US dollar is the world's biggest Ponzi scheme

Vivek Kaul

"Where have you been?" she asked, as I ran into her in the elevator.

"Everywhere," I replied, trying to sound funny.

"I've been looking for you. See I have a doubt. Why don't we have coffee at my place?"

"Okay. Coffee with Kiran can't be all that bad."

"I read in a recent interview in DNA Money that the US dollar is the world's biggest Ponzi scheme. What does that mean?" she asked as she opened the door to her flat.

"You know what a Ponzi scheme is, of course?" I shot back, making myself comfortable on the sofa.

"Yeah, it's named after Charles Ponzi, an Italian immigrant to the United States of America (US), who promised investors in 1919 that he would double their money in 90 days, which he later reduced to 45 days. At its peak, the scheme had 40,000 investors who had invested around $15 million in the scheme. Ponzi had no business model in place. All he ended up doing was using the money brought in by the new investors to pay off old ones. He ran his scheme till the money coming into the scheme was greater than the money leaving the scheme. One fine day, that stopped and the scheme went bust."

"And what makes the US dollar a Ponzi scheme?" I asked.

"I think I asked you that"

"Did you? Well then I should answer that. See, over the years, the US and its citizens have been on a consumption and borrowing binge. The US is the world's largest debtor nation. As on November 19, 2008, it owed a whopping $10.6 trillion to others," I said.

"But how did they get around borrowing so much in the first place?"

"The advantage with the US is that its currency is the international reserve currency. Countries buy and sell goods in dollars. They also have a major proportion of their foreign exchange reserves in US dollars. And where do they get all these US dollars? A major portion of this comes from selling goods and services to the US. The US GDP is around 25% of the world GDP of $55 trillion. So the US is a major market for anything and everything. Once a country has earned these dollars, what does it do with them? It can either keep these dollars in its vaults or invest them somewhere. And where does it invest them? It invests them in financial securities issued by the US government as they are deemed to be safe and at the same time earn some return," I explained.

"But why does the US government issue these financial securities?" she asked.

"Well, for the simple reason that it spends much more than it earns. So to make good the deficit it needs to borrow money. And in order to borrow money it issues these financial securities. Most countries in the world have a good portion of their reserves in the US dollar, which they in turn invest in financial securities issued by the US government. You'd know that China and Japan are the two biggest exporters to the US; they are also the two biggest investors in financial securities issued by the US government. So what does that tell you?"

"You tell me."

"Well, it means there is significant demand for these financial securities. Thanks to the demand, the returns offered on these securities are low, which in turn ensures that interest rates in the US are also low. This encourages more and more people to borrow and buy goods and services that the Chinese and the Japanese have to offer. And when that happens, China and Japan earn US dollars. These dollars are again invested in the financial securities issued by the US government."

"But why is the US dollar and the economy a Ponzi scheme?"

"Oh, I thought you would have known by now. Well, let us say you have a credit card and you go on a spending binge. How will you return that money?"

"Well. I will return it when I get my next salary."

"What if you have spent much more than what you can realistically repay through your salary?"

"I will probably borrow from my parents."

"And how will you return money to your parents."

"I might borrow from you," she replied smiling.

"Well. The point is, if you cannot earn it and repay it, you will have to keep borrowing and playing pass-the-parcel. Similarly, to put it in a very simple way, that's exactly what the US government is doing. When one set of financial securities becomes due for repayment, it issues new financial securities to repay the investors holding the old financial securities. So, money brought in by the newer investors is used to pay off the older investors. That's what makes it a Ponzi scheme. And they can keep doing this because countries which export majorly to the US are ready to keep recycling the dollars they earn through the US economy and reinvest in the US government securities. Worst come worst, the US government can print more dollars to repay," I explained.

"Hmmm interesting."

"If you and I run a Ponzi scheme, we get labelled as fraudsters. But when the government runs a Ponzi scheme, it is said to be financing a deficit."

"But isn't the Government of India also doing the same thing? They also spend more than what they earn and borrow the remaining?" she asked.

"Yes it is. And I can smell milk burning. Ponzi has spoilt my coffee with Kiran, too."

Note: The example is hypothetical............