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Monday, February 7, 2011

Ponzi Psychology

Ponzi Scheme; definition:  "investment swindle in which early investors are paid with sums obtained from later ones in order to create the illusion of profitability"

In this article I postulate that the one governing rule of Ponzis will allow severe selling of assets, or a "P[3] event".

It is broken into various parts to attempt to present some kind of coherent package:

1. First Rule of Ponzi schemes
2. The Financial Markets are Largely a Ponzi Scheme
3. The National Debt Problem
4. Mass Recognition of the Ponzi Scheme
5. Triggering the collapse.
6. Ponzi Sentiment In the Market

I formulated a general rule concerning Ponzi schemes. It can be summed up as such: "When Ponzi schemes are recognized to be as such, they collapse quickly despite maximum bearish sentiment."

In other words, when Madoff's fund was found to be a Ponzi scheme, investor sentiment went 100% negative and the scheme collapsed entirely overnight. So you see where I am getting at? There was no "upside surprise" in that investment once sentiment went full negative. There was no contrary play, only exit.

This has always been true somewhat. But what I am talking about of course is the debt problems of the world.  This is the greatest credit bubble of all time.  And all credit bubbles collapse back to where they started.  

Take our US Treasury for instance. Issuing debt with the false pretense that it is to be honored and eventually paid back in full.  I merely must link to the National Debt Clock for you to get the idea of how absurd it all is  Is any other country really better off? Click on the other tabs to see their situations.

So what is happening in the debt markets with the FED?  Basically the Fed and the Primary Dealers are taking paper from the left pocket and giving it to the right pocket. They then add both pockets as if they were both full and there is your balance sheet.  They do this through complicated market structures and re-purchase agreements and the myriad of "fund facilities" and programs.  They are constantly moving the ball in an effort to conceal it. But they cannot conceal the overall totals for all to see. $14T in the hole.... "it is what it is".

The Fed's balance sheet is already massively in the hole. I argue they are already technically insolvent. Who else is left to take on the needed debt for even only the next few years?  What about 10 years?  Will we miraculously balance the budget before that happens?  Will we need 20 years? How much debt will there be then?

Obviously the point I am making is that there is a stopping point.  Many make the argument, which seems to be well-founded, that once GDP/debt rations reach 100% then you have big problems. Well we are there pretty much if you figure our economy is around $14T and the total debt is around $14T and depending on what you factor into the equation like future debt promises, we are way over that 1:1 ratio.

A parabolic rise in anything collapses back into itself.  The national debt is going parabolic.

They must soon vote on raising the debt ceiling  limit.   What will happen? How will the vote go? What demands will be exacted?  Do they even have a choice? Does the vote matter?  What if they vote no and then what?

We'll soon find out what it all means but the process will be fascinating to say the least. Lets suppose they raise the ceiling to $16B.  Won't they recognize that it will reach that limit within a year or so at the rate we are going?   I wonder if they would even give Obama that much cover.  If they add only $800B or so, the problem will fester in the public media like a sore.

There is no fix to the debt problem. Cancel out all the discretionary spending to the last penny and you still come up short to cover entitlements as Mish blogs about constantly  Soon interest payments suck out every last dime until you are bankrupt. There is nothing complicated in understanding we have a problem  that can be fixed in one way only: Destruction of the debt. And that is deflationary.

Debt promises for future entitlements are the very definition of a Ponzi scheme...."early investors (in this case those that collect from the entitlement system now) are paid with sums obtained with later ones (issuing more Treasury debt) to create the illusion of profitability."

I argue that has been happening in the subconscious of most every American for going on many years now. I remember as a teenager in the early 1980's when I use to think to myself, "How can we ever repay this debt?" That bothered me then even. We weren't even $1T in debt yet!

I have a simple test. Ask anyone if they ever think the debt will be repaid and you'll inevitably get a "Never" for an answer.  That is all you need to know that people have been thinking about this even if the numbers are abstract (how much is a trillion?). They just have not connected the dots in the conscious that this affects them ultimately. Or maybe it is the spell of delusion we are caught up in.

At the very least, the debate soon to take place in the US Congress concerning the debt ceiling will be media fodder I predict. Timmy Geitner has already warned that it would be "catastrophic" if the ceiling is not raised. Another banker threat with a gun to our heads.  He may right.  But surely raising it is just kicking the can down the road. Then another gun to the head next January?  How many bullets must we bite?

Ask another question of young people: Do you think you will collect social security? The majority have already been heavily skewed toward "No."  This then is another conscious thought on the Great Ponzi. The younger generation can recognize it even if they do not call it a Ponzi itself.  Heck even many older Americans are not sure if they can get anything when their time comes.

People are however starting to connect the dots that the debt matters They are mentally prepared. After all, they 1) expect the debt will never be repaid  and 2) suspect they may never get their entitlement promises.

So we have, as a nation, mentally prepared the foundation for this Ponzi psychology.

In wave theory we don't suppose anything needs to trigger an event. We just suppose the waves trace what they must trace.  When P[2] ends, P[3] starts if thats the correct count. At the "third of a third" will be a great panic. They even coined this spot the "point of recognition".

But I am talking about a great collapse in our financial system. What could trigger debt destruction? Higher interest rates for one. Make it impossible to service the debt and you can have an avalanche of defaults which spur layoffs, which spur more defaults, etc.

Or how about the 100's of trillions in notional derivatives, specifically interest rate swaps?  How stable is that system?

How about the fact that computer algorithms are now in control and we cannot change this back overnight even if we wanted to? The "algo's" have no feeling and will surely sell if computes that is what needs to be done.  Yes, Skynet is here.

Will the debt ceiling issue help take national consciousness to the next level? You think the banks want to talk about it?  No! It surely cannot help Ben and Co.  Their balance sheet will be front and center!

How about a Federal Reserve that is on the verge of bankruptcy? (Even if they think they can change the accounting rules, the market has its own rules.)

We don't know what "event" the media will assign to why the markets are falling but they surely will come up with something.  But underneath it all, the mountain of debt is the problem. A mass recognition that the US Treasury and indeed many Central Banks are indeed Ponzi schemes.  And the rush to exit and be the "first" to get out could be as simple as that.

My overall point is quite simple: Mass selling events may continue to occur even if negative sentiment is very heavy bearish if Ponzi thinking is in effect.  This is the great wildcard in "contrary"  investing.  This is the point where contrarian investing would be taken to the extreme limit. We could be buying dips with daily sentiment at historic lows only to get wiped out yet more.  A collapsing Ponzi may have  no upside surprise.

I am not sure how this will play out of course I have no crystal ball. I am merely pointing out that if our financial markets are viewed as a Ponzi scheme by a mass majority in one great moment of recognition, then look out below.  So it is possible.

The US Treasury is a Ponzi scheme. The National Debt is going parabolic. People are well aware of it already but not yet at an actionable level perhaps. All Ponzis and parabolas collapse. We are in the biggest credit bubble of all time. All credit bubble manias collapse.

"That which cannot be sustained, won't be".

A great counter-trend (A)(B)(C) or even [A][B][C] rally is occurring. The size of the rally  makes us forget the underlying situation.  The flash crash in May was no accident. It occurs in the micro in stocks every month. Underneath it all exists the greatest mass illusion ever conjured up by mankind in the form of a credit bubble that dwarfs all credit bubbles to ever come before.  It will end, they all do. And the wave structure suggests the end game is playing out. The Fed is the last buyer of last resort.

Who can bail out the Fed?  That question can only be answered one way: No one.  That is the essence of Ponzi recognition.
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