Wednesday, September 2, 2009

The Mogambo Guru on derivatives

If you're not familiar with The Mogambo, he's quite funny and his column makes reading the economic news a bit easier. Here he is talking about "derivatives" -- essentially, a bunch of bets that banks have placed with each other, and which will eventually raze large parts of the financial world:

And when combined with all the other hundreds of trillions of dollars in other derivatives around the world, we are talking about more than a quadrillion dollars in various bets and hedges, a figure that I figure must be more than the total value of everything in the whole world because even $1 quadrillion comes out to, for each of the Earth’s six billion inhabitants, $166,667 each! Gaaahhh!

The worst part is that the real, in-your-face nominal total of global derivatives may actually be several quadrillion, or even the hundreds of quadrillions of dollars, as has been previously estimated, I forget where, but you can trust me on this one because you don’t forget a thing like learning of a $225 quadrillion estimate for total global derivatives outstanding, which is 4,500 times as large as the world’s $50 trillion GDP, which is so bizarre that I can hardly imagine it, and have drunk many, many shots of various alcoholic beverages trying to get to the “zone” where I can even vaguely comprehend such a figure, which seems to be that narrow “window of opportunity” right before I pass out after raising my head up off the floor and loudly declaring “$166,667? Sure! Why not?”

A lot of these derivatives cancel out-- JP Morgan Chase owes a billion to Goldman Sachs, but Goldman owes a billion to Chase on some other contract, so it comes out even. But we don't know who's got what. Nobody really knows which banks might be left standing and which will be mere smoldering ruins, once these contracts start getting triggered. Certain banks will never be allowed to go under, and the Fed will print new money to give to them to plug the holes in their balance sheets, even if it means decimating the dollar.

The fact that gold has no counter-party risk will be a big part of its appeal, in the not-distant future.

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