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High Stakes Gambling: Derivatives Create Nothing

February 23
16:00 2012

New York Times bestselling author James Wesley, Rawles very elegantly breaks down what ‘derivatives’ are, and why they have imploded our economy:

What are derivatives? The Derivatives Primer sums it up nicely in one sentence: “Derivatives are financial contracts designed to create pure price exposure to an underlying commodity, asset, rate, index or event.” Another way of putting is it is that a derivative contract is a secondary or “derived” wager on the future price of an investment in an underlying market. It is much like the futures markets for stocks, bonds, and commodities. But a derivative can be something even more speculative. A derivative can be a bet on a incremental market change in yet another bet on an incremental change–in effect a hedge on a hedge, or bet on a bet. Derivatives are traded globally, and are less regulated than other financial markets. All traders like to hedge their bets. And these days they typically use exotic derivative contracts to do so.

Derivative contracts can be traded in just about anything: stock, bonds, commodities, credit, interest rates, or currencies. You can place a derivative bet on next year’s price of QQQ (the aggregate price of all NASDAQ stocks), or you can place a bet on the price of tea in China. A corporation can make a forward rate agreement (FRA), predicting the interest rate that it will pay on money that it plans to borrow for a factory expansion in two years. An agreement to borrow or lend a certain amount of principal at a specified interest rate and time.You can bet on the future of the futures market in pork bellies. Economist Robert Chapman summed it up best when he wrote: “The point everyone misses is buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing.”

Here is where it gets frightening for the economic welfare of our society, and world:

The scary thing is that the volume of derivatives trades is much larger than their underlying markets. To give you some perspective, here is a quote from economist Gary Novak, “The total annual product of the globe is around $30 trillion. I estimate that the total value of the global real estate is around $50 trillion. A few years ago, Alan Greenspan said the amount of derivatives on the books was $200 trillion. More recently, the figure was stated to be $300 trillion. Now, someone is saying $770 trillion.” That’s a lot of zeroes.

All information taken from Rawles’ Survival Blog

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