The mystery of Bernard Madoff will be storied a hundred years from now. As history’s biggest financial criminal, he took a cheap rip-off that you can use at home — the Ponzi scheme — and turned it into a global empire worth some $50 billion.
One ingredient was financial intelligence. Madoff had buckets of it. Early in his career, he was the real deal, an actual innovator. He combined this with an amazing lack of conscience, for his scam was rooted most fundamentally in lying and stealing. The difference between him and all who came before was his grand scale, the grandest scale imaginable.
There is a saying in the world of Austrian economics about the business cycle. The puzzle is not to explain business failures. Those are part of the normal course of life, and the sign of a healthy economy. The puzzle is to explain the “cluster of errors” that appears at the beginning of a recession. How could so many have been so wrong about so much at the same time? The business cycle is a system-wide failure, not merely the mistaken judgment of a few.
So it is with Madoff’s scheme. The mystery isn’t how one person was able to fool a few. The scheme in which yesterday’s “investors” are paid off with the money of today’s victims is known in all places and probably all times — and it always goes belly-up to the originator’s complete disgrace. It is a classic example of how moral laws are self-enforcing in the world of economics.
The critical difference this time is that Madoff ran his scheme during an economic boom, a time when people’s normal sense of incredulity is put on the shelf. This is part of the grave cultural distortion introduced by funny money. Money is the most widely demanded good in society, and the Fed is making new quantities of it not as a reflection of new real wealth, but purely as an administrative decree.
There is a sense in which funny money literally drives everyone crazy, leading to what is sometimes called the “madness of crowds.” Guido Hulsmann explains it all in his remarkably timely and revealing new book: The Ethics of Money Production. With artificial stimulation from the credit machine, multitudes are willing to believe in something that cannot possibly be true. In Madoff’s case, it was that he could, even in falling markets, earn 15—20% a year without risk.
Why not? Most everyone believed in some version of the myth. We believed that house prices would go up and up despite the reality that houses are physical things that deteriorate from the instant they are finished, just like cars or computers or anything else. Why did we believe this about houses? Again, you have to look to the fraudulent money system to see why.
And we believed that we could all become millionaires by putting our money in the stocks of companies that weren’t actually earning money or paying dividends, companies whose wealth was entirely based on infusions of cash from the stock market which in turn were based on the belief that others would buy the stocks and so on. In other words, we believed that something out of nothing was possible, and anyone who didn’t believe it was a chump. It’s exactly what people believed during the other great inflations of history.
What’s more, we believed that buying these stocks constituted not consumption, but savings for the future. In fact, people routinely attacked official savings data on grounds that they did not include what people were "saving" in terms of their stock market accounts. In a similar way, people were measuring our national wealth not in terms of accumulated capital, but rather through consumption data, as if granite kitchen counters in bigger houses were a measure of wealth instead of the opposite: the depletion of wealth.
The left is big on attacking the salaries of investment bankers, and they were indeed outlandish. But these too represented not a unique problem, but more evidence of inflationary finance. In a bubble economy, the money chases what is most fashionable, and financial services qualified. So the salaries represented market rates. What was wildly distorted was the market itself.
Now let’s talk about government finance during these years. The market tried to correct itself from 1999—2001, but the government wouldn’t tolerate it. Instead, it used every sign of downturn as an excuse to keep the illusion going, creating billions and billions in new dollars. The Fed drove interest rates lower and lower despite the non-existence of savings available to back them up.
(Low interest rates in a sound money system are a reflection of accumulated capital and deferred consumption. When you see the Fed pushing them down during a boom, it is creating a dangerous mirage.)
Did anyone stop and wonder where the government was getting all this money to pump up the system? Yes, the Austrian economists warned us. The pages of Mises.org and LewRockwell.com were filled with alarms. But it was something people wanted to ignore. We are talking about human nature: the desire to believe in things that do not exist. The government was happy to fuel this sense because it gave the Fed, its connected industries, and the state more power and more money in the short term.
Madoff’s scheme played into the belief that wealth was not something to work for, but something to scheme for. It could be generated by playing your cards right, hooking into the right networks, and finding the right “investments.” The people with whom he dealt had, it turns out, some internal sense that there was something a little bit shady about the whole operation. But they dispensed with this sense when the fat checks arrived, and concluded that whatever was making this perpetual motion machine operate, it did work.
But listen: the government right now is using the same tactic to convince you that it is saving you from the recession. The whole scheme partakes of the same sense of denying reality that characterized Madoff’s scheme. And I’m not just talking about Social Security, which is almost an exact replica of the Ponzi version, except that at least Charles Ponzi didn’t force people to give him money. I’m speaking of something broader. The entire financial system that is propped up by the Treasury and the Fed is based on the same idea: that something out of nothing is possible.
So they will jail Madoff. Wall Street would flog him if it could. He is disgraced for all of history. But meanwhile, the likes of Bush, Bernanke, Paulson, Obama, and all the rest are still riding high, even though their scheme is far larger and more egregious.
Most of us like to believe that we wouldn’t have been tricked by Madoff. But are you being tricked by the elites who claim that they can conjure up a trillion dollars to stabilize our economy by clicking a few buttons on a computer screen? Most people are. Certainly the press seems to have bought it. Many people were outwitted by Madoff. Many more people are today being outwitted by the government and its central bank. And it will all end in disgrace and disaster, only on a far, far grander scale.