Dear Friends,
This post by my friend DK Matai reveals the full extent of this economic crisis. The language may be too technical for some ,and the numbers hard to fathom, but it suggests that the current bailout strategy may be of little more help than a band-aid on a corpse. Apparently the derivatives markets were a means to perpetrate theft and deception on the world's wealth on an unprecedented scale. It is unlikely that we can expect a quick-fix solution to this catastrophe anytime soon.
--Deepak
The Quadrillion Playing Submerged Elephant in the Room
by DK Matai
It is fashionable at present to condemn bank bailouts and to ruminate on hidden
losses: billion dollar losses here and billion dollars there! When bloggers and
so called 'expert' commentators are being bold -- from Huffington to
Taleb and from Ferguson to Roubini -- they talk about a few trillion dollars of
bank losses and reference each other. With respect, they are all missing the
Quadrillion Playing Submerged Elephant in the Room! This elephant has spawned
Eight Bubbles that are collapsing simultaneously as another Giant Bubble --
Government Debt -- is inflated to take away the full buffeting of their simultaneous burst!
It is worth noting that the trans-national play of derivatives has grown from
USD 1.144 Quadrillion to USD 1.405 Quadrillion, ie, +22% worldwide. This is a
staggering increase and most of it is seen in the Over-The-Counter (OTC)
category as opposed to exchange traded derivatives. As a result, the global size
of the derivatives bubble which was calculated last year at USD 190k per
person-on-planet, has risen to USD 206k per person-on-planet. The ever rising
commitment of governments for the repeated bailouts of financial institutions is
partially linked to various flavours of derivatives exposure settlements and
"black hole" losses emanating from off-balance-sheet vehicles.
The traditional argument has been to discount derivatives altogether: "On
one side of the equation there is a loss, on the other side there is a gain.
Nothing disappears. It is just one big shuffle of wealth and assets."
However, if this is the case, why has the US tax-payer had to bail out AIG
repeatedly in excess of a hundred and fifty billion dollars so that AIG could
settle the Credit Default Swap (CDS) and other derivatives claims of the largest
trans-national financial institutions in the world?
In the ATCA briefing, "The Invisible One Quadrillion Dollar Equation"
published in September 2008 we discussed the main categories of the quadrillion
dollar derivatives market as partially quoted by the Bank for International
Settlements in Basel, Switzerland. Since then the quantum has grown
significantly in certain crucial categories and the latest revised numbers
follow:
1. Listed credit derivatives stood at USD 542 trillion, about the same as
before; however
2. Over-The-Counter (OTC) derivatives stood in notional or face value at USD
863 trillion (UP +44%) and include:
a. Interest Rate Derivatives at about USD 458+ trillion (UP +16%);
b. Credit Default Swaps at about USD 57+ trillion (DOWN -1%);
c. Foreign Exchange Derivatives at about USD 62+ trillion (UP +10%);
d. Commodity Derivatives at about USD 13+ trillion (UP +44%);
e. Equity Linked Derivatives at about USD 10+ trillion
(UP +17%); and
f. Unallocated Derivatives at about USD 81+ trillion (UP +14%).
The myth of the single bubble behind The Great Unwind -- manifest as the global
credit crunch -- has essentially been dumped in the last few months and subprime
mortgage default, a USD 1.5 trillion challenge within the USD 5 trillion
mortgage based assets envelope, is seen as a component of a much larger
overwhelming global crisis with unprecedented scale, speed, severity and
synchronicity. The global crisis has wiped a staggering USD 50 trillion off the
value of financial assets - currency, equity and bond markets worldwide - last
year, according to the Asian Development Bank.
The truth that there are as many as "Eight Bubbles" [ATCA] at play
and in the process of bursting together is understood to a greater extent now
than in the past. We have gone from being able to "rescue the world"
with less than USD 1 trillion in October 2008 to USD 11.6 trillion commitments
in the US alone along with a further announcement of USD 1.2 trillion of
quantitative easing by the US Fed in March 2009. There is a realisation
worldwide including the G7 + BRIC + MISSAT that this is a USD 20 trillion
problem and growing. As time goes by, the full extent of the collateral damage
from the Quadrillion Play and 8 Bubbles burst is being revealed.
The bursting process is taking the form of deleverage on an unprecedented
scale. Even 1929 pales in comparison because the industrial production collapse
witnessed over five successive years in the 1930s in the US is now taking place
in five to six months, most notably in Japan. At a follow-up on recent ATCA
roundtable we posed the following questions for Socratic dialogue:
I. If the Dow Jones Industrial Average has fallen from above 14,000 to below
7,500 as a result of some of the 8 bubbles collapsing, ie a 6,500 points drop or
46% decline, where will the equities market reach by 2010 as other larger
bubbles burst?
II. If the world government bond market is around USD 35 trillion, how can
governments rescue the eight bubbles bursting step by step with an ever larger
quantum and momentum?
III. How can Quantitative Easing (QE) defy the laws of financial gravity
without devaluing paper currencies significantly?
IV. What ought to be the focus at the G20 Summit in April to bring about stability in regard to the rising derivatives exposures and use of off-balance-sheet vehicles?
We discussed "Eight Bubbles" in play worldwide in November 2008 and
their approximate scale, based on latest information in 2009, is as follows:
1. Subprime Mortgage linked Loans & Assets (USD 1.5 trillion) within
Mortgage backed Assets (USD 5 trillion);
2. China, India, Eastern Europe and other Emerging Market Loans (USD 5 trillion);
3. Commodities (Commodity Derivatives at about USD 13 trillion);
4. Corporate bonds (USD 18 trillion);
5. Commercial (USD 22 trillion) and Residential property (USD 45 trillion);
6. Credit Cards Outstanding Debt (USD 4.5 trillion);
7. Currencies (Foreign Exchange Derivatives at about USD 62 trillion); and
8. Credit Default Swaps (USD 57 trillion) as a subset of all Derivatives (USD 1,405 Trillion).
The relative scale of the world's financial engine is as follows:
1. The entire GDP of the US is about USD 14 trillion and falling.
2. The entire US money supply is also about USD 14 trillion with rising Quantitative Easing in trillions.
3. The GDP of the entire world is USD 45 trillion and falling. USD 1,405 trillion is 31 times world GDP.
4. The real estate of the entire world is valued at about USD 65 trillion.
5. The world stock and bond markets are valued at about USD 70 trillion.
6. The trans-national universal model financial institutions own about USD 150 trillion in derivatives.
7. The population of the whole planet is 6.8 billion people. So the derivatives market represents about USD 206,000 per person on the planet.
Assuming a 10% conservative default or decline in asset value, this could be a
USD 100 trillion challenge on the base of the Quadrillion Playing Submerged
Elephant in the Room! USD 50 trillion of asset decline is already manifest. What
are the likely outcomes? "Four Scenarios" have already been suggested
by ATCA. We are keen to receive your answers and solutions. Please note that the
numbers quoted are a rough guide.
Published at Intent.com
DK Matai is chairman and founder of ATCA and regularly blogs at Intent.com