I don’t go for multi-level marketing schemes. I don’t care whether the MLM is peddling vitamins, water purifiers, lotions, or solid gold bricks, I won’t take part in it. Both individuals and the U.S. government have spoken out against MLMs, but people still go for them because they promise lots of money.

MLMs don’t work in the long run because they are fundamentally unstable pyramid schemes. You buy into the program, get some other people to buy in under you, then they get others to buy in under them, etc. It doesn’t take very long to realize that the numbers don’t work. Let’s play with a simple pyramid, with each participant getting 10 people below them, and calculate how many people are added in each iteration of the MLM.

1st 1
2nd 10
3rd 100
4th 1,000
5th 10,000
6th 100,000
7th 1,000,000
8th 10,000,000
9th 100,000,000
10th 1,000,000,000
11th 10,000,000,000

At the 11th iteration, we have reached a total of over 11 billion people in the MLM. Since that is obviously greater than the current population of Earth, you can see that a simple MLM can swiftly grow faster than the available number of people on the planet. You could artificially limit growth by allowing only four people in a participant’s downstream group, but this only prolongs the inevitable growth. If you limited each iteration to four times the size of the previous one, you would grow past the human population in the 14th iteration, only three more than in the example above. All of this assumes that the widget or service sold by the MLM is something that every living person wants and will buy. There isn’t a single item on earth that everyone is willing to purchase–not even water. If you don’t believe me, do your best to come up with one and let me know.

Pyramid schemes are not anything new. These schemes are sometimes referred to as “Ponzi schemes,” after Charles Ponzi who developed a huge investment scheme in 1919-1920 before it blew up, as these schemes inevitably do. While it was possible for investors to make fantastic profits after 45 or 90 days, Ponzi constantly relied on a new influx of investors to pay off the previous ones whose payments were coming due. A modern revival of the Ponzi scheme is the “make money fast” letters and emails that continuously make the rounds on the Internet. Most of these never get anywhere, but sometimes these schemes have disastrous effects, such as the Ponzi scheme that trashed the nation of Albania in the 1990s.

We may scoff at how the Albanians fell victim to a Ponzi scheme, but here in the United States we have our own inherently unstable pyramid called Social Security. Some have argued that Social Security doesn’t qualify as an actual Ponzi scheme, but there can be no argument that Social Security relies on the money from current workers to pay benefits for previous generations. Back when President Roosevelt started Social Security, there were sixteen wage earners for every person receiving benefits. The current ratio is about three workers for each recipient, and the number of wage earners continues to drop. This ain’t good.

Here is what the President said in his State of the Union address:

The best way to keep Social Security a rock-solid guarantee is not to make drastic cuts in benefits, not to raise payroll tax rates, not to drain resources from Social Security in the name of saving it. Instead, I propose that we make the historic decision to invest the surplus to save Social Security.

Specifically, I propose that we commit 60% of the budget surplus for the next 15 years to Social Security, investing a small portion in the private sector just as any private or state pension would do. This will earn a higher return and keep Social Security sound for 55 years.

This declaration was greeted with applause and cheers by the audience. The catch is
that I just quoted President Clinton’s 1999 State of the Union address. When President Bush
pointed out the oncoming collapse of Social Security in his 2005 State of the Union address, the Democrats who had cheered President Clinton on the same subject only six years before, instead muttered, griped, and complained that the President was being reactionary. I’ve created a 85kb mp3 sound file of the Democrats grumbling during President Bush’s speech. It seems the Democrats no longer agree that Social Security is a looming disaster, though they lauded President Clinton’s call for a similar fix.

Social Security has been called the “third rail” of politics; similar to the electrified third rail used in subway systems, anyone who as much as touches this political topic is in for a great shock. But is Social Security a good deal? If it were to be proposed today, it would never be accepted by the people. Don’t believe me? Would you agree to an insurance policy that would generate less than a 2% growth of your investment, and at your death the unspent balance goes not to your beneficiaries, but reverts to the government to be spent as it sees fit? If you are honestly excited about such a deal, I want to sell you your next car.

I could almost like Social Security if the money I was earning were to go into a secure account with an interest rate of 2% over inflation. You could think of it as a forced savings account. The problem is that there is no trust fund or lockbox on Social Security money. At the moment there is more money going into Social Security than is needed to pay current expenses, but rather than setting the extra money aside to earn interest, government officials have taken the money and spent it. In its place they have been writing IOUs, promising to pay back the money at some future date. And that date never comes. As P. J. O’Rourke said, “Giving money and power to government is like giving whiskey and car keys to teenage boys.”

So what will you see in the next few months? President Bush and the Republicans will push for ways to make Social Security better, and Democrats will vilify and nay-say every idea they bring up. After all, it will be easier for the Democrats to bury their heads in the sand and pretend that the pyramid scheme we call Social Security will continue to be a rock-solid investment — as solid an investment as Charles Ponzi’s Securities Exchange Company ever was.

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