In 1994, a pyramid scheme appeared on the scene in Russia. The company MMM had gone through several business schemes before settling on their scam in early 1994. It worked much like any pyramid scheme, telling people to invest their cash with them and promising massive returns. In February 1994, the company started an ad campaign on TV. Other companies soon followed suit with similar schemes. The government finally shut them down for “tax evasion” in July 1994. MMM “owed” taxes to the tune of $26M. The majority of investors never got their money back. Those who did only got a fraction of what they had “invested”. MMM is still considered to be one of the biggest Ponzi schemes in history.
But didn’t you ever wonder why MMM’s Sergei Mavrodi was able to get away with his pyramid scheme for so long? Andrei Shipilov asks on his blog. The government was not helpless, he writes. In fact, “I remember well what delight reigned there [in the elite] over the pyramids.”
Recall how it was then, hyperinflation, reaching several hundred percent per year. The massive money supply which arose because of the wild uncontrolled emissions. The population had millions [of rubles] in their hands with nowhere to go because they [the rubles] were worthless.
The treatment prescribed is known, and very painful: it is necessary to somehow remove the money supply, and not exchange it for anything of value; specifically, to remove [the excess money supply] without giving anything in return.
In the 1990s, people would not accept the normal schemes [bonds and the like] that had worked in the past. So the government allowed the pyramid schemes to operate instead, Shipilov alleges. “And when all the extra money from the population was seized, the anger of the people would fall not on the state, but the fraudsters.”
The situation was ideal. Therefore the green-light was given to the pyramid schemes to advertise on TV, any attempt by honest officials (then they still came across as such) to stop the chaos was blocked. The more worthless money removed from the population – the better for the economy.
“Inflation fell immediately…. Within 6 months, all the excess money supply was taken from the population and converted into dust. And the state had nothing to do with it! They didn’t confiscate people’s money, Mavrodi did!
Now, Shipilov explains,
…the government is doing exactly the same thing that Mavrodi did, but more cleverly, elegantly, and much less noticeably. But the result is the same – your money will be gone. Only they are not lost in the MMM tickets, but bank accounts. Even if you do not have a bank account… they will take the account in which your employer keeps your salary. And again, as it was in the 90s, the state will do it, and will blame the bankers.
Shipilov lays out the concept of re-financing to his readers:
You know, it’s a paradox, that bankers have plenty of money, and yet they constantly need hard cash. Here, it would seem is a paradox. At the bank sits trillions [of rubles] in the accounts of citizens and businesses, but the banker occasionally rushes to the market looking where to intercept a week loan for a million or so.
But there is no contradiction. The money that sits in the bank is “long-term”. The bank needs somewhere to put it, somewhere to invest, in order to make a profit. And it does. But not now, in a month, a quarter, six months. And you come to pick up your contribution, and you need the money right now. And the only way for the bank to return your contribution to you is to find somewhere to refinance, to borrow somebody else’s money for a short time, a month, a week, sometimes just a couple of days. That is the bank has to find money somewhere in the short-term.
Moreover, the bank must refinance a small percentage, or the revenue from the “long-term” money will not cover the loss and the bank will be broke. You could say that the availability and the cost of “short-term” money depends on the stability of the banking system.”
That is why it is in the vital interest of the central bank of any country to have available and cheap “short-term” money for the banks. And it [the Central Bank] gives them the money. Have you heard of the term “refinancing rate”? That is the same percentage by which all banking institutions borrow money from the Central Bank.
Since the Central Bank has at its disposal a complete picture of what is happening in the banking sector, it clearly knows how much money the banks need, and puts a corresponding proposal on the market.
For example, to date the total debt of Russian banks in terms of “short-term money”, first of all, to the Central Bank itself, is about half a trillion rubles. This means that the Central Bank must refinance the banks to the tune of half a trillion rubles. And two years ago, this is what happened.
And this is what the Central Bank is doing this year. It is placing at auction loans for credit institutions of 100 billion rubles. But the banks need 400 billion more. It should be possible to borrow from other banks, but they are in the same situation. It should be possible to refinance from abroad, but there are the sanctions. There remain three other ways, either to indulge in risky short-term operations, or sell assets, or to dump the currency (if it still exists) and get paid for it in the badly needed rubles.
All three ways are dead-ends and will lead to the bankruptcy of the banks in the end. The bank bursts, loses money, and the state is not to blame, as in the case of MMM.
And so 1998 will repeat itself, Shipilov predicts. After a long period with a “stable” ruble, people will wake up to find that the exchange rate “has jumped significantly”.
“Or maybe it turns out that you can’t buy anything with your money.”
“But the state is not to blame. It’s all the bankers.”