I have just been reading a very good book, which I recommend. It is called The Final Crash and is written by Hugo Bouleau, the pseudonym of an experienced investment banker who works in the Channel Islands. The argument will be a familiar one that supports views often expressed in contrarian publications. Bouleau gives the book the subtitle Addictive Debt and the Deformation of the World Economy.
The book covers a lot of relatively familiar areas, including gold, oil, raw materials, inflation, U.S. debt, and so on. I note the figures the author gives on the growth of derivatives: “In 2004, the market in credit derivatives increased by 123%, creating an exposure of $8.4 trillion to these instruments of insurance. In 2005, they grew by 105%, such that their so-called notional value stood at $17.3 trillion, which is the excess of all outstanding corporate debt on the planet. The total derivatives market across all sectors is worth an incredible $298 trillion. To put this into context, the value of such instruments was equivalent to less than a third of the world economy in 1990 but equates to nearly 800% of global GDP in 2006. Much like Lloyd’s re-insurers, someone somewhere must be exposing themselves to these credit risks.”
What is certain is that nobody has any real understanding of these risks, either in detail or globally. Their ultimate base, like that of any bookmaker, must be that the banks that issue derivatives keep their books balanced. In theory, as in other forms of banking, every liability is balanced against an asset. But -- as we all know -- bookmakers can go bust, and so can bankers. If the counterparty responsible for matching the risk becomes illiquid, then the whole system can be put at risk.
There were plenty of years in the first half of the 20th century when events were so overwhelming that it seems unlikely that this derivatives system could have survived. 1914, 1917, 1923, 1925, 1929-31, and 1939 all produced events that caused major global financial shocks. We cannot calculate the risk of similar events in the future, but they would include revolutions, global wars, hyperinflations, and slumps.
Warren Buffett says that he cannot get his head around derivatives. So the rest of us can excuse ourselves for being in the same situation. I cannot envisage how one could unwind $298 trillion, if it had to be unwound. But I look at the Middle East and reflect that major wars, revolutions, inflations, and slumps have not permanently disappeared from the modern world.
The book covers a lot of relatively familiar areas, including gold, oil, raw materials, inflation, U.S. debt, and so on. I note the figures the author gives on the growth of derivatives: “In 2004, the market in credit derivatives increased by 123%, creating an exposure of $8.4 trillion to these instruments of insurance. In 2005, they grew by 105%, such that their so-called notional value stood at $17.3 trillion, which is the excess of all outstanding corporate debt on the planet. The total derivatives market across all sectors is worth an incredible $298 trillion. To put this into context, the value of such instruments was equivalent to less than a third of the world economy in 1990 but equates to nearly 800% of global GDP in 2006. Much like Lloyd’s re-insurers, someone somewhere must be exposing themselves to these credit risks.”
What is certain is that nobody has any real understanding of these risks, either in detail or globally. Their ultimate base, like that of any bookmaker, must be that the banks that issue derivatives keep their books balanced. In theory, as in other forms of banking, every liability is balanced against an asset. But -- as we all know -- bookmakers can go bust, and so can bankers. If the counterparty responsible for matching the risk becomes illiquid, then the whole system can be put at risk.
There were plenty of years in the first half of the 20th century when events were so overwhelming that it seems unlikely that this derivatives system could have survived. 1914, 1917, 1923, 1925, 1929-31, and 1939 all produced events that caused major global financial shocks. We cannot calculate the risk of similar events in the future, but they would include revolutions, global wars, hyperinflations, and slumps.
Warren Buffett says that he cannot get his head around derivatives. So the rest of us can excuse ourselves for being in the same situation. I cannot envisage how one could unwind $298 trillion, if it had to be unwound. But I look at the Middle East and reflect that major wars, revolutions, inflations, and slumps have not permanently disappeared from the modern world.
No comments:
Post a Comment