Anatomy Of A Modern Ponzi Scheme / The Daily Reckoning

verfasst von - ELLI -, 07.12.2002, 15:53

-->Anatomy Of A Modern Ponzi Scheme

The Daily Reckoning

Paris, France

Friday, 6 December 2002

---------------------

*** Stocks up...bonds steady...gold up...

***"Inflation is a buy..." Deflation, don't worry about
it, says Friedman.

*** Christmas in Paris...whiter shade of pale...and more!

---------------------

Stocks went down again yesterday. But who cares? They'll go
up and down a lot more before they finally reach a level
where they are good investments again.

In the meantime, the interesting action is in gold and
bonds. As we all know, Treasury bonds are supposed to
fall...because the Fed has made it clear that it intends to
print as many dollars as it takes to avoid deflation. But,
so far, bonds have been holding up...

Of course, the Fed has been inflating for a long time. M2
is growing at 9% per year - 3 or 4 times the growth of the
economy. But this is nothing new. And, so far, this
'inflation' has done little to boost consumer prices.

Instead, in the late '90s, it went into stock prices, and
more recently into real estate.

Since the beginning of 2001, the Fed has been trying rate
cuts to reflate the economy. Even after 12 of them, auto
sales, corporate profits, manufacturing, and prices for
finished goods are still dropping. On the other hand, fewer
people seem to be losing their jobs...and raw materials'
prices are on the rise.

"The economy is in great shape," says Milton Friedman. And
don't worry about deflation, says the Nobel Prize winner.
"Deflation is a consequence of bad policy, not a cause of
bad results." The Great Depression of the '30s could have
been avoided, he says, if the Fed had merely increased the
supply of money fast enough.

Isn't it wonderful, dear reader? We mean, that the economy
is in such great shape....and that central bankers can
avoid any really bad results simply by changing their
policies! But hey, why didn't they change their policies
before $10 trillion got exterminated in the world's stock
markets? And before nearly 2 million Americans lost their
jobs since the slump began in March of 2000? And who's to
say they won't wait until another $10 trillion goes to
money heaven before getting their policies right?

But now almost every economist and analyst in the world -
including those with whom we normally agree....Sjuggerud,
Grant, Gross, and our own Eric Fry...are convinced that the
Fed can do with printing presses what it couldn't do with
rate cuts. Deflation is out of the question, they
say...bonds are doomed...and gold will rise.

Gold rose again yesterday - to $325.60 an ounce. When
central bankers come right out in the open and announce
their intention to destroy the value of the paper currency
they sponsor, who can blame investors for looking for an
alternative?

To some extent, we admit that the whole inflation/deflation
discussion is a waste of time. Nobody reads tomorrow's
papers. Maybe consumer prices will slip into outright
deflation and maybe they won't. Either way, gold is good
protection.

Eric...over to you:

------------

Eric Fry in New York City...

- Old Man Winter paid a visit to New York City yesterday,
dumping snow on the metropolis from dawn to dusk. The
fierce, frosty storm seemed to put Wall Street into a deep
freeze. The Dow suffered a fourth straight losing session,
skidding 114 points to 8,623 - which means that the blue
chips are 0-for-December. The Nasdaq slipped 19 to 1,410.

- The gold market, meanwhile, continues to bask in the warm
glow of monetary instability and geopolitical uncertainty.
The increasingly precious metal jumped $2.50 to $325.60 an
ounce. Silver also joined in on the action by jumping more
than 1% yesterday to $4.62 per ounce, its highest price
since September.

- Are these two monetary metals, mute though they may be,
trying to tell us something? Are they warning of incipient
inflation? We wouldn't rule out the possibility. In fact,
as faithful Daily Reckoning readers are well aware, I've
been predicting resurgent inflation for the last few
months...

- To be sure, deflation remains the talk of the town and
the widespread expectation of most investors. But resurgent
inflation seems increasingly likely. On Wednesday, during
my appearance as a co-host on CNNfn's morning show, I
announced,"Inflation is a buy. If it were a stock, it
would be selling for eight times earnings and less than
book value."

- Admittedly, the mighty forces of deflation and inflation
are still battling each other in a fight to the death. But
inflation seems to be prevailing, or at least that's the
implied verdict from several financial markets. Both the
CRB Index of commodity prices and the gold price have been
trending higher for more than a year. More recently, since
early October, bonds have tanked, copper has surged and the
dollar has failed to rally despite a powerful stock market
rally.

- These various market phenomena - like financial
antibodies - indicate that our economy has been exposed to
the germ of inflation. Perhaps our economic immune system
will ward off a full-blown outbreak of inflation. But
that's not a bet I'd make. Neither would Bill Gross, the
hugely successful bond fund manager at PIMCO.

-"The bond market's salad days are over," Gross asserts in
his latest monthly commentary."The Fed and the Congress
will make sure of that by conquering deflation, promoting
inflation, and perhaps in the process creating even more
financial and economic instability than we have seen in
recent years."

- As evidence of the Fed's determination to sow the seeds
of inflation, Gross refers to Fed Governor Bernanke's
November 21st speech entitled"Deflation: Making Sure 'It'
Doesn't Happen Here."

-"The forcefulness of Bernanke's speech tells observers
plenty about the ultimate winner in the battle between
inflation and deflation," Gross surmises."Bernanke listed
several heretofore rarely used policies that would be
emphatically employed by the Fed to avoid deflation: (1)
should conventional open market purchases of Treasuries not
do the trick, the Fed would extend out on the yield curve
to include even long-term bonds, (2) the Fed could
influence the yields on privately issued securities -
corporates and mortgages - in order to lower the cost of
private credit, (3) the Fed would buy foreign government
debt in a thinly disguised attempt to lower the dollar and
increase U.S. competitiveness and inflation at the same
time....I believe them. These people may be misguided,
their policies might eventually do more harm than good, but
I believe them. They will not allow the U.S. economy to
deflate as long as the current regime (read:"Greenspan's
Fed") is in power."

- Paul Kasriel, economist extraordinaire at Northern Trust,
is also inclined to take the Fed at it word when it
promises to reflate."World's Largest Debtor (U.S.) Pledges
To Pay You Back In Cheaper Dollars," quips Kasriel."In
effect, this is what one of the rookie members of the
Federal Reserve Board, Ben Bernanke, announced to the world
on November 21...So, fear not deflation. The Fed has
implicitly pledged, to its dying breath, that it will crank
up the currency printing presses to prevent it."
(See also: What The Fed Believes)
http://www.dailyreckoning.com/body_index3.cfm?id=4378

Stay tuned...

----------------

Back in Paris...

*** It's beginning to look a lot like Christmas. Christmas
displays are up in the shop windows of Paris. And here in
the headquarters of the Daily Reckoning, we put up a
Christmas tree, complete with flashing lights, reindeer and
angels.

Many of the people who work in our office are Muslim, but
everyone seems to be getting in the holiday spirit.

*** Maria and I decided to go to the theatre last night. A
version of The Glass Menagerie was our destination. But
Maria misread the program and we ended up at a very avant-
garde theatre waiting for a production of something we had
never heard of before and wouldn't mind if we never did
again.

We tell you about this, dear reader, so that you may get
the benefits of attending experimental theatre without the
ennui of actually having to experience the dreadful thing.

The theatre itself was housed in a converted public school
building, with the interior stripped to bare concrete and
spray-painted white. Everything was white. Metal, concrete,
light bulbs, metal chairs, tables - everything was hard
white, unrelieved by tablecloths, upholstery, posters or
any color of any sort.

In the white, white interior, an assortment of Paris
intellectuals and artists had accumulated - nearly every
one of them dressed in black. One man had his hair matted
down in dreadlocks. Another man with a goatee wore a long
overcoat, which had the curious effect of making him look
like a dwarf version of Sigmund Freud.

Still, your editor had his hopes up. At least, in these
off-off-off Broadway productions, actresses sometimes take
off their clothes. But in that respect, as in all others,
the show was a disappointment. Not only were there no naked
women, there were no women of any sort. No men either.

"Structure Multifonctions" had no actors, no plot, no
stage, no music, no dialogue. No nothing. Instead, as near
as we could figure, it was a light display. And...you
guessed it...a white light display. Occasionally, we
thought we saw a hint of pink...or maybe a tint of azure.
Otherwise, it was all white light. And except for the
occasional slamming of a door, as silent as an angry
husband.

Still, the audience sat still. Were they admiring it? Were
they wondering what it all meant? Had they fallen asleep?
We didn't know. But after a few minutes we gave up trying
to figure it out.

"Did you like the show," asked the man in black at the door
as we walked out in mid-show.

"Oh," said Maria."Has it started?"

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-----------------------

The Daily Reckoning PRESENTS: Scams, Frauds and Cons...
throughout history after 'speculative bubbles' have burst,
the scum rises to the surface. But investors coming down
off the 'New Era' high are beginning to see cons for what
they really are. The Sovereign Society's Mark Nestmann
takes a look at the proliferating rate of modern 'Ponzi'
schemes.


ANATOMY OF A MODERN PONZI SCHEME
by Mark Nestmann

In 1919, a 42-year-old ex-vegetable dealer with a silver
tongue borrowed $200, and in the space of six months,
became Boston's so-called"wizard of finance." Adored by
the public as he rode throughout the city in his
chauffeured limousine, Charles Ponzi promised that he would
pay investors $15 for every $10 they invested with him for
more than 90 days. With this appeal, he raised millions of
dollars.

Ponzi told his investors, like himself, primarily Italian
immigrants, that he would use their investments to purchase
International Postal Union reply coupons overseas, then
sell them elsewhere at a higher price. He claimed to be
taking advantage of"currency fluctuations" and
"specialized knowledge" to make 50% profits every 90 days.
But in reality, Ponzi was pocketing the money to pay his
debts. When an investor demanded his money back, Ponzi
would pay out of incoming proceeds.

More than 80 years later, little has changed. What are now
called"Ponzi schemes" operate in much the same way as
Ponzi did decades ago. This column highlights one such
scheme, carried out by John Wayne Zidar, 59, of
Gardnerville, Nevada.

In the late 1990s, Zidar attracted conspiracy theorists to
his"World Community Educational Society" Web site and
other Web sites with claims that"the entire monetary
system of the United States and the free world itself is
nothing more than a giant Ponzi scheme."

While in our view, this is a rather accurate summation of
fractional reserve banking, now carried out by every
government worldwide, Zidar's solution to this Ponzi scheme
was worthy of Ponzi himself. Promising investors returns of
120% or more per year, he sold them"prime bank
instruments," investments that he claimed are free of risk
and government regulation. These"investments" were sold
through investment clubs Zidar operated and at investment
conferences, including conferences held by the Global
Prosperity Group [an organization our friends at The
Sovereign Society first warned members about in October
1998].

According to documents filed with the U.S. District Court
of Western Washington, Zidar took in approximately $74
million from about 2,500 investors, primarily in the United
States. Zidar and his associates used most of the money to
pay off early depositors making withdrawals, giving them
the false impression that they had actually reaped the
promised profits on their investments. Most of the
remaining funds were deposited in offshore bank accounts
controlled by Zidar and his friends or spent on luxury
homes and cars.

On August 14, 2002, a jury found Zidar guilty on 28 counts
of fraud and money laundering. The jury also delivered a
guilty verdict against one of Zidar's accomplices, Steven
Craig Moreland, 34, of Tyler, Texas, on 14 counts of fraud
and money laundering.

Like Charles Ponzi, according to a report published in the
Seattle Post-Intelligencer, Zidar"had little formal
education or financial training" and, before turning to
financial frauds, he"had worked as a car salesman and, as
recently as 1997, as a night janitor at a chain steakhouse
in Florida."

What led 2,500 investors to suspend judgment and invest $74
million in Zidar's scheme? (Incidentally, the commercial
crime bureau of the International Chamber of Commerce
estimates $10 million is"invested" in similar schemes in
North America daily.)

A possible explanation is that even reasonably intelligent
people that would ordinarily avoid something"too good to
be true," will embrace it if it is presented as"insider"
or"specialist" information. Certainly, this is the way
that scam artists market"prime bank instruments."
Promoters claim to have inside information on a"secret"
world market that is available only to the"super rich" -
or to people who, like them, are"very well connected."

I came to this conclusion after spending a morning several
years ago discussing"prime bank instruments" with a man
who had invested more than $100,000 in such a program. He
was about to invest another $50,000 based on the statements
he had received"proving" that he had earned 100% in his
first month of"trading."

I can't say for certain what happened next, because I never
heard from this person again. It's probably safe to say,
however, that unless he was one of the first investors to
cash out, his money disappeared.

Even in this post-bubble environment, Ponzi schemes
continue to proliferate. Recently, a company contacted me
and offered to set me up in an investment paying
approximately 60%/year. Trading statements supposedly
verifying this return were said to be audited, but when I
asked for a copy of the audited statements, I was told they
were not available. The company also claimed a four-year
track record despite only having been incorporated only a
few months before contacting me.

The coup-de-grace was when I learned that the company
president had recently attended a"get-rich-quick" course
and then sued the promoter for failing to deliver on his
promises!

Is this a Ponzi scheme? I have no way of knowing for
certain. Am I going to invest?...not likely.


Cheers,

Mark Nestmann,
for The Daily Reckoning

P.S. On a practical note: How do you avoid prime bank
schemes and similar frauds? Apart from shying away from
deals that are"too good to be true," the answer is due
diligence. Does the person promoting the investment have
legitimate credentials - or is he gainfully employed as a
school janitor?

"A professional investigator charging $75/hour or so can
uncover enough information in a few hours to give you a
good idea of whether the investment being considered is a
reputable one," says offshore 'scambuster' David Marchant.
"Of course, some companies charge much more. New York-
headquartered Kroll Associates charges $200 per hour, plus
expenses. Their services might be worth considering if
you're considering an investment in the hundreds of
thousands of dollars, but might not otherwise be cost-
effective."

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• Anatomy Of A Modern Ponzi Scheme / The Daily Reckoning - - ELLI -, 07.12.2002, 15:53