Wednesday, March 9, 2022

Turning The Wealth Pyramid Upside Down

When we look at upside down wealth pyramid at the left, I have a big problem with the picture it promotes. It is clearly based on someone's opinion of what investments are safe. The one thing it does well is to scream that some investments have a high degree of risk and it is best not to put all our eggs in the same basket. 

Another issue is how a 401 or pension will fare during hard times or if we do see a huge number of defaults. Consider this an indication that placing your wealth into paper promises means it has the potential to vanish or be converted into something to would never agree to. Again, the devil is in the small print or the fact "they" can change the rules at any time.

While a great deal of speculation has been showered upon us concerning inflation turning to deflation, we will not know the true direction of things until they occur. One thing to keep in mind is that government employs a tremendous number of people that will never accept a cut in pay. This will put a solid net under falling prices. Combined with the refusal of many workers to consider working for anything near minimum wage helps push away the notion of deflation. In fact today, my local paper announced the City Council in Fort Wayne, Indiana just approved retroactive COVID-19 hazard bonuses for all city workers.

It is important to move towards forecasting based on probability rather than predictions. Keep in mind a great deal of how we deal with the options before us is centered on how we position ourselves. This can result in a lot of study and hard work or, in the case of many people, be a duty we cast off to other people. The harsh reality is that there is no guarantee that any strategy we choose will be able to stand up to the barrage life throws at us. 

If we are indeed about to enter a body-slamming bear market that will reshape the financial landscape, what many people want to hear is how to make a million dollars overnight in a bear market. This is far more difficult to do than say. So much depends on timing and the direction the dominoes fall. Sadly, the inverted pyramid above should give us little reassurance we are in control of our own destinies. 

While overall I see investing in precious metals in a positive light, even investing in gold has a slew of drawbacks. The same holds true with bonds and cash. With bonds, there is the huge risk that they will be repaid in deflated or less valuable dollars or defaulted on. When it comes to holding cash in its truest form, not only are you bludgeoned by inflation but risk it will be stolen or lost. 

Old Chart, Derivatives Are Now Much Bigger

Interestingly, the widest and most perilous area of where to stash your wealth is that of derivatives. On occasion, it is important to revisit issues that have been swept under the rug or simply overlooked. For most people, the derivatives market falls into this category, partly because they don't understand exactly what derivatives are or why this market is so important. The problem is the derivative market has the potential to explode like a bomb.

Derivatives are financial contracts, set between two or more parties, that derive their value from an underlying asset, group of assets, or benchmark. These contracts hold the power to unleash a great deal of pain and grief during volatile markets. Years ago, 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. 

Since then, the derivative market has only grown larger. today, the world’s annual gross domestic product is around 100 trillion dollars. Trying to regulate this complex market is easier said than done. While QE was able to halt an implosion of derivatives and the resulting contagion and shock that would have spread throughout the financial system following the 2008 financial crisis this time we may not be so lucky. 

Returning to the inverted wealth pyramid, I see little to spur optimism going forward, add in geopolitical tensions and slowing economic growth across the world and it is very easy to envision risks pushing things over the edge. If history is any indication, the idea this time is different will prove to be false. Contagion seeping over from one sector of the economy to another has the potential to create a rather grim future in which we are forced to pay for our past sins of excessive greed and arrogance.

Several things are moving down a path I saw coming but like many of you, I'm shocked by the twist and speed things are moving. The one big surprise is how a little war can rapidly turn things upside down and be declared as the catalyst for our economic downfall. I have not been writing much as of late because I've been spun by much of what is happening, however, I plan to settle back in and crank out a few new articles soon. Stay safe, and remember this is not the time to take on new risks or believe the propaganda being thrown at us.


Footnote; Below are a few YouTube videos worth a quick look.

In a special update, co-founder and CEO of Real Vision Raoul Pal shares with us how he’s approaching the market amid this incredibly chaotic environment. Raoul outlines several scenarios for how the Russia-Ukraine situation could play out.

 (Republishing of this article welcomed with reference to Bruce Wilds/AdvancingTime Blog)

1 comment:

  1. Egon Von Greyerz from Matterhorn Asset Mgmt has the global derivatives at a whopping $2.5 - 3 quadrillion