FUNDAMENTAL TRUTH #8: “Of course Social Security will fail; that’s what Ponzi schemes do.” -Old Pithy

Posted by PITHOCRATES - April 6th, 2010

A PONZI SCHEME is a scam.  A ‘get rich quick’ scam.  A great ‘investment’.  One that seems too good to be true.  And is.  Charles Ponzi didn’t invent it, but he was so good at it that they named it after him.

In a nutshell, here’s what it is.  Say I’m a swindler and I approach ten people.  I say to them, “Give me $100 each and I’ll get you a 50% return on your investment.  In only 45 days.”  They’re skeptical but interested.  Sure, it sounds too good to be true, but what if it’s legit?  That’s a helluva return.  Surely that’s worth the risk of a $100 investment.  So they make the investment.  Wouldn’t you? 

45 days later, I give each and every one $50.  Just like I promised.  They’re so shocked at their good fortune that they all but crap their pants.  They don’t know what the investment is and they don’t care.  When asked if they want their principal back they ask, “Why?!?  Where else can I earn 50%?”  So they keep their money invested.  And they give back the $50 so I can reinvest that, too.  This is just too good of a sure thing.

Am I a financial genius?  Perhaps.  But that’s irrelevant.  Even a financial genius can’t earn 50% with such certainty.  Not legally.

So how did I do it?

THE SECRET IS that I didn’t do anything.  They gave me $1,000 ($100 X 10).  And, 45 days later, I pulled that $1000 from my wallet and paid out $500 ($50 X 10), leaving $500 in my wallet.  There was no investment.  It’s just an illusion.  I just gave them some of their money back.  And kept the rest.

Money comes in.  Some of it goes out as a ‘return on investment’.  But there is no investment.  There is no principal earning anything anywhere.  This is how the Ponzi scheme works.  A lot of money comes in.  A little of it goes out.  The swindler keeps the rest.  And it keeps working as long as the investors believe the lie.

As word spreads about these crazy returns on investments people are falling over each other to give you their money.   You can see how it grows.  And it’s lucrative.  If the total amount people invested is, say, 30 million dollars, you make yourself 15 million dollars at the low end.  More if people reinvest their earnings.  And, of course, they will.  I mean, what else is paying 50%? 

Eventually the house of cards falls.  Over time, the amount of money going out gets closer and closer to the amount of money coming in.  Until, one day, more goes out than comes in.  It always does.  People may close their accounts because they need the money to buy a home or build a business.  Enough people do this and the cash flow will reverse.  And when it does, something has to change. 

You lower the ‘return on investment’.  Your investors, of course, won’t like that.  They may invest less and stop reinvesting their earnings.  This compounds the problem.  You try to find more investors.  Of course, this isn’t going to happen with declining returns.  No one wants to get in on the downward slope of a good thing. 

You then ‘cook the books’, using creative accounting practices to sustain the lie.  But that just delays the inevitable.  And it makes the financial hole deeper in the process, ensuring the crash will be even bigger.  Then it does crash.  And people start going to jail.

SOCIAL SECURITY IS very similar to a Ponzi scheme.  It’s cash flow.  The money coming in goes right back out in Social Security benefits.  There is no investment.  There’s no principal somewhere earning something.  It’s a pure transfer payment from one group of people to another.

Today’s recipients are making obscene profits on their initial social security ‘investment’.  When working, they contributed a pittance compared to what they have and will collect.  You see, when FDR set up Social Security, old people weren’t living as long.  But people are living longer today.  About 20 years longer.  That’s 20 years or so of benefits that the actuaries never banked on. 

But it gets worse.  As the benefits grew the birthrate declined.  There was a rise in the use of birth control and abortion.   This resulted in a population ‘shock’ as the average family size quickly shrunk.  Put the two together and you’ve got a big problem.  The rate the older/retired population is growing is greater than the rate the working population is growing.  That means fewer people are supporting more people in retirement.  This translates into more money going out than coming in.

A DECLINING RATE of population growth is a HUGE problem for government.  Government expands.  It never contracts.  (Sad but that’s just the way it is.)  It needs the population to expand at least at the same rate to pay for that massive government spending.  When it doesn’t, something has to change. 

You increase social security taxes.  You reduce the amount of the monthly benefit check.  You increase the eligibility age for social security benefits.  You fight to grant illegal aliens citizenship to increase the tax base.  You make people work until they die so you never have to pay any benefits.  You cook the books and talk about a ‘trust fund’ and send out statements showing the growing value of your ‘retirement account’ and your ‘projected’ benefits.

But this just delays the inevitable.  And it makes the financial hole deeper in the process, ensuring the crash will be even bigger.

AND WHAT ABOUT that Social Security Trust Fund?  It’s a myth.  It doesn’t exist.  It’s like a unicorn that only exists in fairy tales.  It entertains and lets you escape reality.  But it’s just a fantasy.  All the money you paid into the system via payroll taxes is not sitting in a pile someplace earning interest.  They spent it.  Confused?  Think of the trust fund as that briefcase in the movie Dumb and Dumber. 

Lloyd/Jim Carey tries to return a ‘lost’ briefcase (unknown to him it’s full of ransom money) to a beautiful woman across the country.  His best friend, Harry/Jeff Daniels, travels cross country with him.  Broke, cold and destitute in Aspen, the briefcase opens and they see all that money.  They use it to get some essentials: a suite at an expensive hotel, some new clothing and, of course, reliable transportation.  A Lamborghini Diablo.  But, every time that they took money out of that briefcase, they put in an I.O.U. for the amount taken.  Responsible, yes, but the kidnappers would rather have had the money.  As good and as decent as Lloyd and Harry are, the prospect of them honoring all of those I.O.U.s just wasn’t good.  They’re a couple of idiots, after all, as the name of the movie suggests.

This is the Social Security trust fund.  There’s no money in it.  It’s full of government I.O.U.s.  They’re promises to repay your money…with money they will take from you at a later date. 

A PONZI SCHEME will work until the point when people begin to withdraw their principal.  Without any real asset tied to the investment, it can’t refund any principal AND maintain the ‘return on investment’ payments.  It survives on cash flow.  If too much cash is going out (i.e., people pulling out their principal), the direction of the net cash flow reverses and the whole house of cards comes crashing down.

The same thing is happening with Social Security.  There is no real asset tied to the Social Security system.  It survives on cash flow.  And the direction of net cash flow is pretty darn close to reversing.  A smaller working population is now paying for a larger retirement population.  The house of cards is teetering.  It will either fall or there will be big, unpleasant changes in our future.  Or both.

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