First the easy question. A Ponzi scheme is the scam that Bernie Madoff has worked. He claimed he had an investment company, and sent out monthly reports of trades. It turns out he never made a single trade.
What he did was take peoples money and pay investors from the money put in by new clients. That is why Ponzi schemes are also known as Pyramid scams.
Now as long as the pool of money increases with the addition of new investors, the scheme can be kept hidden. but as soon as there is an economic turn down and the pool of new investors shrinks, then the whole scheme collapses like a pack of cards, and the investors loose their base original investments.
Now to understand derivatives, and why I and many othersw really consider them very well hidden Ponzi schemes you have to understand what has happened over a long period of time. That gets us to the long version! I will try and make it as simple as I can.
I think, I can best explain this with reference to my own observations.
The Victorians understood the difference between trade and commerce. Trade between nations, is I buy something from you, and you buy something from me. That is trade. Commerce is just crude business activity.
Now in the West after WW II standards of living rose at a tremendous pace.
At first there was real production. However this created huge demands for resources especially energy.
One of the first big landmarks in the road to ruin was in 1973 when Nixon signed the bill for the importation of foreign oil.
Now when I was a child during the 50s and sixties, we lived in a house high above the west bank of the Medway towns, on the river Medway Kent. These towns were ports and a center of manufacture.
Ships would come in and out, lots of them, on every flood and ebb tide. Ships were also built in those towns. The ships came in with all sorts of goods, lumber from Scandinavia, lamb and butter from Australia, and goods of every kind.
Those ships left with cement mixers, road building equipment, injector pumps, aircraft parts, sophisticated electronic parts from Elliot automation and cement.
As you stepped out of our house, you could here the noise of labor and the creation of wealth all along the banks, from Rainham, Gillingham, Chatham, Rochester and Strood.
Now the societies of the West wanted not only lots of goods, but a lot of social services including health care. They also through their unions negotiated high wage packages, often holding the country to ransom with strikes. Between taxation and wages, people could no longer afford their goods and high life style. So, gradually at first, we saw the introduction of goods from the Far East built with cheap labor and no social safety nets.
Gradually the noise from industry on the river grew quieter, and the ships came in on the flood tide low in the water, and left on the ebb increasingly high in the water. Between these factors and the importation of energy, the trade gaps of Western nations have ballooned.
The factories which generated the wealth are now idle and decayed.
On a trip to the UK, when the crisis really picked up speed I took a few picture. I'm sure there are the same scenes all over the Western nations.
When I was growing up this factory was a hive of activity.
This was Grays ship yard, that I knew as Lemon's Yard. It is were at the end of the eighteenth century, HMS Bellaraphon was built. She fought under Nelson at the Battle of the Nile and at Trafalgar. She took the surrender of Napoleon. Now only the pub remains, and that seemed to be failing fast.
What was once thriving industry, put to grass.
The sheds you see on the right, were ships were built for a thousand years, now a museum, owned by the English Estates.
No ships leaving on the ebb tide.
They say a picture is worth a thousand words, and to me these are.
I hope you now see the seeds of our eclipse.
So as we surrendered production, property became the major source of creation of real worth.
Now the holders of the debt and trade imbalances, have become increasingly worried about our ability to make good on the debt. So they wanted the debt backed by property. This led to the creation of the derivative that has become known as the mortgage backed securities. Many, including Warren Buffet, have warned for years that these instruments were the road to financial ruin.
So investments got wrapped in Mortgage paper, to secure their worth.
The problem is there was not enough property to wrap all this debt, so the building of a house became an instrument to create paper instead of somewhere to live.
So unscrupulous builders, bankers, realtors, and Mortgage brokers put any body with a pulse in a $250.000 plus home.
Things were so bad to the West of the Twin Cities here, that they were going to homeless shelters, and giving them mortgages for homes in Wright county. This is all in the court records now. To top it off many of those house have no prospect of getting clean water or having waste disposal. Yet there were grandiose names, like "Opportunity Drive."
So if you build something there is no need for, then what you built has no value. That is what has happened to a lot of housing. Not only that the buyer could not afford them without deceptive teaser rates.
What this boils down to is that the wealth was not there, so a lot of those derivatives really are in essence Ponzi schemes.
Not only that everything was sliced and diced. Bad paper was mixed with good, just like mixing good and rotten fruit, with the same result.
Things stated to unravel three years ago. However last summer"s big run up in energy cost brought the whole Ponzi scheme down like a pack of cards.
What will happen next I think will depend on the degree of International co operation that can be achieved.
To bring this back to audio/video, members here by buying cheap Far Eastern Goods, have put China in the drivers seat, at the rounds of world financial conferences that will be required.
One thing is certain, that coming out of this the standard of living and expectations in the Western nations, will have to decline drastically.
Any other alternatives will lead to war, but that gets us on to another topic.
