|An Economic "Fog Of War"|
Each day it is becoming more obvious the main goal of QE was to bolster and prop up the underlying value of assets that feed into and support the massive derivative market. They have allowed this to take precedence over the economy. Since 2008 the central banks knew an implosion of derivatives and the resulting contagion spreading from it would indeed bring the whole financial system crashing down. So far the actions of the central banks and government stimulus has delayed a massive economic Armageddon, but by not addressing the real issues and causes at the root of our problems they have only put off and set back the event. A complacent public will eventually be shocked to find they must shoulder the cost of these policies that will come in the form of an economic reset and financial trauma.
|Interest Rates Verses Government Spending|
In March of 2014 I wrote about how everyone paying attention knows that the size of the derivatives market dwarfs the global economy. Paul Wilmott who holds a doctorate in applied mathematics from Oxford University has written several books on derivatives. At the time Wilmott estimated the derivatives market at $1.2 quadrillion, to put that in perspective it is about 20 times the size of the world economy. The world’s annual gross domestic product is around 55 trillion dollars. This large poorly regulated market and the contagion associated with it remains the Achilles Heel of the world economy. The fact is today many of these financial arrangements are related to cross border investment and currencies.
Many of the bets placed in the financial casino known as the global market are shrouded intentionally or merely by the nature of the transaction. This can easily move them into the area of "carry trades" or some other highly leveraged trade that slip into the area of derivatives. Derivatives fall into many categories from futures, options, credit default swaps, and any complex combinations of these. They can also be used to wager, bet, and spectate on a market move or direction. Regulation is difficult and spotty at best in that a derivative transaction in one country might be considered a simple spot trade in another. Many of these transactions that appear on the surface as simple are in reality a bet on a bet on a bet. Remember this is only part of a much larger market that includes hundreds of trillions of dollars in non-reported agreements and private contracts.
Through the fog we must recognize that nothing can be more disruptive and destabilizing to an economy than cross border money flows and the carry trade. Both these practices have dramatically increased as the central banks of the world have engaged in the mass printing of money and keeping interest rates artificially low. Such an economic environment screams for gamblers to come forth and enter these games in search of quick gains and easy money. In reality much of this is totally out of the control of central banks, or that of any regulatory agency, but because of their actions it goes on everyday. Also, troubling is the people making money in the process of structuring and selling these agreements often play fast and loose with the value of the collateral backing them or flat out lie about it.
In the financial markets of today things have grown far less transparent due to speed at which transactions occur and the complexity of our modern world. Often when we look behind the curtain we find the products of sophisticated traders are highly leveraged and stack layers of risk upon the huge amount of risk that already exist. When we mix in the impact of derivatives and its sister the "shadow-banking" sector we find the water gets really murky. The policies of recent years have set the stage for a scenario of where the dominoes begin to fall. Recent moves of central banks entering equity markets and government pension funds becoming big buyers of stocks speaks volumes as to how the red flags of caution have been totally ignored. Bottom-line is the fog before us could be hiding a big black hole ready to suck us in.