The Sovereign Ponzi - Tick By Tick Research Email


Dear All


In 1903, a young Italian man by the name of Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi (Charles Ponzi to you and I) arrived upon American shores aboard the SS Vancouver.  With dreams of becoming one of the worlds super elite, Ponzi swiftly moved from being a dishwasher to the Branch Manager of Banco Zarossi in Montreal (which ironically turned out to be already running a "Ponzi Scheme" far before Mr Ponzi's arrival).


Fast forward eleven years, including a brief spell in Atlanta Prison, and Ponzi was ready to launch his greatest scheme of monetary fraud.  In lay terms, Ponzi set out to arbitrage International Reply Coupons between Italian and US rates using investor money.  However, after running into a wave of red tape, Ponzi realised that the impressive returns that were being promised could simply be paid out of fresh money as long as he could secure a consistent flow of fresh investor capital.  A Ponzi Scheme if you will.


If we re-evaluate part of the penultimate sentence…"could simply be paid out of fresh money as long as he could secure a consistent flow of fresh investor capital"…we get to the point of today’s email: Confidence.  More specifically, confidence in Sovereigns.  


“Optimism is the faith that leads to achievement. Nothing can be done without hope and confidence.”


Helen Keller


At this point, I would like to ask how a Ponzi scheme differs from the modern sovereign bond market?  If the primary activity in government bond markets is the refinancing of existing debt, are we not in a Ponzi scheme of our own?  By this, I mean that Modern Governance and Treasury is based upon the idea of securing a consistent flow of investor capital to meet payments of the existing principal.  Is it not? 


If we look back to the origin of Government Bonds, it becomes clear that they were designed as a method to fund the activity of war.  An activity that, if successful, would produce future cash flows that are capable of settling the initial borrowing.  From a Finance standpoint, this lending would provide a positive CAPM value for the war. 


Compare this to the bulk of modern Sovereign Finance, by which I mean the process of refinancing, and it becomes clear that there is no future cash flow resulting from the activity and, as such, the whole system has become built on the idea of investor confidence; embedded with the idea that countries can inflate away the cost of borrowing over the medium to long-term.


Over the last 24 months, this practice has become increasingly comprehendible by the investors of government securities and we have already started to see the first few wounded being carried off the battlefield for treatment and we can be sure that they wont be the last.  If the continued trend of higher rate refinancing starts to spread away from just profligate European nations, it won't just be the PIIGS we talk about.  Think West meets East with a little island in the middle or UJU for short.


After that short introduction, I would like to introduce a number of articles that are worth reading as we enter what the Mayans believe to be the last year of the current era.


1) Brazil Overtakes the UK as the 6th Biggest Economy in the World - CEBR (Click HERE)


2) Things That Make You Go Hmm - Grant Williams (Click HERE)

Grant talks about the factors that he feels will be the most pertinent in 2012 


3) IceCap Asset Management - December Presentation (Click HERE)


4) New York Taxi Medallions - Bloomberg (Click HERE)

Arguably the safest investment in the world and up over 1000% in the last 30 years.


5) Graph of the ECB Balance Sheet - Zerohedge (Click HERE)



Over the festive period, I was fortunate to be given a copy of Keith Gessen’s Diary of a Very Bad Year, which in essence is a collection of interviews with an Anonymous Hedge Fund Manager throughout the credit crisis.  Whatever I may or may not think of the content, one fundamental topic emerges out of the book.  The topic of false hope (or Hopium) that exists in the market as we enter a downturn.  After every wrought of the market, the HFM still shows a quite aspirational confidence that the market has reached its bottom due to good economic data or a form of government intervention.  Yet the next month, the market takes a proverbial skydive once again.  Sound familiar?  It should.  You've been warned.   



"So if a higher-than-usual unemployment and slow economy is something like a chronic risk, the government can deal with that by borrowing and spending on stimulus.  If the government takes all this risk onto itself, it may attenuate those chronic risks, but at the risk of you might get to the point where something goes wrong in the US and then the governments creditworthiness is in jeopardy and you have a huge mess" 


Anonymous HFM – 2009 – Diary of a Very Bad Year 


Best Regards

George Adcock 







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