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Findings & Forecasts 12/05/2012



Deriv­a­tives. After the near-total melt­down of the finan­cial sector in 2008, one might expect that big banks would cur­tail their exces­sive risk-taking behavior. Alas, not so. In fact, just the oppo­site has occurred: More risk exists in today’s banks than at any time in history.

The largest nine banks have an overall expo­sure to deriv­a­tives of over $200 tril­lion, a figure that is more than three times the size of the entire global economy. For all global banks, the total “notional” value of deriv­a­tives is well over $1,500 tril­lion; $1,000 tril­lion is $1 quadrillion.

There is no reg­u­la­tion in the deriv­a­tives mar­kets, where only the law of the jungle pre­sides. Preda­tors and prey jockey for sur­vival in dimly lit trading rooms. If a fellow predator gets “eaten,” the news of it is taken with sat­is­fac­tion that more is left over for the remaining survivors.

In sim­plest terms, a deriv­a­tive is a bet on the out­come of some future event. While a bookie takes a bet on the out­come of next week’s horse race, deriv­a­tive traders make bets on events months and years into the future.

A bet works like this. I pur­chase $1 mil­lion in low-rated cor­po­rate bonds that cur­rently yield 6 per­cent and are not due for repay­ment for another 10 years. I’m going for the higher income knowing that there is a higher risk of default. Thus, I seek to find a bettor that will bet against that risk for a tol­er­able fee. Banker X thinks my bonds will be paid off when due, and charges me $25,000 for the assur­ance that if the cor­po­ra­tion does default, the bank will make up any dif­fer­ence. My $25,000 pay­ment is pure income to the bank, and there is no off­set­ting lia­bility recorded.

How­ever, if my cor­po­ra­tion defaults five years down the road, and I lose $800,000 in the process, then banker X imme­di­ately owes me $800,000, which, by the way, is also the so-called “notional value” of the con­tract. Because of all the uncer­tainty, the cur­rent notional value of a deriv­a­tive con­tract can only be guessed at.

If you ask a bookie what his “expo­sure” is, he may say some­thing like $100,000, but he knows that he will not lose all of his bets. Some will cost and some will profit. If he is really good, he will take home a pay­check every week — fewer pay­outs than bets received. If the odds go against him and he cannot pay, then clients with crow­bars are chasing him down the street.

Bankers think the same way about deriv­a­tives. Of course they know that they will lose some bets, but given their mega­lo­ma­niac per­son­al­i­ties, they figure they will win more than they lose and hence, the more bets that they can make, the more money they can pocket. This is why the deriv­a­tives market con­tinues to expand.

Sellers of deriv­a­tives have cul­ti­vated (suck­ered) an industry of pur­chasers who wrongly believe that they can lower their actual risk by adding deriv­a­tives to their overly-risky invest­ments. Put another way, if there were no deriv­a­tive market, people would not make such risky invest­ments in the first place. The temp­ta­tion to take on too much risk because deriv­a­tives are avail­able is called “moral hazard.” In this writer’s opinion, the entire deriv­a­tives market is one big cesspool of moral hazard.

When things go wrong again, this market will destroy the entire global finan­cial system: Cen­tral banks, banks, insur­ance com­pa­nies, wealthy investors, pen­sion funds, sov­er­eign wealth funds, national trea­suries, etc.

How­ever, there is another moral hazard that is enabled by the deriv­a­tives market: That is, for those who long for the death of cap­i­talism, finan­cial armageddon may be per­ceived as only be a few trades away…

Eating our seed corn. It’s farmer’s wisdom to always put enough seed away from this year’s crop to allow for replanting next year. Such wisdom has been lost to the rest of America, which has been rou­tinely eating its seed corn every year for sev­eral years now.

The above chart shows Net Domestic Invest­ment as a per­centage of nom­inal GDP, or Gross Domestic Product. NDI sub­tracts out con­sump­tion of fixed cap­ital, com­monly knows as depre­ci­a­tion. Since 1965, the rate of growth of NDI has steadily declined and is cur­rently stuck at zero growth.

There are a number of things that could be inferred from this chart, but the most promi­nent is that a healthy society con­tin­u­ously replaces its invest­ment cap­ital, and a declining society does not. To truly turn eco­nomic America around would require 6 – 10 per­cent of our GDP to be invested into cap­ital goods and infra­struc­ture — the means of pro­duc­tion. Given the cur­rent eco­nomic con­di­tions, this is absolutely impos­sible… the seed corn is gone.

— —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  —  — –  Note: Addi­tional con­tent on this page is avail­able only to Pre­mium sub­scribers of Find­ings & Fore­casts.
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5 Responses to “Findings & Forecasts 12/05/2012”

  1. So… What are we to do with our money? If the seed corn is gone, the crops won’t be planted and the future will be famine for growers and con­sumers. How do we pre­pare to out­last this event and save lib­erty?
    “An August F & R Member in Good Standing’
    Frank Lan­drey
    434 – 944-2728

    P.S. Would you be inter­ested in a “good price” for my book “A Sta­tist Spy Tells All” to be given away for new sub­scribers as an incen­tive to sign up? My web­site is Please visit it soon.

    “A Sta­tist Spy Tells All” is in paper­back (335 pages)and self pub­lished. My web­site has three “free” chap­ters. The eBook can be priced very low. The CFR and TC are exposed in a unique way. Con­gressman Larry McDonald is res­ur­rected, so to speak, with his story being told from a new angle. The his­tory of America is re-lived with the Cen­tral Banking bat­tles revealed. The four cen­tral banks are brought back to the public’s mind. Pres­i­dents who are our real heroes are ele­vated. Unlikely heroes are all linked together for their attempts to cir­cum­vent or for actual vic­to­ries over the Cen­tral Banks. The reader has plenty of “vil­lain facts” in their own words taken from books, arti­cles, and Con­gres­sional Records.

    My eBook has been made into a radio script and pro­duced to be a drama.
    It is a story of two men who sup­pos­edly meet in the Boise, Idaho, Julia Davis Park by acci­dent. Their con­ver­sa­tion turns into a lec­ture by lap top com­puter about the impact of a little known book pub­lished in 1912 which has been used to remake America into that author’s dreamed dic­ta­tor­ship for the country. America is living in the last chapter of this mys­te­rious author’s polit­ical novel. The problem is the author of that 1912 book was a real person, Edward Mandel House, who was the alter ego of Pres­i­dent Woodrow Wilson. Franklin Roo­sevelt was his lackey too.

    The book “A Sta­tist Spy Tells All” and the audio book “Dia­bol­ical Deeds” pro­duced from it have been made into 12 — 27 minute radio dramas.Can you help me find three com­pa­nies who would be willing to adver­tising their com­pany and or prod­ucts on radio sta­tions to help pay for my pro­grams’ air­time? Any ideas on how to pro­ceed would be helpful.

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  2. Jack says:

    Edward Griffin of “The Crea­ture From Jekyll Island” and ghe God­fa­ther of exposing the unfed­eral unre­servie has his own growing net­work that you may be able to add your material.

    You can sign up for his incoming news here

    There is a con­tact email to his web­master here

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  3. Thomas Woodward says:

    I know you but you don’t know me. We met once attending Cross­roads Church south of Grass Valley, CA. It was a while ago, maybe even before Todd Johnson’s tenure ended. After you moved north another member (I don’t remember who) told me who you were and about your online newsletter. I’ve appre­ci­ated reading it and wanted to ask you if you also read The McAl­vany Intel­li­gence Advisor. The most recent issue greatly details the ram­i­fi­ca­tions of another 4 years of Obama and the cer­tain con­se­quents. If you don’t suscribe, I’d like to mail you the cur­rent issue. No need to return it; I get two copies. Let me know if you’re inter­ested. Regards, Tom

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  4. Ware says:

    The “Amounts out­standing of over-the-counter (OTC) deriv­a­tives” is $647 tril­lion, not $1500 trillion.


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  5. Patrick Wood says:

    Yes, this is the esti­mate offered by the Bank for Inter­na­tional Set­tle­ments (BIS). Other bodies have dif­ferent esti­mates. Because there is no reg­u­la­tion of this market, nor are there any agreed-upon stan­dards for val­u­a­tion, it is impos­sible to find agree­ment between one esti­mate and another.

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