Derivatives are an absolute disaster. They are not something that would be produced in any great measure by the free market. While it would seem that they are the province of financial sophisticates, in fact they are really something that was pushed by know-nothings, proven failures, and welfare queens.
There is no question now surely that the banking business is and always was a subsidised protected industry. Basically an arm of government. And that the government and the finance industry can scarcely be told apart. This is an industry with thousands of regulations to protect its cartelization features but whats missing is the few regulations that would be needed to stop these guys from debasing the value of our money, inflating the value of our assets, and armtwisting every bugger into this orgy of debt.
Yesterday I bought the Financial Review and they were now announcing talk of the Federal Reserve buying banks shares. So letting these welfare queens create money isn’t enough of a subsidy? Cartelization regulations not enough for them? An 850 billion dollar bailout not enough? Sweetheart loans behind the scene not enough for these guys? Getting financing at whosesale prices backed by the printing press insufficient for their needs?
When you see someone making 400 million from banking remember he is a welfare queen. He created no wealth in the making of this money. The fact is that these guys are now rent-seeking parasites.
Now how do derivatives work? why are they in such demand? and how is it that they have grown so that their outstanding amounts of perhaps a thousand trillion dollars?
The short answer is below:
“Derivatives allow fractional reserve of items that are tradeable over the computer. This fractional reserve of non-cash tradeable items creates the need for more derivatives, so its a pandemic that feeds on itself.”
Thats it in a nutshell. Copy this somewhere so that you can tell people what these skanky derivatives are all about and their true hidden purpose.
How is it that the nominal outstanding value of derivatives could have grown to ten times all the assets in the world (by one estimate)? What is causing this from the demand-side? The fact is that what is causing this is essentially fractional reserve of EVERYTHING run wild. Not just fractional reserve of currency. But of all traded commodities. Not only all commodities. But many shares of companies. All of these have been pyramided on with the derivatives as the way of keeping the pyramid builders out of trouble.
This is the ugly secret that this derivatives boom attempts to hide. And the upshot of it all is that we will lurch from one crisis to another until we stop subsidising these banks, let them all go broke, and replace the derivatives function with honest storage of commodities. Honest sales of real shares that cannot be owned by two or three people at once.
Its this practice of fractional-reserve-EVERYTHING that is the cause of this ridiculous derivatives blow-out.
The only way I can put the derivatives story in perspective is by demonstrating the principle behind it by giving an entirely hypothetical example of a provider of a commodity. Just as an example I’ll use an hypothetical provider of Gold. But firstly we must find out what real and valid speculation and warehousing of entities is supposed to acheive.
In a free society, without bank welfarism and special laws favouring some but not others, there is a very important role for the speculator. The speculator is the guy that provides a fair price and a consistent supply for items of all sorts. But usually for producer goods commodities. He has an offsider who performs the warehousing function.
Now supposing you were to survey an industry and find out that there is likely to be a shortage or a slowdown in production of some item whose supply and demand tend to be inelastic. Supposing you worked out that there would be great production constraints looming. Well you could buy and hoard that commodity. Its important to note that this hoarding has a number of effects. It increases the remuneration to the industry. Encouraging them to expand production. it increases the price to end users, encouraging them to find ways to use less of this stuff.
Essentially the speculator is creating a pretend shortage ahead of the real looming shortage. So that people have time to adapt to it. Because of this capitalism, free of fractional reserve special priviledges, is a system of pretty stable prices. Most prices will be falling. But the price of a few key items will be rising but will not lurch up suddenly and then crash. Quite different from the lurching runups in the prices of vital things that we have experienced in our lifetimes but most particularly very recently.
Also capitalism isn’t a system that features backlogs or shortages of things. Yet we are getting breakouts of shortages on top of our lurching prices. Derivatives are one half of this picture and we really haven’t seen anything yet. Things will get much worse.
For example take the oil market. Ludicrously the oil price is down at 80-90 USD. Part of this is because of recession. But just an example of how stupid this is, gasoline reserves in the US are at record lows. So low in fact, that everyone filling up their tank right now would apparently run the place dry.
So we will find that the oil price goes for another lurch like it did last year. What would have happened under capitalism is that the oil price and inventories in refined products would have grown higher a very long time ago. But then it would tend to a more stable price which would give both supply and demand time to adjust. But we will find ourselves with constant crises and lurching prices in all the things that we really cannot do without. And derivatives arer key to what is going on here.
The speculator under capitalism is a person who would help the price of oil stay stable. He would set up an alternative supply and demand. But seeing as the price of oil must get higher until a mature sea-based or oil-liquification industry is at hand right now we would have huge stocks of these petroleum products. In setting up these huge stocks the warehousing companies and the speculators would have prematurely boosted the earnings of the producers AND THE PRODUCERS OF OIL SUBSTITUTES. This would have kept the industry in a healthy state at the same time as helping found the new industry in substitutes.
As things stand the oil industry is in a very bad way. Their rigs are decades old. They haven’t developed the technology for the deep sea stuff. And the coal liquification industry, which ought to be booming, is still in its fledgling stage.
Its not just real goods that would be more stable under capitalism. Right now this socialist money has put almost our whole population of elderly people under stress since their superannuation has been trashed. Essentially the banking industry has taken a balloon full of gold coins, replaced it with air…. and sooner or later the balloon was going to pop. Thats whats behind all these phenomenol finance industry salaries. The top brass in these banks are our most expensive per capita welfare recipients. Even worse than most of the public servants.
There is an excellent discussion of the role of the true speculator In Murray Rothbards book “Man, Economy, And State”. The discussion starts at about page 130. He doesn’t emphasise this. But note it is implied that REAL GOODS WILL BE STORED. Speculation has next to no wider social benefit if not for the ability to store real goods.
This is why I made the claim in an earlier thread that only stored commodities represent authentic insurance. But storage of real goods has nothing to do with these ignorant know-nothing fantasists dealing in make-believe and selling fresh air…. minus even the air or the freshness, in todays market.
Now supposing you are a gold dealing arm of a banking operation. And almost no-one takes delivery of this gold. In fact there is great advantage to not taking delivery. You can be a better speculator. You can jump when the price is right but not necessarily if you have a tonne of gold buried on your hobby farm. But what happens is that the gold dealer can sell fresh air. He can fake a sale of gold. So he can sell the gold without buying it.
But what then if the price of gold goes up and he’s stuck with this fraud? Well the thing is when this deal first gets going what is happening is that the phoney sale is telling the market that there is MORE GOLD SUPPLIED THAN THERE REALLY IS!!!!!! Hence he is likely safe for a long time since the gold price will tend to go down.
So many stupid libertarians, total idiots, get about talking as if this sort of thing is freedom of action. And oftentimes these people put themselves out as supporters of the price system. But the bloody price system is totally screwed by this practice. Because while it might have seemed that it was an innocent enough practice to sell this fresh air. Well its not ok. Because immediately it means that the producer is not getting the price that the price signals ought to be telling him. He’s not getting the resources or the incentive he needs to expand productions. In effect instead of having positive inventories we are working on negative inventories.
Anyway now this fellow has a debt. As soon as this practice crops up the dealers who are practicing it have lowered their costs. They can now affect to provide gold with cheaper margins than their competitors. This will encourage dishonesty in their competitors or drive the other dealers out. Now the margins will be too thin. As a consumer, if you are a total fantasist, you might imagine that this is a good thing. ‘Thinnner margins are better for the consumer’ you might be thinking. Just like our banks loan out on pretty thin margins and they will have to get wider under capitalism. If you take a fantasy approach to matters you might feel that this is a bad tihng.
So what happens if people start taking delivery with greater frequency? Well what will happen then is the now corrupted profession will start putting delays on delivery. This is not capitalism. Under capitalism you don’t have delays or shortages. But now the whole industry is in the shit. What they ought to do is increase the gold price but doing so would bankrupt all of them.
So what do they do? No pressure. They all buy FUCKING DERIVATIVES. Now they’ve got their derivatives they then have to have a period of a runup in prices. That way they can clear their backlog. Exercise their options, bring the industry belatedly to oversupply, and then the practice starts up again and the price is crashed to far below what any authentic market rate ought to be.
You cannot get delivery on gold for 14 weeks right now in the US. And the fourteen weeks is probably a lie. The price of gold therefore ought to be twice as high. So what else can they do? The options people aren’t going to buy into this forever?
So the next thing to do is get the government to bail them out. Either the dealer or the options people can be bailed out of this mess. So these assclowns will go to the Feds and intimidate them into thinking that the high gold price threatens the US dollar. Or some other subterfuge. But in any case, since government and the banks are two aspects of the same racket it doesn’t matter if its subterfuge or not. The bailout will begin.
What will likely happen then is that the fabled and rumoured “plunge protection team” will bail out the dealers and the banks. They will likely borrow a shitload of gold from the Federal Reserve, clear the outstanding make-believe shorts, plunge the gold price again… And thereby rip off the producer, the true speculator with foresight, and further distort the market.
Now this is happening in gold. But its happening also in silver. Its happening in everything imagineable. From mortgage debt. To fuel. To everything. Anything that you can buy derivatives in you will have people practising fractional reserve in this item. This is reflected in the behaviour of companies.
Supposing an airline is worried that their price of fuel will go up? Do they buy extra fuel and set it aside? Do they get someone else to do it on their behalf? Well the fact is they probably couldn’t get someone to store it for them if they wanted too. The fractional reserve “providers” of fresh air would likely have undercut any valid storage operation.
No the airline will just buy some options to purchase this fuel instead. Hence when the fuel price goes up and they use their options they are HURTING THE REST OF THE MARKET. Since they get the fuel cheap and everyone else has to get their fuel at a more expensive price than they would have if that company hadn’t bought the options. But in the interim no new fuel was stored. The producers weren’t encouraged to produce more, since the Airplane company didn’t buy real fuel. And the price system was distorted.
Under capitalism the short-term interest rate is around zero. That is you cannot go to the bank and get interest on on-call money. And also there wouldn’t typically be much interest paid even on a three-month or six-month deposit. Nominal interest rates more generally would tend to be very low.
Prices generally would tend to fall under capitalism. Hence if there is the anticipation that there is something that can be stored whose price will rise there is not much of a financial opportunity-cost to buy and store this stuff. People don’t tend to go in for a lot of insurance in any form since their cash balances are high, and the market itself functions very well, precluding disasters and disastrous price movements. So the demand for insurance is very low.
But now with these derivatives, all this selling of unreality, and nobody storing any damn thing, prices will lurch all over the place. Hence the addiction to derivatives feeds on itself. Derivatives are often used as insurance. But insurance itself would not be needed a great deal under capitalism.
This emphasizes that the only stable financial system is one that works most typically under a situation of growth-deflation. And it ought to be 100% multi-commodities. Without growth deflation we will be reliant on these thieves for all sorts of banking and insurance products.
There is 1000 trillion in outstanding derivatives by some estimates. And almost no-one storing anything anymore. All the true and valuable speculators gone and replaced by these assclowns who can now steal off the public to the tune of hundreds of billions of dollars.
WHAT TO DO.
Get out of debt and stay there. Take delivery of anything you can whether it be share certificates, gold or silver. And if anyone figures out a good way to store a lot of diesel and other stuff then that is worth thinking about. Because these crony-communists have taken away our price system in an orgy of stealing. And prices of these absolutely necessary producer-goods will continue to lurch in the way that they have been doing but worse.
There is simply nothing for it but to take all these assholes down and make them settle. Make them settle up on all their shares, all their gold, all their outstanding sales that are not backed up with any damn thing.
Alternatively we could have a phase-out in all areas like we need to do with the banks. That means opening up all their books. Forcing them to increase their “reserve asset ratio” of whatever it is they have been selling, and phase it all out that way.
By the way there is more than one Paulson involved in this sort of stuff. Cambria was singing the praises of this fellow called John Paulson who had gotten a team of people to figure out a roundabout way of selling these mortgage securities short. It was the biggest successful trade ever. It wasn’t even particularly clever. So all these people involved are rolling in money. Each and everyone that gained from that trade is a welfare recipient. Since if it wasn’t for the other Paulson bailout the whole lot of the people, providing the other side of this trade, would have gone broke and the “successful traders” would be lining up for cents on the dollar like everyone else.
Its not clever. They are not big heros either of these Paulsons. They are just welfare recipients and thieves and they ought to be thought of as such.
WHAT SHOULD OUR GOVERNMENT DO?
Well we can stop subsidising our own banks. We can put the discount rate up sky-high and use exclusively debt retirement to boost money supply. We can establish a reserve asset ratio and phase out that sort of fractional reserve. We can make our own brokers settle or alternatively force them to come to 100% backing of whatever shares they are selling. And make no mistake about it. Our guys will be breaking the law relentlessly just like the Americans.
We can make warehousing of commodities that are normally traded on the stock exchange a tax-free industry so long as these guys always work on 100% backing.
Like for example, with all the expected lurching in prices it would be useful to have someone store gasoline, diesel and other things, and lend it out at high interest (in terms of the commodity rather than in terms of cash) when shortages or price surges come as they inevitably will.
So supposing you lend all these dealers a lot of diesel and gasoline when they are struggling to supply the public. They will want to borrow it since the prices will be very high at that time. When the prices come down they might then have to pay you back with interest in terms of resupplying your stash. Now maybe this sort of thing is or isn’t doable. But it would be a good way of keeping us immune from the corrupted finance market if the government made this sort of activity tax-free.