Op-Ed: The Quadrillion Dollar Derivatives Dilemma, And How A Harder Currency Can Save Us

Executive Brief

A financial derivative is a contract which derives its value from an underlying asset, and almost every asset in the world now has some form of one attached to it. They are purportedly used for hedging risk, and do perform this function in a small number of instances, but the majority of them increase the risk exponentially in search of greater reward. The riskier the bet, the larger the potential payoff. Quite often when the casino (bank) loses on these risky bets, the working class taxpayers end up footing the bill, as we witnessed in the 2008 derivative-driven financial crisis.

There is no money for a bailout when the derivative market unravels again, it's time we explore new options.

Read the full story below. 

Although their packaging and delivery has changed greatly, derivatives have largely remained a source of economic instability even in years prior to the Great Depression when they were sold in 'bucket shops'. Criminal law refers to a bucket shop as an operation in which the customer is sold what is supposed to be a derivative interest in a security or commodity future, but there is no transaction made on any exchange. There is never any delivery of the asset to the buyer and the whole deal is nothing more than a wager on the future price. Bucket shops specializing in stocks and commodity futures flourished in the United States from the 1870s until the 1920s. Practices learned in bucket shops are still alive and well today, as only a very small percentage of derivatives are actually traded on the open market, with the rest traded privately in unregulated, over-the-counter deals.

"Financial weapons of mass destruction"
-Warren Buffet, speaking on derivatives

According to the US Federal Reserve, there is only 1.48 trillion dollars of US currency in circulation, but there is over $60 trillion in derivatives tied to it, as stated by the Bank for International Settlements. Of further risk not only to the U.S., but the entire global economy, the five largest American banks have around $250 trillion in exposure to various derivatives. Who will the banks turn to for a bailout this time now that the taxpayers have already been bled dry? There is not even close to enough money in the world to cover all derivatives, with their value around 10x that of the world GDP.

The global derivatives market has grown unabated since the '08 financial crisis, increasing in value by about $200 trillion. Because banks act as financial intermediaries between the saver and the borrower, offer virtually no transparency as to what is in some of the 'investments' they pitch to their customers, and are allowed to inflate the money supply by only being required to keep on deposit a fraction of customer deposits (fractional reserve banking), they are basically in control of the entire money cycle. There are no other players in the game, and with the government doing little more than playing with interest rates, who is watching the big banks?

Former U.S. Representative and Liberty Advocate, Ron Paul believes that "The first step towards monetary freedom is to allow open competition in currencies. Once gold and silver are allowed as legal tender and can be sold without sales tax, everyone can use them to store their wealth and to pay for the things they want to buy." In 2015, his son Rand Paul became the first major U.S. presidential candidate to accept bitcoin donations.

Everyone has their own theory on how to remedy the situation, my stance is simple, a harder currency standard will make it more difficult to create wealth out of thin air. A hard currency is less likely to depreciate in value suddenly, and since most digital currencies are deflationary, they are much harder than any other currency. In a chief economists workshop, Bank of England declared digital currency harder money than the gold standard.

Because big banks can't fabricate wealth with bitcoin and other cryptocurrencies like they can with the U.S. dollar and other fiat currencies, when the house of cards comes crashing down, having some investment exposure to non-government digital currencies may be the only thing that saves you from a repeat of the last financial crisis.

Sources:
https://annualreport.deutsche-bank.com/2015/ar/deutsche-bank-group/facts-and-figures.html

https://www.occ.gov/topics/capital-markets/financial-markets/derivatives/dq215.pdf

http://thenextturn.com/canadian-bank-derivatives-exposures-2016-q1-update/

http://www.google.com/finance?q=NYSE%3AGS&fstype=ii&ei=CCL6UNCILIrCkgXZeA

https://www.google.com/finance?q=NYSE%3AJPM&fstype=ii&ei=cmW9VuHOBdPNuAS9yb74Bg

https://www.google.com/finance?q=NYSE%3AC&fstype=ii&ei=sW69VtHoDJaeuATOzrnABg

https://www.google.com/finance?q=NYSE%3ABAC&fstype=ii&ei=vWq9VpnvAsyYuASXoqXYDA

https://www.sec.gov/Archives/edgar/data/895421/000119312514067354/d639242d10k.htm

https://www.federalreserve.gov/faqs/currency_12773.htm

http://www.bankofengland.co.uk/research/Documents/conferences/ah0515.pdf

The views expressed by the authors on this site do not necessarily represent the views of DCEBrief or the management team.

Author: Brandon Cheliak

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