Doomsday Derivatives
Contributed by JL Cook
Trying to understand what is happening concerning the economy and what that means to the average American is just about impossible. The technical Wall Street investors toss around terms we don’t understand and the mainstream media tells us only what they want us to know. Immediately we need to toss out the nightly news propaganda and then try to make sense of opposing opinions given to us by economic analysts to find some semblance of truth and understanding.
Back in 2008 when the crisis hit I was working at a staffing company that staffed healthcare professionals in hospitals on short term contracts. Right before the crisis hit we had over 1000 positions available at hospitals across the country. In less than 30 days we had less than 50. How could something that happened on Wall Street involving mortgages affect the number of positions available at hospitals? At that moment when I sat and stared at my computer screen it dawned on me how very fragile the entire system truly was. I didn’t understand what was happening, how it started, or when it would stop. I was completely blindsided like many Americans. It was a helpless feeling that I am sure was shared by a lot of people. Within the following month the CEO was issuing pink slips and the same was happening across the country in all areas of the economy. I decided I better make an attempt to understand what just happened. Since then I have tried to gain an understanding of what is termed the “economy.” My uncle always told me that if we don’t understand and remember history then we are doomed to repeat the same mistakes. I’d like to add on to that piece of advice and say that if we can’t prevent the same thing from happening, at the very least we can be forewarned and prepare for it.
I would like to explain just a few things that I learned and a few things that are happening that are very important to understand. I’m not a financial analyst and I’m not offering any type of financial advice. I’m just sharing some of what I learned that literally left me dumbfounded.
Our Lord doesn’t blind side us or try to trick us. He warns us. In Revelation 6:6 it basically says that it will cost a day’s wages for a couple of pounds of wheat. Basically that is working all day for a half a bag of flour! If it’s in the bible you know it is coming. Our Lord kept it simple so that all ages and all people in all parts of the world could understand it. Depending upon when someone read it and where they were at in the world, they would apply to it a different explanation of how that could happen. In this day and age we would need to explain it in terms of such things as fractional reserve banking, stocks, bonds, securities, derivatives, and hyperinflation all in the perspective of the world economy. Everything is so intricately connected now that what happens in the global economy and now affects the average working American.
The only two things I can think of that would drive the cost of food so high are hyperinflation, where our money becomes worthless, or food scarcity. Food scarcity could be from either lack of food or a supply problem, or both. Heaven helps us if we have both hyperinflation and scarcity at the same time. In this article I would like to talk a little bit about what could cause an economic crash. An economic crash could cause hyperinflation, supply problems, or both. There are many things that could act as the trigger that will start the crash, but I feel that what will ultimately crash will be the derivatives market. This happens to be the one thing most of the people I talk to know the least about and is the most dangerous.
Derivatives! Allow me to explain to you, to the best of my ability, what a derivative is. In the simplest of terms it’s a bet. That’s right. It’s a wager. It’s legalized gambling in my opinion. If you Google “derivatives market” it lists things like Forwards, Futures, Options, Swaps, counter parties, and exotic instruments. I almost think they give these things all these different names just to confuse the average person. The definition they give is that a derivative derives its value from the underlying entity. Just think of it as some sort of a bet. Let me give you an example of what a derivative contract might be. The real numbers don’t matter in this example, it’s only for illustration. Let’s say I think the price of soybeans is going to go up. I can “go long”, meaning I can buy a derivative contract when soybeans are $50 a bushel with the “bet” that the price will go up. If I thought the price would go down I would “go short”. Let’s keep it simple and say the contract is for one bushel of beans. There typically is an expiration date on the contract I just bought too. Let’s say it is 3 months. At the end of the 3 months if the price went up I make money. If the price goes below $50 I lose money. I never actually bought the bushel of beans and I will never sell the bushel of beans. In derivatives you never actually buy the beans. It’s simply a bet that the price will go up or down. So if I bet the price would go up someone else bet the price would go down. There are always two parties involved in the bet.
The company that manages the contract, or what I consider the wager, gets a fee for setting it up and making sure the loser pays the winner. The money flows to them and they disperse it to the winner. Like I said, it’s just like gambling. Is there a limit to the number of bets, or contracts, which can be made? Nope. Not that I am aware of. The managers of this debt most of the time require that the person buying the derivative put up some sort of collateral. What can be used as collateral is a whole other conversation. The managers don’t actually require you to put down the whole $50 for the beans. It’s usually just a percentage of the $50. I’m sure the percentage is based on a lot of things such as what the contract is on or your ability to pay if you lose. Let’s say the percent is 20%. This 20% is called your “margin”. You have to pay this when you buy the derivative contract. These managers reserve the right to increase this margin at anytime during the length of the contract. For example if the price of soybeans starts dropping like a rock, the manager can call you up and tell you that the margin has been changed to 25%. That extra 5% is payable immediately. You better have the money available. After all if the price dropped to $0 you were good for the $50, right? That extra 5% the managers are requiring is called a margin call.
I could write another whole article on how margin calls can be used to affect the stock market. So now that you have an idea of what a derivative is let’s talk about the size of the derivatives market. How many derivatives “bets” are actually out there? I’ve heard ranges of 50 trillion to over a quadrillion. That’s over a thousand trillion. To put this into perspective the global yearly GDP is about 74 Trillion depending upon who you ask. That is the entire economic trade of goods and services for the entire world. You now have a fundamental understanding of what a derivative is. The meltdown part can be a bit more complicated to explain but in the simplest of terms, the loser can’t pay. So for example, let’s say the price of soybeans when up to $75 bushel. Whoohoo! The winner just made $25. The loser now has to pay the $25. What if he/she can’t pay? Well the manager should be able to offer me some sort of guarantee right? Sounds all good and dandy but if they managed a whole bunch of contracts where the loser can’t pay they may not have enough money either. (I think they actually sell insurance for this sort of scenario too. ) They should at least have that margin that the loser paid right? They should give the winner that! Typically they absolutely should have that money. It’s supposed to be protected. The manager has to put that money into a separate account. It isn’t their money after all. It’s not part of their fees. It belongs to their customers. Well what if that manager took that money, did something with it, and now can’t pay it back? They should go to jail right? One would sure think so, but in the case of Jon Corzine, a dirty rotten fink, that isn’t always the case.
Back to the point. If the loser doesn’t have the money to pay they probably have other stuff they can sell to get the money. So now the loser sells whatever they have to get the money. It could be other stocks, contracts, bonds, etc. If this happens on a massive scale and everyone is trying to raise cash to cover their bets it creates a domino effect of each person trying to sell at the same time to raise cash. When everyone is trying to sell at the same time the demand for stocks, bonds, securities, etc. falls. The price of all these instruments falls so the loser has to sell more and more to raise the amount of cash they need. Because the loser has to sell more of the stocks to raise the cash it pushes the prices down even further. What happens if there aren’t enough buyers and all the losers can’t pay? Crash! Or in other words, a derivatives meltdown. This next crash will be bad because the central banks won’t be able to bail out these managers of derivative contracts. The amounts are just too big!
According to Global research 5 U.S. Banks hold over $250 Trillion in derivatives. I encourage you to research more about this to get a full understanding of just how big the derivatives market is. Since a derivative contract can be taken out on almost anything, if any one industry crashes too hard or there is someone who owns a whole lot of one type of derivative contract who can’t pay then the domino effect can start. It would take many years to sort out who actually owns the collateral that was pledged as the margin. I guess that is just one of the risks you take when you gamble. Keep in mind that all this madness happening with derivatives will affect each and every one of us when it implodes. Banks will close because they will be out of cash. Credit cards will quit working. Government subsidies such as Social Security checks, food stamps, and welfare will stop. Businesses won’t be able to pay their employees because the banks are closed. Food supply will be interrupted because truckers won’t be able to buy gas. Everything will come to a screeching halt. Please prepare now. Remember, Noah didn’t wait until it was raining before he started building the ark. He started years before. Be like Noah.
I plan on writing some follow up articles, but in the meantime if you want to learn more about what is really happening in the financial world I highly recommend reading some of the writings of Brandon Smith and Gerald Celente. In my opinion they are both saying fasten your seat belts and keep all hands inside the car as it is going to be a very bumpy ride. I love Gerald Celente, and I affectionately call him Mr. Sunshine. If you want the raw truth with no sugar coating, search him out on YouTube. Brandon Smith breaks things down so that the average lay person like can understand it. He does a superb job of putting things into perspective. Lastly, I would be remiss if I didn’t give a shout out to Andy Hoffman. All three of these gentlemen have been trying to warn everyone what is going to happen. There are many more but these three are my favorites.