Zomato Results Show That ‘Investor Authority’ is a Myth

A few days back, the food delivery company Zomato delivered its first financial results after getting listed on the stock exchanges.

As has been extensively reported in the media by now, the company continues to lose money. The revenue from operations of the company for the period April to June 2021 amounted to Rs 844 crore. The total expenditure was at Rs 1260 crore. To put it in another way, for every Rs 100 that Zomato earned, it spent Rs 149.

If we look at the same metric for the period January to March 2021, the company had spent Rs 128 for every Rs 100 that it earned. For the period April 2020 to March 2021, the company had spent Rs 131 for every Rs 100 that it earned. Clearly, the expenditure that the company has incurred for every rupee that it earned during April to June 2021, was higher than it was in the past.

A possible reason for this could be higher discounts offered to consumers to drive up sales before the company’s initial public offering hit the stock market. As I have said on multiple occasions in the past, Zomato, if it works, is a long-term bet.

The baseline success rate of startups is low to begin with. Many ecommerce ventures have failed in the past. The joker in the pack is whether people will continue ordering once discounts are off the table and once the company decides that it’s time to stop bleeding in order to drive sales.

Also, whenever this happens, will the sales be substantial enough. This means will enough people order food using the app for the business to be a viable proposition.

In that sense, the success of Zomato also depends on the success of India’s economic story, which has been stagnating in the recent past. The more jobs we are able to create, the more people will earn, and the more they are likely to order food than cook at home.

The current business model of the company isn’t viable, and that is obvious. Whether it will become viable in the days to come is a question that remains. So, we will leave it at that.

Nonetheless, there is another important point that needs to be made. In a letter to the shareholders, Zomato CEO Deepender Goyal said:

“We will do earnings/analyst calls once a year, at the end of each fiscal, where we will share a more detailed commentary on the year gone by along with key metrics.”

This when Rs 756 crore or 60% of the total expenses of Rs 1260 crore during April to June 2021, have been categorised as other expenses without an explanation for where this huge amount went. Are these discounts that the company is offering to the prospective customers? Or the money it is paying its delivery partners? Or both? This needs to be detailed. Of course, Zomato is not breaking any law here.

Further, this lack of transparency doesn’t seem to have bothered the newly minted shareholders or the so-called owners of the company, in any way. Nonetheless, this does show us something that the economist John Kenneth Galbraith talked about in his last book The Economics of Innocent Fraud.  

As he wrote:

“The myths of investor authority, of the serving stockholder, the ritual meetings of directors and the annual stockholder meeting persist, but no mentally viable observer of the modern corporation can escape the reality. Corporate power lies with management.”

Or as he puts it in an even more direct way:  

“No one should be in doubt: Shareholders—owners—and their alleged directors in any sizeable enterprise are fully subordinate to the management. Though the impression of owner authority is offered, it does not, in fact, exist.”

The management with their employee stock option plans are also part owners of companies these days.

By deciding to give out details of its business only once a year, Zomato, like many other companies before it, has once again proved what Galbraith had talked about in his 2003 book. That when it comes to the modern corporate structure, investor authority doesn’t really exist. And it’s basically a myth.

Of course, the investors themselves aren’t bothered about such details right now. They are busy with “greed, optimism, exuberance, confidence, credulity, daring, risk tolerance and aggressiveness,” as Howard Marks writes in Mastering the Market Cycle. The speculative orgy is currently on and there is no point in looking at data, examining it and asking questions.

But then all good things come to an end. Couples breakup. Marriages fail. SRK grows old. Lata’s voice doesn’t sound the same anymore. Kohli ends up out of form for an extended period in test cricket. And stock markets fall. Of course, one doesn’t know exactly when. But most times, this is how things go.

Of Government Taxes, Bitcoin and the Fiction of Money

Anything can be money if individuals on both sides of the economic transaction are ready to accept it as money. As Yuval Noah Harari writes in Sapiens – A Brief History of Humankind: “Money is anything that people are willing to use in order to represent systematically the value of other things for the purpose of exchanging goods and services.” Of course, for something to emerge as a form of money at a societal level, it needs to be widely accepted.

This is the hope that the believers in bitcoin and other cryptocurrencies have been peddling for a while to make them look like attractive investments. That one day when enough number of people across the world are tired with the government backed fiat money or paper money as it more popularly known, cryptos will take over.

Of course, you can’t wait for that to happen, and you need to buy bitcoin now. This is one of the ways in which the fear of missing out or FOMO, is created.

So how logical is this argument? How much should we trust it? These are questions well worth asking.

If you look at the history of money, different things have been money at different points of time. In the prisoner-of-war camps of the Second World War, cigarettes emerged as a form of money. They are a great example of the fact that anything can be money if both the sides of the economic transaction are willing to accept so. Also, any system where conventional money is not around, like in a prison, does not continue to stay in a vacuum, and newer forms of money emerge.

Different agriculture commodities including tobacco have been money at different points of time. So have been different metals, everything from iron and bronze to silver and gold.

Hence, different things have been money at different points of time, during the course of human history. What this tells us is that as long as enough people accept something as a form of money, it can continue functioning as money, until it doesn’t.

This means that bitcoin and cryptocurrencies can also become a form of money, over a period of time. Nevertheless, if we leave it at just this, it will be lazy reasoning at best. Also, this is where things get a tad complicated.

Allow me to explain.

Pure paper money or fiat money or money not backed by any commodity (gold, silver, tobacco, iron, copper etc.) has been around for many centuries, nevertheless, it has flourished and been widely accepted only in the last hundred years.

Why is that the case? Why do people happily and readily accept money not backed by any commodity as a form of payment, on most days?

As L Randall Wray writes in Modern Money Theory:

“The typical answer provided in textbooks is that you will accept your national currency because you know others will accept it. In other words, it is accepted because it is accepted. The typical explanation thus relies on an “infinite regress”: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will probably take it.”

To put it a tad simplistically, paper money is accepted because paper money is accepted. Are we saying there is a mass delusion at work? Is fiat money fiction?

As Jacob Goldstein writes in Money – The True Story of a Made-Up Thing:

“Money is a made-up thing, a shared fiction. Money is fundamentally, unalterably unalterably social. The social part of money—the “shared” in “shared fiction”—is exactly what makes it money. Otherwise, it’s just a chunk of metal, or a piece of paper, or, in the case of most money today, just a number stored on a bank’s computers.”

Now that maybe true, but that’s not important. What is important is to understand what keeps this shared fiction, this mass delusion, this myth, or whatever else you might want to call it, going. And this is where the government, which issues fiat money and controls the fiat money system, comes in.

For the government, it is important that its citizens continue to believe in the shared fiction of fiat money and continue accepting it as a form of payment. What keeps it going? Before answering this question, it is important to understand that there are three things that make a government a government: a) The right to tax. b) The right to legal violence. c) The right to create money out of thin air.

Two out of three rights are important to the context of bitcoin and cryptocurrencies. The right to tax and the right to create money out of thin air. In the past, I have talked extensively about the fact that any government letting bitcoin and cryptocurrencies operate smoothly is essentially giving away its right to create money out of thin air. And they aren’t exactly waiting to do it. (You can read about this here, here and here).

So, what about the right to tax that any government has?

As Wray writes:

“One of the most important powers claimed by sovereign government is the authority to levy and collect taxes (and other payments made to government, including fees and fines). Tax obligations are levied in the  national money of account: Dollars in the United States, Canada, and Australia; Yen in Japan; Yuan in China; and Pesos in Mexico. Further, the sovereign government also determines what can be delivered to satisfy the tax obligation. In most developed nations, it is the government’s own currency that is accepted in payment of taxes.”

And not just in developed nations, even in lesser developed ones, the governments accept tax payments in the fiat money of the country. This is what keeps the fiat money system going. As Wray writes: “It is because anyone with tax obligations can use currency to eliminate these liabilities that government currency is in demand, and thus can be used in purchases or in payment of private obligations. The government cannot easily force others to use its currency in private payments, or to hoard it in piggybanks, but government can force use of currency to meet the tax obligations that it imposes.”

In simple terms, government taxes can only be paid in fiat money and that creates demand for fiat money or paper money not backed by anything, and keeps the system going.

A counter argument to this might be that while this might be true in countries where taxes form a significant part of the economy, but how does it work in countries where taxes are not a significant part of the economy. Why does the paper money system still hold?

The answer lies in the overall structure. Companies which operate in a country need to pay taxes to the government in fiat money. So, they carry out their business in fiat money; accept and make payments in it. This means their employees, suppliers (their employees), contractors (their employees), distributors (their employees) and so on, everyone gets paid in or must pay in paper money as well.

When people who are a part of the overall business system, which needs to pay different kinds of taxes, get paid in paper money, they go out and spend that paper money. Hence, individuals and institutions who sell to these people, must then accept paper money. So, the cycle keeps going. And there is demand for paper money or fiat money.

Also, it is worth mentioning here that taxes form a significant part of the economy in any developed country in the world. For any monetary revolution to happen, the governments in these countries need to buy the idea of bitcoin and other cryptos, and also actively promote them. El Salvador classifying bitcoin in a legal tender isn’t going to help that cause. Or the fact that Nigerians have taken on to bitcoin like no one else. These are exceptions to the rule.

The larger point here is that the structure of fiat money being needed to pay government taxes, keeps the paper money system going and will continue to keep it going in the time to come. The demand for fiat money will remain. As long as that is the case, bitcoin and other cryptos will be a sideshow at best, keeping the believers interested, at least for a while.  

Also, governments are not going to give up on their right to create money out of thin air. This explains why money central banks are now in the process of planning and/or launching their respective central bank digital currencies.

Of course, people who do not like to pay their fair share of taxes also do not like the idea of being a part of the formal financial system (which is what fiat money system on its whole is at the end of the day). Therefore, people who are a part of the black economy like to convert their profits on which they haven’t paid cash, into other assets like real estate (held benami), gold (easy to store), precious stones (easy to move around) etc. It also explains why people operating in the black illegal economy love bitcoin and other new forms of crypto.

On the flip side, those who run the fiat money system have been abusing it post 2008, when the financial crisis broke out, and post late 2019, when the world was hit by the Covid pandemic.

A lot of fiat money has been created out of thin air, to get economic activity and economic growth going again. This is offered as a major reason by crypto believers, as to why the world should be shunning paper money and buying bitcoin and other cryptos. There is a lot of paper money being created out of thin air, but only 21 million bitcoin are only ever going to be mined.

Hence, the cryptosystem is built around the concept of scarcity whereas with more and more paper money being created, high inflation can become the order of the day and wealth stored in fiat money can lose value at a very fast pace.

The trouble with this argument is that while more bitcoin cannot be created, anyone and everyone, who understands these things, can create a new cryptocurrency. Which is why there are thousands of cryptos going around. As renowned investor Ray Dalio put it in a note on bitcoin: “Competition will, play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works.” Given this, in the years to come, gold will still be around, about bitcoin, we really don’t know.

So, the point is you don’t know which crypto is going to be around in the days to come. And given that, how do can you ensure that the value of your wealth remains the same, by investing in crypto. Plus, at the risk of sounding cliched, the price volatility of cryptos continues to remain a huge risk.

Something which falls by 50% in a matter of months, cannot even aim to be an asset class, forget being a form of money. The crypto believers now offer the example of stablecoins, which are basically cryptos pegged to paper or fiat money. They have price stability. But their stability comes from being linked to fiat money in the first place. 

As Mark Carney writes in Value(s) — Building a Better World For All: “The highest-profile examples of stablecoins… are best thought of as payments systems rather than money per se since they derive their moneyness from the underlying sovereign currencies.”

To conclude, a small story. Before the crypto crash happened, a gentleman on Twitter very confidently told me that he would rather buy dogecoin, which was launched as a joke on bitcoin, than the US dollar. This is because the dogecoin wasn’t being created out of thin air (which is not true, given that the amount of dogecoin goes up every year, but we will ignore that here) and the dollar was.

His point was that the US dollar was not backed by anything. The US dollar is not backed by anything in the physical sense of the term, but it is backed by the US sovereign, the biggest economy in the world, perhaps the most innovative economy in the world and the biggest empire the world has ever seen. Also, the dollar has an exorbitant privilege. While other countries need to earn it, the US can simply print it. Which explains why the demand of for the dollar continues to remain solid, despite its abuse.

Yes, to that extent, it is not backed by anything and bitcoin and other cryptos are backed by everything.

What I can’t get my head around is that if you can’t trust the government (and there are reasons not to), how can you trust a few random guys launching their own crypto in their own backyard. Something which can be moved up and down by a few tweets. How is this fiction better than the government’s fiction? I really don’t have an answer for that.

Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund

What Does Official Government Inflation Mean for You? 

For May 2021, inflation as measured by the consumer price index (CPI) stood at 6.3%. It was the highest since November 2020, when it had stood at 6.93%. 

Of course, this has been splashed all over the media since yesterday evening when the figures were published. But do you ever sit back and think about what does inflation really mean for you? (I mean why would anyone sit back and think about inflation, but nonetheless please humour me for a bit). If you haven’t, let me set the cat among the pigeons.

1) The government publishes inflation as measured by the CPI every month. So, when it says inflation in May 2021 stood at 6.3%, does it mean that inflation for you, dear reader, also stood at 6.3%? Or that you paid 6.3% more for things on an average in May 2021 than you did in May 2020? Have you ever thought about this?

The CPI consists of many items whose prices are regularly tracked by the government (specifically, by the ministry of statistics and programme implementation). All these items have a certain weight in the index.

So, food items overall have a weight of 39.06% of the index. The assumption here is that the average Indian makes nearly two-fifths of his expenditure every month on food.

If you are reading this, chances are your expenditure on food every month as a proportion of your total expenditure, is lower than 39.06%. I say this simply because you are reading this in English, and anyone who can read English in India, is likely to be better off than an average Indian.

Hence, inflation of 6.3%, isn’t your rate of inflation. It can be higher or lower than this, depending on stuff you regularly consume.

Take the case of petrol prices. They have risen by 62.28% in the last one year, if we look at the inflation as measured by the wholesale price index (this data as per inflation as measured by CPI, hasn’t been published in the recent months).

In inflation as measured by the wholesale price index, petrol prices have a weight of 1.6%. In inflation as measured by CPI, they have a weight of 2.19%. Your expenditure on petrol as a part of your overall expenditure, is likely to be more than this.

Also, on a slightly different note, rising petrol, diesel and gas prices, feed into food prices, because food needs to be moved from where it is produced to where it is consumed.

2) As people earn more, their spending on food as a proportion of their overall spending comes down. Also, within the food basket, spending on cereals comes down and spending on foods which have protein (eggs, pulses, meat, etc.), goes up. The spending on milk also goes up. 

When it comes to the CPI, this can simply be gauged from the fact that the weightage that food has in the urban part of the CPI is much lower than the rural one. When it comes to urban India, the weightage of food items in the CPI stands at 29.62%. In case of rural India, the weightage is much higher at 47.25%.

This is primarily because the average urban Indian earns more than an average rural Indian and hence, incurs a lower proportion of the overall expenditure on food.

Of course, as people earn more, their spending on items other than food increases and that starts to matter more. Even here the stuff that CPI measures and your regular consumption basket may not intersect. Let’s take the case of household goods and services, a heading under CPI.

This heading keeps track of inflation of bedsteads, almirahs, dressing tables, chairs, furniture, bathroom and sanitary equipment, bedsheets, mosquito nets, air conditioners, sewing machines (yes, still!), washing machines, invertors, refrigerators, etc. In May 2021, the inflation for all these items overall stood at 3.89%. 

Here is the thing. While these items are important in the overall scheme of comfortable middle class living, they do not have any impact on regular expenditure, given that they are one-off purchases. Hence, they don’t impact your regular consumption and, in the process, your regular inflation.

But this is a point that is not important for the government. The government is trying to figure out the rate of inflation for the society at large, so that this can help in other ways, like figuring out the adequate level of interest rates for one. 

3) But there is a flip side to the above point as well. The health inflation in the last one year has been 8.44%. Now anyone who has had to deal with India’s urban private health system in the last one year, will tell you that is a load of bunkum. Prices have gone through the roof and the rate of inflation doesn’t really capture it. 

Of course, going to the hospital is also not something that most people do regularly (I am not talking about basic visits to a personal physician here). Hence, anyone who has had to spend some time in a hospital this year, or has had to finance a close one’s stay, would have ended up spending a lot of money and paid significantly higher prices than last year. 

So, one-off expenditures during a particular year can really make a mess of your finances, and that is something the inflation as measured by CPI doesn’t really capture.

Also, on a slightly different note, as Madan Sabnavis, the Chief Economist of CARE Ratings puts it: “Problem with most of the inflation numbers relating to personal care, health, recreation, transport is that once prices are increased they would not come down and hence becomes a new base.”

The point being that inflation measures the rate of increase in price over a period of one year. Hence, the annual inflation itself may not be high, but that doesn’t necessarily mean that things are not expensive.

4) Different states have different rates of inflation in different years. In 2019-20, among large states, Kerala had the highest rate of inflation at 6.1%. Bihar had the lowest at 2.2%. 

Source: Reserve Bank of India. 

What does this mean? It means that the inflation you experience also depends on which part of the country you are in and the inflationary pressures it is experiencing during a particular year. Of course, within a state, whether you are in an urban area, or a rural one, also makes a difference.

5) Clearly, the official rate of inflation doesn’t tell you much about anything. Hence, what can you do about it? First and foremost, you need to do an expenditure audit and figure out the things you spend your money on regularly (you will be surprised). This shouldn’t be so difficult if you make purchases online or make payments digitally or use plastic money. 

The important point here is to identify the most important items and not every possible one, and keep track of expenditure on the important items, over a period. A simpler method is to just keep track of regular monthly expenditure and that too can give you some inkling which way your finances are headed, and whether you are spending more or less than you were doing in the past. 

This is not a totally foolproof and methodical system but more of a crude method to get around the uselessness of the official rate of inflation at an individual level, when it comes to consumption. Of course, there are other implications which I do keep talking about. 

Charles Ponzi and Bernie Madoff Would Have Been Proud of the Ponzi Schemes of 2021

Bernie Madoff, the man who ran the biggest Ponzi scheme of all time, died in jail on April 14, 2021, fifteen days shy of turning 83.

A Ponzi scheme is a fraudulent investment scheme in which older investors are paid by using money being brought in by newer ones. It keeps running until the money being brought in by the newer investors is greater than the money being paid to the older ones. Once this reverses, the scheme collapses . Or the scamster running the scheme, runs away with the money before the scheme collapses. 

The scheme is named after an Italian American, Charles Ponzi, who tried running such an investment scheme in Boston, United States, in 1920. He had promised to double investors’ money in 90 days, which meant an annual return of 1500%. At its peak, 40,000 investors had invested $15 million in Ponzi’s scheme.

Not surprisingly, the scheme collapsed in less than a year’s time, under its own weight. All Ponzi was doing was taking money from newer investors and paying off the older ones.

Once Boston Post ran a story exposing his scheme in July 1920, many investors demanded their money back and Ponzi’s Ponzi scheme simply collapsed, as money being brought in by newer investors dried up, while older investors had to be paid.

Madoff was smarter that way. His scheme gave consistent returns of around 10% per year, year on year. The fact that Madoff promised reasonable returns, helped him keep running his Ponzi scheme for decades. But when the financial crisis of 2008 struck, it became difficult for him to carry on with the pretence and the scheme collapsed.  

As I wrote in a piece for the Mint newspaper yesterday, Madoff was Ponzi’s most successful disciple ever. While Ponzi’s investment scheme started in December 1919, it collapsed in less than a year’s time in August 1920. On the other hand, documents suggest that Madoff’s scheme started sometime in the 1960s and ran for close to five decades.

Nevertheless, both Madoff and Ponzi, would have been proud of the Ponzi schemes of 2021. The only difference being that the current day Ponzi schemes are what economist Nobel Prize winning Robert Shiller calls naturally occurring Ponzi schemes and not fraudulent ones like the kind Ponzi and Madoff ran.

A conventional Ponzi scheme has a fraudulent manager at the centre of it all and the intention is to defraud investors and take the money and run before the scheme collapses. A naturally occurring Ponzi scheme is slightly different to that extent.

Shiller defines naturally occurring Ponzi schemes in his book Irrational Exuberance: 

“Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere. When prices go up a number of times, investors are rewarded sequentially by price movements in these markets just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the markets will go up further. There is no reason for these stories to be fraudulent; they need to only emphasize the positive news and give less emphasis to the negative.”

Basically, what Shiller is saying here is that the stock markets enter a phase at various points of time, where stock prices go up simply because new money keeps coming in and not because of the expectations of earnings of companies going up in the days to come.

Ultimately, stock prices should reflect a discounted value of future company earnings. But quite often that is not the case and the price goes totally out of whack, for considerably long periods of time. 

A lot of money comes in simply because the smarter investors know that newer money will keep coming in and stock prices will keep going up, and thus, stocks can be unloaded on to the newer investors. Hence, like in a Ponzi scheme, the money being brought in by the newer investors pays off the older ones. In simpler terms, this can be referred to as the greater fool theory.

The investors buying stocks at a certain point of time, when stock prices do not justify the expected future earnings, know that greater fools can be expected to invest in stocks in the time to come and to whom they can sell their stocks.

Of course, this is not the story that is sold. If you want money to keep coming into stocks, you can’t call a prospective fool a fool. There is a whole setup, from stock brokerages to mutual funds to portfolio management services to insurance companies selling investment plans, which benefit from the status quo. Their incomes depend on how well the stock market continues to do. 

They are the deep state of investment and need to keep selling stories that all is well, that stocks are not expensive, that this time is different, that a new era is here or is on its way, that stock prices will keep going up and that if you want to get rich you should invest in the stock market, to keep luring fools in and keep the legal Ponzi scheme, for the lack of a better term, going.

 — Bernie Madoff 

This is precisely what has been happening all across the world since the covid pandemic broke out. With central banks printing a humongous amount of money, interest rates are at very low levels, forcing investors to look for higher returns. A lot of this money has found its way into stock markets. The newer investors have bid stock prices up, thus benefitting the older investors. The deep state of investment has played its role.

Of course, the counterpoint to whatever I have said up until now is that unless new money comes in, how will stock prices ever go up. This is a fair point. But what needs to be understood here is that in the last one year, the total amount of money invested in stocks has turned into a flood. Take the case of foreign institutional investors investing in Indian stocks.

They net invested a total of $37.03 billion in Indian stocks in 2020-21. This was almost 23% more than what they invested in Indian stocks in the previous six years, from April 2014 to March 2020. This flood of money can be seen in stock markets all across the world.

Clearly, there is a difference, and the stock market has worked like a naturally occurring Ponzi scheme, at least over the last one year.

This Ponziness is not just limited to stocks. Take a look at what is happening to Indian startups…oh pardon me…we don’t call them startups anymore, we call them unicorns, these days. A unicorn is a startup which has a valuation of greater than billion dollars.

How can a startup have a valuation of more than a billion dollars, is a question well worth asking. I try and answer this question in a piece I have written in today’s edition of the Mint newspaper.

As mentioned earlier, there is too much money floating all around the world, particularly in the rich world, looking for higher returns. Venture capitalists (VCs) have access to this money and thus are picking up stakes in Indian startups at extremely high prices.

Many of these startups have revenues of a few lakhs and losses running into hundreds or thousands of crore. The losses are funded out of money invested by VCs into these unicorns.

The losses are primarily on account of selling, the service or the good that the startup is offering, at a discounted price. The idea is to show that a monopoly (or a duopoly, if there is more than one player in the same line of business) is being built in that line of business and then cash in on that through a very expensive initial public offering (IPO).

As and when, the IPO happens, a newer set of investors, including retail investors, buy into the business, at a very high price, in the hope that the company will make lots of money in the days to come. Interestingly, IPOs which used to help entrepreneurs raise capital to expand businesses, now have become exit options for VCs. 

If an IPO is not possible, then the VC hopes to unload the stake on to another VC or a company and get out of the business.

In that sense, the hope is that a newer set of investors will pay off an older set, like is the case in any Ponzi scheme. Of course, this newer set then needs another newer set to keep the Ponzi going.

The good thing is that when investors buy a stock of an existing company or in a new company’s IPO, they are at least buying a part of an underlying business. In case of existing companies, chances are that the business is profitable. In case of an IPO, the business may already be profitable or is expected to be profitable.

But the same cannot be said about many digital assets that are being frantically bought and sold these days. There is no underlying business or asset, for which money is being paid. Take the case of Dogecoin which was created as a satire on cryptocurrencies.

As I write this, it has given a return of 24% in the last 24 hours. An Indian fixed deposit investor will take more than four years to earn that kind of return and that too if he doesn’t pay any tax on the interest earned.

Why is Dogecoin delivering such fantastic returns? As James Surowiecki writes in a column: “There is no good answer to that question, other than to say Dogecoins have gotten dramatically more valuable because people have decided to act as if they’re more valuable.”

As John Maynard Keynes puts it, investors are currently anticipating “what average opinion expects the average opinion to be.” Carried away by the high returns on Dogecoin, the expectation is that newer investors will keep investing in it and hence, prices will keep going up. The newer investors will keep paying the older ones. That is the hope, like is the case with any Ponzi scheme, except for the fact that in this case, there is no fraudulent manager at the centre of it all.

Of course, the only way the value of Dogecoin and many other cryptocurrencies can be sustained, is if newer investors keep coming in and at the same time, people who already own these cryptocurrencies don’t rush out all at once to cash in on their gains.

If this does not happen, as is the case with any Ponzi scheme, when existing investors demand their money back and not enough newer investors are coming in, this Ponzi scheme will also collapse.

– Charles Ponzi 

Given this, like is the case with people who are heavily invested in stocks, it is important for people who are heavily invested in cryptos to keep defending them. Of course, a lot of times this is technical mumbo jumbo, which basically amounts to that old phrase, this time is different.

But this time is different is probably the oldest lie in finance. It rarely is.

And if dogecoin was not enough, we now have investors going crazy about non-fungible tokens (NFTs), which in simple terms is basically certified digital art. As Jazmin Goodwin points out: “For example, Jack Dorsey’s first tweet is now bidding for $2.5 million, a video clip of a LeBron James slam dunk sold for over $200,000 and a decade-old “Nyan Cat” GIF went for $600,000.” The auction house Christie sold its first ever NFT artwork for $69 million, in March.

In a world of extremely low interest rates and massive amount of printing carried out by central banks, there is too much money going around chasing returns.

There aren’t enough avenues and which is why we have financial and digital assets now turning into naturally occurring Ponzi schemes, giving the kind of returns that the original Ponzi scamsters, like Ponzi himself and his disciple Madoff, would be proud off.

Madoff’s scheme delivered returns of 10% returns per year. Ponzi promised to double investors’ money in three months or a return of 100% over three months. As I write this, Dogecoin has given a return of more than 600% over the last one month.

Here’s is how the price chart of Dogecoin looks like over the last one month.

Source: https://www.coindesk.com/price/dogecoin.