Is US system a mega Ponzi scheme?

Recently I think about the idea of my Professor, Tom Nguyen, of whether US is a mega Ponzi scheme. The main argument is: US almost always pays old debts with new debts (and an increase in debt ceiling), moreover, default is not an option toward US’s debts.

I did keep this question in my mind for days and US system does look like a Ponzi scheme.  However, there are the right and the wrong with this approach: The right side tells that it was true in the past, especially from the fall of Bretton Wood system in 1971.  Plus, since its inception US new debts were mostly used to pay for old debts with a higher debt ceiling.  The debate of congressional men and administrative officers of US government aren’t something very new and special.  Since 1971 there are 70+ debates like this one, both democratic and republican leaders agree up front one idea: Default isn’t an option.  The wrong side, I think, of this approach is: the Ponzi scheme is supposed to go on forever until it collapses, however this will not go on forever without a strong intervene from the US government, and because of that, we cannot classify it as a Ponzi scheme.

There are many reasons for me not to think of US system as a mega Ponzi scheme:

(1) Everybody knows this – and when everybody knows this, they have their actions.  In the past, all Ponzi scheme collapsed upon people reveal the truth – this is not true with the US case.  Almost all of other Ponzi schemes, the investors/victims do not know about this.  And when they do know, the Ponzi ends.  However, this is not the case with US system.

(2) US government doesn’t want it to be looked like a mega Ponzi scheme therefore has worked hard to cut spending and lower the debt proportion in the future.  This is not a characteristic of a Ponzi scheme.  They, the US leaders, simply know this mechanism can’t go on forever.  So the better option is to do something toward it – this showed from the latest and newest debate on US debt crisis that has just reached an agreement yesterday.  I watched them very closely.

(3) In case US can’t solve the problem, there is at least 2 things will push US to rethink the system if they finally want it to be a mega Ponzi scheme.  The US knows this and I don’t believe they will let this happen:

(3a): Diverse international options with gold, other currencies, and commodities – last 11 years people saw gold increased – and USD decreased.  Traders and financial institutions are not the main players on this phenomena as most people think.  They are not large enough, they are active – but not the final leaders.  The key driven leaders behind this phenomena are national banks of emerging countries especially those from Asia.  Whether we don’t know this phenomena to go on, national banks from these countries will continue to sell USD to buy gold and other inventoriable assets. So, which are other inventoriable assets can be used to store value and hedge the depreciation of dollar?  I notice the countries with large oil backed often did not pursue gold actively, except Venezuela, in the last 11 years.  This has a 2 strong implies: first, without USD, there is a lot of inventoriable and durable assets to keep value of the vault – Gold and oil are 2 notable examples.  Second, since 2000, the whole world did start to take actions toward the US system by continuously sell USD and buy other things: other currencies and gold.  This is not the case with oil because many sophisticated reasons that I’ll reveal in other notes.  Summary and conclusion: as USD to lose it power, a mega Ponzi scheme becomes irrelevant.  Because this trend is already formed, and firmly formed, US won’t let the USD to lose it power, by any mean.

(3b): With (3a) to continue with the last 11 year trend, USD will depreciate even more and there will be another country or countries to take the role of US and there will be another currency or currencies to take the role of USD.  There is the intention: China, Japan, EU, or multi-polar group of strong currencies.  I don’t know whether Arab world will involve in the race but those countries in the future have the potential.  Now, Arab world and Middle East do not have a strong international coverage because: first, political instability – most of Arab and Middle East countries do not have a democratic political system, they have kings and royal families, and they have dictators, or dictatorship political system.  From the Arab Spring with the involvement of: Tunisia, Egypt, Libya, Bahrain, Syria, Yemen, Jordan, Lebanon, Saudi Arabia, Sudan, and others the regional situation here has been more tense than ever.  Second, religious conflicts between inside Islam denominations (notable Shi’a-Sunni relation), religious-political conflicts inside Islam world (Palestine-Israel relation), and  between extreme Islam with western world have been for hundreds years.  Overall, the region hasn’t shown any reconciliation and stability signal in both the short and long term yet.  I expect Arab world to continue its strong influence to the world in energy and finance (they are one of the biggest investor in the world, they are just simply too rich).  However religious and political instability remains strong barrier.

EU is itself in trouble with debt crisis notably with Greek, Italy, Portugal, and Ireland.  Basically EU system is alike the US system.  However EU is much more unstable due to its decentralization of political power.  The paradox of EU is: it has a common currency and financial system, however very different in political and fiscal policies among countries, this is not the case with US.  This makes the stabilized efforts between different countries and territories extremely hard.  Do you think inflation in France and Greek the same?  Do you think interest rate in Belgium and German the same? You bet.

Japan since long has a lot of money and invest around the world.  But the financial system in Japan is too conservative.  Plus, Japan is not a country that involves deeply in the global value chain.  Japan involves only to the top of the pyramid: only the most sophisticated, most high-tech (whatever tech: IT, robot, bio, semi-conductor…). Only US, BRIC, EU, China, and India involve deeply in the global value chain.  So if US, BRIC, EU, China, and India stop breathing for a day, the whole world will be frozen.  But if Japan stops breathing for a day, Vietnam’s silk cocoon can be still harvested and sold to China, then China dyes it and sells to India, India makes it fabrics and sells to France/England/Italy (depends on whether you like LV, Burberry, or Versace) and then France/England/Italy sells to US, the world still revolves and the sun still shines.

China is rising and people talked about China a lot so I hold my breath here.  But China, from my point of view, is like a new rich guy.  There are a lot of inequality, uncertain, insecurity, and unsustainability inside China. China is feared, but China has a lot of problems to deal with before being another US.  I don’t think in the range of 30 years China can do it.  This is only my personal point of view.

So if the USD steps down today, noone can replace it.  However US knows, someday, someone can do it – like the US did, in term of political stability and financial strength.  But there is another idea: Only US have both oceans: Atlantic Ocean and Pacific Ocean.  Think about this.  China has only Pacific, with a lot of struggles from Taiwan, Japan, Korea (South and North), and ASEAN.  India has only Indian Ocean. Arab World and Middle East don’t have many.  EU shared with US Atlantic.  Brazil has the south of Atlantic Ocean.  Think about it.  Think about the geo-political and military advantage of US at this point.  If you understand this point, you will see why China is so crazy and fiercely with the intervene into ASEAN.  It’s a must for China to become global superpower to control that sea route.

The game isn’t easy for anyone to step up.  But there are the intentions and there will be.  US knows this, so better not to stir it up.  Pays the debts on time, makes the national proportion of debt lower and makes the globe to trust on US superpower, politics, economy, and society, or whatsoever must be much much better.

So, internationally – people don’t want the US to be a mega Ponzi scheme. Nationally – US itself doesn’t want to be a mega Ponzi scheme. They will work hard to prove this point. However do you think US debt will increase? yes and yes. But think about it as when you’re a child, you own 10 bucks. When you grow older, you own 50 bucks, but you have 30 bucks asset. And when you have family, you own 200,000 bucks – but at least you have a house. And it goes on that way. You can go on and go on, but only if you can prove you have the trust to back it up: a character, position, or asset. Then it will be fine, and not a mega Ponzi scheme.

There is a lot of ideas associated with this issue: US credit downgrade risk, oil and petrodollar between US and Arab world, US debt ceiling dealt yesterday, and so on. But I’ll let it other notes then.

– Portland, OR – August 1st, 2011 –

Tri Ton

Businessperson with private equity expertise. Interested in strategy and investment.


  1. Pingback: The curious case of US credit downgrade – Tri Ton – World on Perspective

  2. I add the core discussion comments from my facebook with my professor Tom Nguyen:

    Prof. Tom Nguyen: The American people import huge quantity of Chinese products by just printing out dollars and pay the Chinese. The Chinese is essentially financing American good life style by accepting the $ IOU. For the Chinese, the main issue is to find out what it could do with this huge dollar reserve. Should China loans more to the US for the US to pay its debt and interest? From the US standpoint, how would it get out of this huge debt with China? How would the US erase all debts with China?

    Tri Ton: Yes, I also want the debates like this one and learned a lot through challenges like this.

    For the China-US relations – I think this is one of the most easy-to-be-confused thing on modern trade. From the Chinese stand point, the buying and accepting $ IOU is not a banking decision. It’s the trade policy decision. China employed a growth-by-export model and its largest market is the US. What is the imply of this? This mean, when China sells goods to the US, China will take back the USD. And this means that China has to do something with this USD. They can’t just keep the USD in their vault and let it lose value by inflation and opportunity cost.

    So is there much options for China to choose from this situation? No, There is not. With a huge dollar amount from export to US every year, China need a market where are marked by both deep and wide market, high liquidity, and the ability to absorb a huge bunch of USD that China has.

    Therefore in the case US default China will still buy a lot of US T-Bills, because the dollar amount gained back by exporting goods need to be recycled somewhere.

    From the US stand point. Is it good for US to raise debt from China? I think so. I don’t think law makers in US want the US to erase the debts with China. Because the problem is: US need those debts to to their things. It doesn’t matter whether it is China or Japan or Arab Saudi.

    So China knows this, if they still employ the model growth-by-export toward US, China has to pay the price by continuing to rely on dollarization of its foreign reserve. To deal with the situation, China can (1) buy other things, but this is only on small percentage, gold is another example (2) employ a growth model that’s less relying on export to US by focusing on domestic consumption.

    The key point I want to stress is: it is the linked system between US and China that tied them together and tied China with US T-Bill. It’s not the China option to get out of this situation by deciding not to buy US $IOU from banking and investing stand point.

    Additional information with China is, the QE2 of the Fed will let China lose around 25% of its US$ 1.2 trillion USD reserve (around US$ 300 bln). If the US default, or the AAA rating be downgraded, the interest rate of T-Bill will increase and this will be another strike for China’s foreign reserve.

    Prof. Tom Nguyen: China cannot use US dollars to buy US lands or US military equipment to strengthen its armed and naval forces. However, China can buy gold or oil with US dollars, and also brand new plants in the area of petrochemical, fertilizer, refining… If China buy US T-Bills, they are loaning back the money to help US economy grow. This is what they did with most of their hard earned money. The US is rejoicing on this special relationship and the risk would be on Chinese shoulder if dollar depreciate. This is exactly what is happening right now. Every countries are now using their dollar reserves to buy gold. If dollar weakens so much, no country would sell their land or minerals or products for US dollars. Then real trouble would begin for China.

    Tuan Le – Trader @ Horizon Securities in Vietnam: well if demand for gold would push this metal up to new record, US is the guy who get benefit due to biggest gold reserve. The unbalance between gold and USD will be a big advantage with US rite?

    Tri Ton: Tom Nguyen Yes thank Prof. I reached the same conclusion :)! That’s why China is altogether doing the 3 things: diversifying its reserve, changing the growth model to less heavily rely on US, and …blaming US for being “irresponsible” and “immoral” :))

    China with itself credit rating agency Dagong did downgrade US to A+ and they claim they would downgrade US to D if the US default by this August 2nd. However Dagong doesn’t have any international voice, then never mind them.

    For Le Van Nhat Tuan, you’re right – but US can’t sell gold. Because if they sell gold there is nothing left to back for the trust in USD. There is one option talked about during the last debt ceiling debate is whether US can sell gold to pay off its debt. However the option was soon rejected by the reason I noted above. And if the price of gold is pushed down by the selling, it’s just like US commit suicide.

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