How You Legitimise a Pyramid Scheme

Pssst…wanna buy a rare tulip bulb?

A couple of weeks ago, they were selling for 10 guilders, now it’s going for over 100.

May I ask what makes it so rare?

To which we are told, ‘They just are.

Not being all that familiar with the exotic flower market, you think aloud, ‘Can’t you just propagate more of the bulbs, and they won’t be so rare or valuable?’.

The temerity to even entertain this thought bubble, earns you the rebuke of ‘Obviously, if you have to ask that question, you simply do not get it.’

And so, with facts abandoned and belief established, the scheme gains the mob’s legitimacy…temporarily.


Tulip Price Index

Source: History.com

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The trick to a good con is in having a somewhat plausible story and then blinding people to reality.

What’s the easiest way to obscure a person’s vision? With dollar signs. Lots of dollar signs.

When the perceived road to riches is found, objectivity is lost.

Doubts and doubters are not entertained.

They are howled down by the self-assured insiders…the ones who (apparently) get IT…whatever the ‘IT’ is.

Ponzi

In 1920, Charles Ponzi achieved lasting notoriety with his international postal reply coupon arbitrage ‘opportunity’.

Ponzi convinced people he was buying postage coupons abroad at a discount and selling them at face value in the US. Tremendous profits were to be had. A half-truth was all Ponzi needed to germinate the seed of his scheme.

Throw in the promise of a 50% return in a matter of weeks and money poured in.

A journalist named Richard Grozier sensed all was not right.

In theory, you could make a profit from the arbitrage opportunity. But nothing like the alleged ‘profits’ Ponzi was delivering to investors.

Why?

Well, how could Ponzi claim to be trading US$10–15 million in coupons when there are only a few hundred thousand dollars worth in circulation?

The numbers did not add up.

The rest, as they say, is history…and so was Charles Ponzi.

Madoff

Bernie Madoff knew all about the subtle art of seduction.

He cultivated an image of sophistication, respectability, and exclusivity.

Year after year, Madoff’s fictional proprietary trading system — the ‘split-strike conversion strategy’ — delivered investors consistent above-average returns…with no volatility.

Bernie knew the lure of superior past performance would entrap the unsuspecting, gullible, and greedy into his web of deception.

Bernie’s scheme appealed to the heart…not the head.

But not everyone fell for Bernie’s scam.

Harry Markopolos — a quantitative financial specialist — sensed one and one was not making two.

As reported by The Guardian in March 2010 (emphasis added):

In a newly published book, No One Would Listen, Markopolos describes agonising over how Madoff could produce 1% to 2% returns every month, in positive territory 96% of the time, producing a 45-degree curve of profit — with no volatility. For months, he tried to reverse-engineer Madoff’s stated strategy of using a basket of S&P 500 shares hedged against risk using options on Chicago’s derivatives exchange.

After analysing Madoff’s vague, broad-brush statements to clients, Markopolos concluded that it was impossible — not only was it mathematically inconceivable to smooth out all the ups and downs in the S&P index’s performance, Madoff would need to use more options than existed on the entire Chicago Board Options Exchange, where nobody owned up to seeing any volume from Madoff’s firm at all.

Harry thought he had an open-and-shut case against Madoff.

In 2001, Harry presented his findings to the US Securities and Exchange Commission (SEC). The result? He was ignored.

Not to be deterred, in 2005 he gave the SEC a weighty report titled ‘The World’s Largest Hedge Fund is a Fraud’. The result? He was ignored.

The maths didn’t lie. But as often happens when things are going well, the truth becomes a casualty. People prefer the lie.

Which brings us to a scam that is magnitudes bigger than tulips, Ponzi, and Madoff. A scam that, in due course, will go down as the most infamous in history.

Bitcoin

In August 2008, absent any fanfare, the domain name bitcoin.org was registered. On 3 January 2009, the anonymous Satoshi Nakamoto launched the Bitcoin network.

Blockchain technology promised to create a peer-to-peer network to generate ‘a system for electronic transactions without relying on trust.’

The ideal of decentralised finance (DeFi) took hold. It’s highly likely the original adopters believed fervently in the ideal.

But as Albert Einstein famously said:

In theory there is no difference between theory and practice. In practice there is.

In practice (and I might say also in theory) the ideal is flawed.

Firstly, contrary to what Nakamoto thought, the Bitcoin system relies solely on trust…a trust Bitcoin [BTC] can retain value and relevance.

Secondly, the whole notion of DeFi is a furphy. Control of the crypto network rests in the hands of a powerful few.

DeFi is nothing more than a clone of the centralised financial system.

The crypto faithful have this rebel-with-a-cause mindset.

However, I strongly suspect the only cause they’ll have is one where they lament their folly.

The present-day equivalents of Richard Grozier and Harry Markopolos have been sounding the warnings on Tether [USDT] (the bitcoin price manipulator), but no one is really listening.

The US Journal of Finance published an excellent 52-page research paper titled ‘Is Bitcoin Really Untethered?’.

The findings? The maths simply does not add up. Tether appears to manipulate the price of bitcoin…so much for decentralised finance.

And there was this press release by the New York Attorney General on 23 February publicly declaring Tether is a scheme that lies (emphasis added):

“Bitfinex and Tether recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines,” said Attorney General James.

Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie…

Does any of this matter to the faithful?

Not a jot. Read the commentaries and these findings are dismissed with ‘they would say that wouldn’t they’ or ‘they just don’t get it’.

Oh, how I wish these free-thinking rebels would come up with new excuses…we’ve heard the same lame reasoning with tulips, Ponzi, Madoff, and countless other scams.

Does it ever cross the minds of the cult members that the reason some really intelligent people — like John Paulson, Jeremy Grantham, Michael Burry, John Hussman, Charlie Munger — ‘don’t get it’ is because there’s actually nothing to get?

Is it possible those who’ve successfully navigated the highs and lows of all types of investments and investment conditions can spot a fraud a mile off?

I think so.

The fact is, believers want to believe…irrespective of what evidence is provided to the contrary.

Even after Ponzi admitted to and was convicted of fraud, there were still some investors who held onto their certificates. Believing their ‘investment’ would one day come good.

Bitcoin produces nothing. It has no assets, income, customers, cash flow, or dividends. Bitcoin’s value is derived solely from manipulated speculation.

In a nutshell, bitcoin — like tulips, international postage stamp arbitrage, and a split-strike conversion strategy — has value while people believe it to be so.

The maths does not lie…bitcoin is basically worthless.

Next week, I’ll show you why those who think cryptos are a way of staying outside the grasp of authorities are sadly mistaken.

Until then.

Regards,

Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

PS: Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory— investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.


Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.


The Rum Rebellion