The Fonzie-Ponzi Theory Of Government Debt

Fonzie soon became my word association for other confidence tricks. For example, paper currencies are Fonzies because their value rests entirely on confidence in the governments that back them.

And where do Ponzi schemes fit in?

Well, Ponzi schemes have characteristics that don’t quite fit The Fonz. Namely, they need an endless supply of participants to sustain confidence and stay alive. Once the participant pool depletes as it eventually must, Ponzi schemes are revealed as scams. Whereas Fonzies can persist indefinitely (at least in theory), Ponzis must eventually collapse.

Ideally, public debt would always cruise along in Fonzie mode. Governments would rely on the confidence of their creditors, but without taking too many liberties with those creditors. But in reality, finances sometimes deteriorate and push public debt into Ponzi territory. The precise point where this transition occurs depends on the amount of austerity that’s needed to put public debt ratios on a clear downward path, as well as the likely effects of that austerity. Instead of using numerical measures (for now), I’ll say that restoring discipline at the Ponzi point would cause the economy to break down for an unusually long period, failing to create jobs or growth. The downturn may or may not meet the textbook definition of a depression, but it would lead to depression-like joblessness. Think of current circumstances in Greece, for example.

The Ponzi characteristics of the no growth, no jobs scenario are based on politics. Politicians are sure to second-guess austerity in a depression or depression-like economy. If they didn’t, they’d be pilloried and voted out of office, replaced by populists and demagogues. Demagoguery thrives in difficult times—by whipping up a hurricane of discontent. And warnings of fiscal ruin at an indeterminate time in the future? They carry all the force of a gentle breeze. Political realities ensure that short-term thinking carries the day, whereas the Cassandras who insist on fiscal responsibility fade away.

With austerity becoming a bad word in such challenging circumstances, debt resumes its climb toward a higher threshold, one that brings a more destructive outcome. That ultimate threshold—mainstreamers call it debt tolerance, whereas I’m joining the heterodox thinkers who call it the Keynesian endgame—is when investors refuse to lend more money, forcing default or hyperinflationary money printing. It then becomes obvious that the government’s borrowing was a Ponzi scheme. It needed an endless supply of participants to stay alive, but the appetite for debt isn’t endless.

The difference between the Ponzi point and the Keynesian endgame is crucial. At the Ponzi point, the game isn’t over just yet, but it’s a foregone (if not widely recognized) conclusion that you’re on a path in that direction. The path is firmly established because measures to curb deficits would wreak havoc on the economy and change the political calculus about austerity.

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