billion. Retirees lose their pensions and stock market investments. Many will be left with just their FDIC insured deposits if the government does not default.

What applies to the financial markets applies to our entire economical model -- our current economy is built upon a foundation of ever increasing debt. To keep our system from collapsing, it must grow. Housing prices must go up, salaries must go up, sales must go up, tax revenues must go up. If we reach the limit of our growth potential, the whole thing will implode and the poor schmoes at the bottom will get crushed.

Sounds just like a pyramid scheme to me. But, hey, I could be wrong!

[G:As it turns out, I'm not the only one who sees it this way! Check out Joe Romm's piece: Is the global economy a Ponzi scheme, are we all Bernie Madoffs, and what comes next? Part 1]

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