By Larry Haverkamp (Doc Money)
[email protected]
April 28, 2009
Good v bad risk
US$200 trillion in world wealth is small compared to the new centrepiece of this recession: derivatives.
They are US$1,232 trillion, which is - get ready - US$1.232 quadrillion. A quadrillion is 1,000 trillion, or 1 followed by 15 zeros.
By the way, did you know that a googol is 1 followed by 100 zeros? That's huge.
Back to derivatives.
In June 1998, the underlying value of privately traded (over the counter) derivatives was US$75 trillion.
Ten years later, it had grown to US$684 trillion.
The other half of the story is exchange traded derivatives like futures and options.
These come to US$548 trillion, bringing the grand total to US$1,232 trillion or US$1.232 quadrillion as of June 2008.
Here's how they work
Derivatives make it possible to bet on the rise or fall of interest rates, currencies, oil, food, metals and more.
Instead of buying gold, for example, you can make a bet with a counterparty that gold prices will go up. It is speculation (gambling) and it creates a new risk that wasn't there previously.
Derivatives can also reduce risk through hedging.
Do they reduce risk through hedging (good) or increase it through speculation (bad)?
We can get a hint by looking at the value of all derivatives. As explained, it stands at US$1,232 trillion, which is six times the US$200 trillion value of the world's wealth.
It shows that something besides innocent hedging is going on since there is not that much wealth in the world to hedge. Speculation is likely.
This speculation is crowding out 'good' risk. For example, a bank giving a car loan produces risk, but it is productive since it results in someone owning a car. It boosts GDP. (Good.)
Derivatives speculation also produces risk but it is not productive. It does not add to GDP or the world's wealth. It only shifts it around through counterparty bets that are won and lost. (Bad.)
The move from productive to unproductive risk is a new development. It is a dark force that is unique to this recession.
[email protected]
April 28, 2009
Good v bad risk
US$200 trillion in world wealth is small compared to the new centrepiece of this recession: derivatives.
They are US$1,232 trillion, which is - get ready - US$1.232 quadrillion. A quadrillion is 1,000 trillion, or 1 followed by 15 zeros.
By the way, did you know that a googol is 1 followed by 100 zeros? That's huge.
Back to derivatives.
In June 1998, the underlying value of privately traded (over the counter) derivatives was US$75 trillion.
Ten years later, it had grown to US$684 trillion.
The other half of the story is exchange traded derivatives like futures and options.
These come to US$548 trillion, bringing the grand total to US$1,232 trillion or US$1.232 quadrillion as of June 2008.
Here's how they work
Derivatives make it possible to bet on the rise or fall of interest rates, currencies, oil, food, metals and more.
Instead of buying gold, for example, you can make a bet with a counterparty that gold prices will go up. It is speculation (gambling) and it creates a new risk that wasn't there previously.
Derivatives can also reduce risk through hedging.
Do they reduce risk through hedging (good) or increase it through speculation (bad)?
We can get a hint by looking at the value of all derivatives. As explained, it stands at US$1,232 trillion, which is six times the US$200 trillion value of the world's wealth.
It shows that something besides innocent hedging is going on since there is not that much wealth in the world to hedge. Speculation is likely.
This speculation is crowding out 'good' risk. For example, a bank giving a car loan produces risk, but it is productive since it results in someone owning a car. It boosts GDP. (Good.)
Derivatives speculation also produces risk but it is not productive. It does not add to GDP or the world's wealth. It only shifts it around through counterparty bets that are won and lost. (Bad.)
The move from productive to unproductive risk is a new development. It is a dark force that is unique to this recession.
