Is It a Ponzi Scheme?

[leonidas]

One of the fundamental principles of economics tells us that people respond to incentives. In a free market economy, profit that is definitely the best incentive directs business toward activities that increase wealth. However, the 2008 recession showed that the Ukrainian government as well as the American government had different take on the key element of economics. I am taking about bailing out.

The Tymoshenko government bailed out couple private banks by purchasing around 90% of stocks in each privately-owned bank. For instance, state-owned Ukrprombank
purchased Rodovid Bank. Everything seemed to be OK until a new announcement made by the Rodovid bank's administration. Rodovid needs additional $1 billion to restructure its debt. Ernst & Young will supervise Rodovid's debt restructuring. It looks like the Tymoshenko government is really good in turning any lucrative business in a bankrupt. I still wonder how did the government manage to let the state-owned oil company NAFTOGAZ go bankrupt?

The main problem is not even bailing out again. Now a main issue is that the Tymoshenko government has no money to finance a bail-out. A money-printing stunt thrown by the National Bank of Ukraine has already inflated domestic money supply to all time high of the last decade. Inflation is rampant in Ukraine! Moreover, the government budget resources are almost exhausted. At present moment, the government budget has less than $100 million at its disposal that is even lower than the dramatic 1998 level. Russia's prime minister Putin has already rushed to reprimand Ukraine's president Yushchenko for defaulting on payments for Russia's natural gas. Wait a sec, what does Ukraine's president have to do with this? Ah, it must be the politics.

So what does the Tymoshenko government do in search of external financial resources? The government announces sales of government bonds. The Tymoshenko government sells 6-month Ukraine's government bond with 30% yield! Even Brazil is more modest with 8.76% yield on its 6-month government bonds. Many domestic and foreign experts express their concern that the Ukrainian government can run a Ponzi scheme. I agree that it looks really weird.

[V-G]

Thank you for posting this, leonidas. Very interesting topic.

It does raise some red flags, but what can be done? My father runs a business in Ukraine and his words to me last week were "you cannot take a step without having to grease someone's hand". I suspect that E&Y will have hell of a time supervising there. Government theft and misappropriation of assets has been a burden since 1991 and it seems that little has changed.

But to answer your question, I do not believe this is a Ponzi scheme, I believe this is simple fraud! The cover up is to issue more securities with insane returns. How do you pay those off? Oh... print more money.

What is Ukraine's policy on inflation? I am not in the loop, but if it isn't strict then I assume a massive inflation is on its way.

Wow... I had no idea things were that bad in Ukraine.

[StormAU]

Simple fact, when you haven't got the Gold etc. reserves to back up the level of currency in the open market you take money out of circulation. Putting more money in just feeds inflation at an unnatural rate. Why is it that leaders still do not understand this basic thing?

As for such high returns on bonds, well ......, all I can say is it is ludicrous and someone is getting a cut of the "profits" somewhere along the line. Times like these have pushed rates down all over the world, Australia was the first economy to lift rates and to my knowledge no other country has done that yet, except it seems Ukraine.

[V-G]

I don't think it is a matter of those in power not understanding the basics, but rather their oblivious attitude to what is to come. They steal and hope to get away with it, period.

Bad economic times means people start saving, so do businesses, which is a catch 22 as one needs more spending to stimulate the economy. By lowering the rates, it allows public to borrow money cheaply and allows for a great business opportunity - thus increasing spending, which in turn fuels the economy. That is why strong economies take action that makes logical sense.

Weak economies going against the grain with their policies is just another red flag for fraud.

How can anyone in Ukraine hope for better times when they read news like this, I'll never understand.

[Albatross]

Originally Posted by V-G

But to answer your question, I do not believe this is a Ponzi scheme, I believe this is simple fraud!

Whadaya mean? A ponzi scheme is a form of fraud. A government which borrows money, which it can't pay back, relying on future borrowings to pay back old loans, fits the definition of a ponzi scheme pretty nicely.

It's not remarkable that Ukraine is doing it. Governments all over the world are doing it and the US among them. What's remarkable that the US and other Western governments so far can get away with paying a 2 or 3% interest rate for newly issued debt. Ultimately, even these governments will default. The only question is if they will do it openly or through inlating their currencies. Because of Ukraine's internal weakness, it's just collapsing a bit quicker then the rest.

[AlexMc]

I think the US can always print more $ whereas not many people are going to rely on UAH

[StormAU]

Originally Posted by AlexMc

I think the US can always print more $ whereas not many people are going to rely on UAH

Read my first post in this thread, if the US prints more money without having enough Gold etc. reserves it will just feed inflation at an unnatural rate. There must be some form of security, i.e. precious metal reserves for example kept in government stores, to be able to keep fiscal policy in check. Having more money than reserves devalues currency while commodities increase in price. This then feeds inflation because people have to spend more in order to live.

On the other hand if there isn't the money in circulation that is held in precious reserves the currency is artificially inflated and that can also have disastrous effects on an economy. So basically circulation must = reserves.

Pre-WW2 Germany, current day Zimbabwe and a few other countries all were/are caught in that trap and it takes years, sometimes generations, to get out of it.