See Inside Scientific American Volume 310, Issue 6

The Whole Economy Is Rife with Ponzi Schemes

Many ordinary business practices resemble the infamous con game

The Ponzi scheme has been a recurring fixture of economic life in rich and poor nations at least since the 19th century, creating a few millionaires and ruining the lives of millions. Yet most people have only a vague idea of what they are, which may explain why so many continue to fall for their strange and almost mystical allure. This topic, of course, has acquired a certain urgency because of the recent global financial crisis and headlines about the Bernard Madoff scandal, the biggest ever Ponzi scam, which occurred at the height of the turmoil.

Anyone who followed the Madoff debacle probably thinks about Ponzis as being deliberately concocted frauds. Instead of using investor money to fund a productive business venture, the con artist channels the proceeds from new investors to pay interest to earlier ones. But economists have started to realize that this type of behavior can also occur spontaneously, even unconsciously, simply by having one expectation feed on another, creating a frenzy of speculation, an inflating economic bubble that is doomed to eventually crash.

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