Crypto Is to Capitalism As Qanon Is to Politics, Part II

(Best read after Part I.) It may be tempting to view crypto-fueled Ponzi schemes as anomalous with respect to capitalist economies. I want to argue a contrary point: that Ponzi schemes are as normal as any aspect of Capitalism.

The mathematician Benoit Mandelbrot wrote about something called “fractals.” I read one of his books years ago. Going from memory, a fractal is a pattern that mimics a larger shape from which it branches out. Here is a simple example:

As you move towards the tip, the shapes of the leaves are identical, though successively smaller. That is my metaphor for Ponzi arrangements, relative to finance as a whole. They extend from but mirror a larger pattern.

For elaboration of the context for Ponzi schemes in capitalism, I can’t resist offering an extended quote from the great economist Hyman Minsky, whom I was privileged to have met. This is from his paper for the Levy Institute on his “financial instability hypothesis”:

Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified. Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit.

Speculative finance units are units that can meet their payment commitments on "income account" on their liabilities, even as they cannot repay the principle out of income cash flows. Such units need to "roll over" their liabilities: (e.g. issue new debt to meet commitments on maturing debt). Governments with floating debts, corporations with floating issues of commercial paper, and banks are typically hedge units.

For Ponzi units, the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.

(Fun fact: Minsky had the goods on Donald Trump’s financial style, all of thirty years ago.)

For me a key takeaway is the organic character of the natural transition from hedge finance to Ponzi, fueled by ordinary business incentives, that underlies the chronic instability of world capitalism. Under our regimes of unregulated finance that prop up the obscene fortunes of a thin, amoral segment of society, crises are not a bug; they’re a feature. In light of climate change, they will be the death of us all.

In a Ponzi scheme, the rate at which payments to old depositors have been promised outruns the inflow of new deposits. When a business is forced to sell off assets to meet debt obligations, it is swirling around the toilet bowl, since it is those assets that are the basis for future income. It is liquidating itself. This is the ordinary process of going broke, ubiquitous in every market economy.

Social Security has been attacked as a Ponzi scheme, since its finance is on a “pay as you go” basis: current benefits are financed (mostly) by future beneficiaries’ taxes. But that doesn’t make it a Ponzi scheme. As long as the tax base grows quickly enough, due to population and GDP growth, there is no necessary risk to future beneficiaries. We’re not going to run out of workers or GDP. In a Ponzi scheme, the payouts are inordinately high compared to inflow of new contributors. That’s why the scheme eventually collapses.

The crypto world described by Zeke Faux is filled with all sorts of ridiculous characters pursuing depraved life-styles. The incredible thing is how rich some of them are able to get, if only for a limited time. It’s not a little grating that what to them amounts to pocket change is a level of wealth that most people spend a lifetime scratching and clawing to achieve, and never making it. A cliche is that youth is wasted on the young. So is wealth.

These worthies are led to believe not only that they are geniuses, but that they will remake the world. They like to cite the example of El Salvador, reported by Faux as a fraud. After exposure to their idiotic pronouncements on world politics and its problems, one has to wonder how they managed to make any money at all, let along hundreds of millions of dollars, or more. In their own way, their understandings are as ignorant as the blather of Qanon.

For instance, a common mantra among crypto enthusiasts is how crypto will eliminate world poverty. Meanwhile, as Faux reports, the use of crypto for massive scale criminal activity is doing exactly the opposite.

The commonality of cryptoworld, even its less criminal side, with ordinary economies, and the demented social outlooks of its leading denizens, are more of an indictment of everything else. If you let a relative crash in your living room and shit on the floor, that’s on you, isn’t it?