Is the Financial System One Giant Pyramid Scheme?

CRYSTAL BALL

So how exactly will an economic system that survived for centuries and has seduced the world’s majority into its tentacles’ embrace suddenly fail?

Answer: there are two trends slowly converging into one chaotic mess: resource scarcity and demographics.
The first trend, resource scarcity, was discussed in detail in the previous issue of the Arbitrage (Winter 2010) and so I won’t go into the specifics here.

But to put the matter into perspective, we can think of the Malthusian trap (the theory that the human population growth rate will outpace humanity’s ability to farm enough food to feed this growth). For many decades, the world avoided mass Malthusian starvation because we’ve consistently developed new agriculture technologies to grow higher yields of food. Similarly, the world economy continues to grow because we too freely and cheaply reap from the Earth untold amounts of raw materials that we then turn into riches.

But how much longer can this go on?

Outlined in the Arbitrage’s previous issue, the reality of a finite world is that it will run out of many of its non-renewable resources (especially oil) within the next 50 years or so. And over the next decade, we will begin to see the effects of this growing scarcity in the form of increased prices (inflation) on just about everything we buy.

Meanwhile, when talking about demographics (the subject of the Arbitrage’s next issue), the well known, Comte adage holds true: demographics is destiny.

Economists have few ideas about how to maintain a country’s economic growth if its population is in decline. Remember, our present financial system is predicated on infinite upward growth in resources and population. So without either, the columns of the system begin to crack.

Presently, the birth rates for much of the developed world average out to 0.1%, far below the 2.1% needed for a population to replenish itself (sourced from the Population Reference Bureau’s 2006 World Population Data Sheet).

Roughly speaking, with less people, the labour force shrinks, leading to higher wages whose cost is past on to the consumer; this inflation leads to reduced demand, cut backs in the private sector, layoffs and may lead into a downward recessionary cycle.

Likewise on the government side: a country’s tax base shrinks, causing a nasty chain reaction that weakens its ability to pay for pension plans and public services. This leads to across the board government sending cuts, meaning greater unemployment and increased employment insurance costs that the government won’t be able to afford. This will then lead to the government continually turning to the central bank for loans to pay for needed public services, and in time, once a country reaches the point where it’s borrowing to pay down debts of borrowed money, that’s one step away from a country going bankrupt.

There are no crystal balls, but the fact remains that these two trends are real, well documented, and their effects are generally easy to predict: a gradual reduction in economic and population growth and a possible breakdown in the current financial system’s ability to continue functioning.