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$1.2 Quadrillion Derivatives Market Dwarfs World GDP (Derivative Thread Discussion Here)

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  • Are you sure you want to delete this post?
    Thread for financial derivatives discussion, what they are, how they effect economies, etc.

    As always, feel free to skip right over my spill and join in.  I'm explaining below of what I know of derivatives and where the world economy currently sits at

    As of mid-2010, which is the most recent, statistical number I could find on Google, the world's derivative market stands at a staggering $1.2 quadrillion.  That's right, a QUADRILLION.  Not a million, not a billion, not even the hard to really wrap your head around amount of a trillion, but a quadrillion.  Actually, more than a quadrillion. 

    $1,200,000,000,000,000.  Can you even imagine that amount of money??  I can't.  A quadrillion is a trillion TIMES 1,000.  And, the derivative market is actually, collectively valued at MORE than that, by an extra $200 trillion, (and counting no less).  What?!?

    For comparison, consider this.  Currently, the world GDP is $63.12 trillion.  So, that's 19 times smaller than the derivative market.  19 times smaller; again, what?  How is this even possible? 

    I don't pretend to completely understand what a derivative is, let alone understand the vast, complex financial derivative market. But, I do know that fundamentally, a derivative is anything that is valued based upon some other asset. In other words, it derives its value from something else.  Simple example, to know the actual value of what it means to own a derivative contract containing 100 shares of GE, one would have to know, or derive the value of a single share of GE.  And, then multiply its current share value by 100.

    Of course though, that's the easy example.  It can get much more complicated than that.  You also have to consider various kinds of stock options that come into play, in particular what are called "call options" and "futures" to really get why gambling on derivatives can all by itself completely destroy an entire economy.  Just consider 2008's crisis with the Lehman Brothers and mortgage derivatives.  A reckless, gigantic institution invested in very large derivative contracts (containing a LOT of individual U.S. mortgages grouped together), gambled on these derivatives with reasoning and logic for doing so based almost entirely on hypothetical and principled, educated guess-work that the housing market would not collapse, and everyone severely paying the price when they gambled too much, invested in too much of a % of the total housing market share, and went bankrupt.

    And, with that lies the problem with derivatives, it seems.  On one hand, considering the use of "call options" and "futures" in the stock market world allows economies to work, in a big way, playing on respectable, time-tested odds that the market won't collapse any time soon.  This is how farmers get bank rolled, for example.  But, on the flip side, if too much of a grouped contract derivative is gambled upon by too few investors and they lose and can't afford to pay off their gambling debt and opt for bankruptcy, that could easily led the entire economy into catastrophe, simply because they are playing with more money than they actually can back up.  Not too mention, more money, in that case, than the entire economy's GDP is valued it.

    This is crazy.  And, the craziest thing is, the gambling is currently uncapped and almost completely unregulated.  So, to my mind, it seems that the derivative market is potentially extremely dangerous to everyone, not just the high-rolling investors, their unbridled existence further tempt risky investments on an enormous scale, and ultimately derivatives seem to turn the entire world marketplace into a ridiculous high risk/high reward casino-type game that only a few humans on this earth can actually afford to play.

    Problem is, seems that few are playing, or even have the potential to gamble with what is, quite literally, all of the wealth in the world, and then some.  For, even without the derivative market, all advanced world currency structures mostly consist of fiat currency anyhow, fiat meaning not real.  Not tangible, but virtual.  Amounts of money only found on stock tickers and other various printable tallies.  For example, if you asked the CEO of Bank of America, for arguments sake, to psychically show you ALL the money the bank claimed to own, they couldn't do it.  That psychical amount of hard cash does not actually exist. 

    To conclude, it seems that derivative market trades and investments exist largely on the principle of faith. And, pretty much on faith alone. Faith that markets won't collapse or faith that large commodities won't suddenly drop in value, for good.  But, really though, that's not much different from how our more straight-forward economic systems operate already.  The big problem here seems to be regulation.  Capitalism is great, if investors ultimately only hurt themselves, if they fail big time.  But, adding derivatives to the equation makes unbridled capitalism a scary and unsustainable economic structure.  It's NOT too big to fail.  Hell, we've all seen it personally happen.  And, it WILL happen again, just a matter of time.  My money says that derivatives will ultimately tank the world economy, before anything else has a chance to.  At this rate anyway.

    Solutions? Thoughts?  Did I explain it right?  I am new at this concept...

  • Are you sure you want to delete this post?
    One more thing.  :) I think I should also define "value" and source my info.

    Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP

    Article explains it better than I can, and is what initially sparked my interest.  Here's an exert, explaining "notional value":

    $1.2 quadrillion is the so-called "notional value" of the worldwide derivatives market.  To understand the concept of "notional value," it's useful to have an example. Let's say you borrow $1 million to buy an apartment and the interest rate on that loan gets reset every six months. Meanwhile, you turn around and rent that apartment out at a monthly fixed rate. If all your expenses including interest are less than the rent, you make money. But if the interest and expenses get bigger than the rent, you lose.
  • Are you sure you want to delete this post?
    Remember GDP does not measure all consumption or output. Only final goods and services.
    So a lot of economic activity goes uncounted. Furthermore, it does not account for non-monetary output and consumption, such as the output provided by housewives and consumed by households.

    Everyday trillions of funds are exchanged/swapped.....firms trade billions to earn fractions of a percent in profit. 

    Problem with derivatives is their unregulated, opaque nature allows for fraud.

    And with a pile up of liabilities, every which way if something goes wrong, economic slow downs and recessions are inclined to produce exponentially larger losses. When somebody can't pay, the dominoes start falling.

    It's a crony capitalist corporate socialist system.

    Big Finance gets whatever it wants. The worst get on top.

    Rightwingers need to go back and read the "Road to Serfdom" AGAIN.

    "Do the Republicans really want federally insured banks to be able to invest again in “extremely complex” financial derivatives that can bring the return of the “green slime” that destroyed the global economy?  Under what principle of “limited government” should the government subsidize that kind of speculation?"-Bill Black on JP Morgan's faux hedging (here).