Awesome Statistic About Derivatives
Posted by Jason Apollo Voss on May 30, 2011 in Blog | 2 commentsI wanted to share with you an awesome statistic about derivative securities which comes courtesy of that investment industry scion, Mark Möbius, and the magazine that quoted him, Bloomberg. And by awesome, I don’t mean good. I mean awe-inspiringly bad.
The total value of derivatives securities around the world exceeds total worldwide gross domestic product by…[drum roll please]…10! Holy poo!
Imagine if the total value of mortgages in the world exceeded the underlying collateral by a factor of 10! Folks, these derivative securities are completely unsecured by any collateral. Specifically, only 10%. In my many years of investment experience this is the single scariest statistic I have ever heard.
What it means is that derivatives, which derive their value from an underlying asset, exist in overabundance by a factor of 9x! How could it be that these contracts could be bought and sold? Why would anyone transact? It goes back to what I have been saying about future and commodities markets for years and years. To trade these contracts buyers and sellers should have to possess or be willing to possess the underlying commodity.
Wanna trade orange juice futures? No problem. You have to be prepared to take delivery of the commodity. That would ensure that the value of derivative contracts matches the value of the goods from which they derive their value. Duh!
A natural question that flows from this statistic and the understanding that there is no collateral underlying these contracts is: what happens when people start to get frightened about the value of their derivative contracts and there is a race to the exits (i.e. the selling becomes like lemmings)? Financial catastrophe.
Jason
Jason,
I am in shock! I had to immediately Google the article in question. How does one verify the accuracy of this information? Given the lack of transparency in derivatives trading, is such verification even possible?
I am by no means a financial expert, but the system seems perched precariously at a highly unstable equilibrium in which the slightest nudge, say another computer trading glitch like we saw last year, could send the markets into turmoil again overnight.
I am very concerned if this statistic is true. I speak not merely as a financial investor but as a human being. The financial elite are behaving like the Greek Pantheon, engaging in power games with each other for their own petty amusement without regard for the massive collateral harm to the rest of society! Our governments are unwilling or perhaps unable to intervene on our behalves. What, if anything, can be done?
By the way, I’m now a regular reader and appreciate your blog and your book. I’ve never formally invested money into anything other than a savings account, but I’ve developed a keen interest in finance and macroeconomics since the recent financial crisis. I’m also an engineering Ph.D. student and believe that your criticisms about over-reliance on linearized/localized analyses are valid well beyond the field of finance. Thanks for writing.
Hello Stephen!
By the way folks usage statistics demonstrate that Stephen is the biggest fan of the “What My Intuition Tells Me Now” blog. I hope it doesn’t embarrass you Stephen to highlight your loyalty publicly. Thank you for your support!
As for the data. Mark Mobius is amongst the most important investors of the past 50 years. Normally I don’t give a free pass to anyone, but he has proven to be reliable. That said, the derivatives market is not opaque in terms of the volume of, and value of, contracts. It is opaque in terms of who owns what and how the various bets intertwine to create risk in the overall financial system. So here is what we can discover using that ancient research tool, The Internet.
* 2010 worldwide gross domestic product = $61.96 trillion. Source: http://en.wikipedia.org/wiki/World_economy. Ultimate source: The CIA’s World Factbook.
* Total notional value of outstanding over-the-counter derivatives contracts = $601 trillion. Source: Bank for International Settlements; http://www.bis.org/publ/otc_hy1105.htm
So let’s run the math to see how close Mark Mobius’ general statement was: $601 trillion divided by $61.96 trillion = 9.7x. Mr. Mobius said the value of derivatives were approximately ten times the value of global GDP and he is correct in that statement.
Hope that helps. Looking forward to hearing more from you Stephen!
Jason
Now that is the value of the contracts themselves. But the contracts derive their value from the underlying assets. So how much are those underlying assets worth?
* Total notional value of foreign exchange derivatives 2010 = $58,193,869,000,000
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