In the wake of the recent $50B Madoff ponzi-scandal that has left many affluent people absorbing massive investment losses, there has been a lot of attention paid to fraudulent pyramid schemes by the media.  However, this focus has been in exclusion of an astronomically larger pyramid scheme that is hurtling toward a dramatic collapse.

There are two very large forces that are pushing this ‘pyramid scheme’ toward collapse.  The first force to reckon with is the perpetually increasing amount of debt-financed consumption.  The second looming specter is the dramatic liability from government entitlement programs that will be revealed in the coming decades.

Let’s begin by discussing the trend of debt-financed consumption.  In and of itself, debt is not inherently good or bad . . . it is all a matter of what the debt is used to finance.  When money is borrowed at a fixed rate of interest for investment in long-term projects with a higher rate of return, it produces very good results.  When long-term money is borrowed to finance short-term consumption, it requires that future production be sacrificed to repay the obligation.  The intense problems come when the amount owed to finance short-term consumption grows so large that the interest cannot be paid from current income.  (This is true for both individuals and governments)

The second large force in this pyramid scheme is the government entitlement liabilities from programs such as Social Security, Medicare, Medicaid, and subsidizing financial institutions.  The department of the treasury currently estimates the aggregate net entitlement liability at approximately $57 Trillion dollars.  (This amount grows to $61T when state and local government liabilities are added-in, which represents over $500k per household.)

The most likely result of this pyramid scheme is that the treasury will ‘print money’ or de-value the currency by increasing the amount of dollars in circulation to finance the nominal obligations.  (Politicians have a noted tendency to terminally avoid decisions that involve dramatically raising taxes or dramatically cutting benefits)A  This will have a net effect of destroying the purchasing power for income and savings, while diminishing the net impact of outstanding debt obligations.