Tuesday, February 09, 2010

Of gold bugs and ponzi schemes

One thing that gold bugs are fond of saying is that fractional reserve banking is a Ponzi scheme. Err, no. Fractional reserve banking is where you agree to loan your money to a bank in exchange for a certain amount of interest, the bank then loans out that money to someone else at a greater rate of interest, and the bank makes its money on the spread between what it is paying you, and what its borrowers are paying the bank. That is an honest business operation. The bank is serving as a means to spread the risk of lending your money amongst multiple borrowers, rather than a single borrower being able to default and cause a 100% loss. In short, when operating properly, a fractional reserve banking system is a means of spreading the risk of loaning your excess capital amongst sufficient people that the risk you'll not be able to get your money back when the loan is due is reduced to a very small amount.

So why do gold bugs state that an honest business operation is a Ponzi scheme? That's a good question, and I don't know the answer to it. A Ponzi scheme has certain characteristics:

  1. The central defining characteristic of a Ponzi scheme is that a Ponzi scheme pays off prior investors with the money from new investors. But banks don't pay you interest with money from new investors, banks pay you interest with the interest money they get from loaning your money out.
  2. The Ponzi scheme gives unusual or higher than normal rates of return. C'mon, have you had your money in a bank recently? Can you say that any bank is giving you an unusually high rate of return?!
  3. A Ponzi scheme claims to rely on some esoteric investment approach. Uhm, what's so esoteric about paying a low interest to people loaning you money, loaning that money out at higher interest to other people, and then making a profit from the spread?
  4. A Ponzi scheme has a central schemer. There is no central controller of any modern banking system, even the Federal Reserve is as much controlled by banks as vice-versa.
In short, none of the attributes of a Ponzi scheme apply to fractional reserve banking. Any time a gold bug calls this simple business arrangement a Ponzi scheme, said gold bug is either showing that he's an idiot who doesn't know what a Ponzi scheme is, or that he's a liar. Either way, mention the word "ponzi scheme" in the comments on any of my posts in reference to banks and that's a sure way to get your comment deleted -- I don't have patience with either idiots OR liars.

-- Badtux the "Better idiots, please!" Penguin


  1. Ugh, I remember the short period of being a gold bug.

    Fortunately I was able to sell it all at a small (very) profit. The bid/ask spread on that shit is criminal.

  2. As I've repeatedly pointed out, you can't eat gold, and you can't use gold in commerce so it is worthless as a unit of exchange too. Its only use in a modern economy is as a store of value, and there are a lot better investments to use for that because, as you point out, the bid/ask spread on gold is shit.

    Personally, if I had a lot of money to invest right now, I'd be closely looking at real estate. The fundamentals are starting to get back to realistic levels and if you maintain the properties, you can get some decent cashflow out of them. I expect prices will go down further over the next two years as additional waves of foreclosures hit the market so market timing is going to be an issue, but you can't generate any income with gold, while you can generate income with property. Seems like a no-brainer to me, but what do I know, I'm just a bird-brain penguin.

    - Badtux the Snarky Penguin

  3. IMHO, it's a bit early for real estate. That whole option ARM thing has to play out, then whatever else might be lurking in the wings, then the dust has to settle, then things have to start picking up again.

    I'm thinking a decade at least.

    Unless there's another real estate Ponzi scheme. (Sorry, couldn't resist.)


  4. That's why I mentioned the market timing bit. On the other hand, real estate has one advantage that other investments don't have -- you get cash flow out of it. As long as the fundamentals look good -- that is, prices are at a level that is long-term sustainable by regional income, demand, etc. -- the fact that prices are going to go down some more is not all that pertinent in the long run, because they're going to bounce back up to where the market fundamentals are eventually.

    But that all depends upon what you're intending to do. If you're intending to buy low, then flip high, this is definitely not the time to do. If you intend to buy property for the long haul as a cash flow play, on the other hand, and don't intend to sell it anytime soon... well, that's a different tale, market fundamentals in your market may or may not support doing that now.

    - Badtux the Cashflow Penguin

  5. My market is southeast MI. I still think CA has a lot of downside potential.

    Fundamentals might look good now, but they can deteriorate. Rent has to cover expenses. Ans rents can go down.

    One of my former colleagues bought a repo house a couple of years ago for under 30K. He put about another 30 into it. I'm having lunch with him today, so I'll see how that turned out. Fundamentals ought to be very good for that kind of money.


  6. Yeah, housing still has 1-2 years of fail left, depending on the area. Here, prices are still eye-poppingly ridiculous, but I got a line on a little house in foreclosure, not as a rental but as my home for the next xx years. It's overpriced as-is but I think I can get them down another 20-40K because it's a tiny old house in a yuppie entitle-tard town so it might work.

    Rental property, meh. It's really hard to make the numbers work unless property prices are really depressed and there's a high rental demand. This would be a rare convergence. Low-end properties might clear you $100 a month (if that) which isn't worth the cash outlay and potential repair disaster.

    The notion of becoming wealthy by being a landlord is a toxic Carlton Sheets fantasy, unless you bought a Manhattan penthouse for $25K cash in 1962.

    My landlord (I rent a condo) is in deep financial shit and will not fix a goddam thing unless it's an emergency and two weeks ago I had a plumbing disaster that probably cost him 8x more than it would have had he just fixed the goddam problem in the first place when I told him about it. If it wasn't a condo I'd make him an offer, viz: Oh yay, I own a box of air. Whee! Special assessment? WTF?

    Anyhoo, yeah.

  7. 42, it's all about return on investment. If you have $100,000 spare cash to invest because you're a heart surgeon who has that in his petty cash drawer, let's see: You can put it in a passbook savings account at 1.5% and draw $1500 per year interest from it. Or you can put it into a house that generates, say, $450 per month rent and draw $5400 from it, or 5.4% interest. Well, actually, figure you're going to spend a couple thousand a year on maintenance and taxes and such, so that's more 3.4% interest, but in case you haven't noticed, in today's world where short-term Treasuries are selling for 0%, that's not *too* bad.

    And the thing about rents is that they tend to follow the inflation rate. Yeah, you could buy a 30 year Treasury for 4.625% today. But if inflation returns to its twenty-year norm of around 2.5-4.5%, that means your real rate of return is going to be anywhere from slim to none.

    That said, there's some decided downsides to being a landlord:

    1) Vetting your renters. You ideally want renters who are financially stable with a credit and rental history, but depending upon the nature of the property that may not be possible. If you have a 4-plex in a run-down part of town, for example, your typical clientelle isn't going to have a credit history and tracking down their previous landlords isn't realistic (said landlords being shady characters for the most part). Your best bet in that case is to rent by the week, require at least a month's deposit up-front, and then you'll only be a week out of pocket after you file the eviction notice rather than a month out of pocket.

    2) Management costs for collecting rent, getting people in and out of the houses, etc.

    3) Maintenance costs. If you're not doing a lot of the minor stuff yourself (the things that don't require pulling a permit), you'll get nickel and dimed to death.

    In other words, the only way to make money in the landlord business is to be a hands-on landlord who keeps on top of everything yourself, rather than relying on a management company. *AND* have a bunch of money to invest in the first place (similar to that old "how to make a small fortune in mining" saying -- i.e., start with a large fortune ;). Still, if you have the dough, the fundamentals are now getting down to the point where the rate of return exceeds a lot of other potential investments. It's just a very hands-on kind of investment, unlike, say, buying Treasuries and collecting your interest.

    - Badtux the ROI Penguin

  8. Hahahah! I just came across your site googling goldbug+idiot.

    Gotta see the article at the top of zerohedge today - EPIC facepalm.

    They're alleging fraud in ETFs, claiming that 'Canada's only bullion bank' Scotiamoccata is empty (LOL there's several) and the comments are even worse. And somehow, despite this massive 'fraud' being 'exposed', the price is expected to skyrocket? Funny I don't remember gold doing so well after Bre-X


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