Here’s another speculative question that maybe no one on the planet can answer:
I’ve read that there are trillions of dollars worth of derivatives and credit swaps that are expected to explode the economy in some really horrific ways. How would that whole scenario play out in a deflationary economy?
Here’s another speculative question that maybe no one on the planet can answer:
I’ve read that there are trillions of dollars worth of derivatives and credit swaps that are expected to explode the economy in some really horrific ways. How would that whole scenario play out in a deflationary economy?
In a deflationary cycle, particularly where there is asset price deflation, derivatives necessarily will lose value. As synthetic assets predicated on the values of other securitized assets, the loss of value on the underlying assets cannot help but transmit that loss of value into the derivatives markets.
We saw a microcosm of this when the 2003-2007 housing bubble burst sparking the GFC: as home prices fell and mortgages became unaffordable, the value of the securitized mortgages underneath the ginormous amount of derivatives generated by Wall Street collapsed, and took the derivatives with them. The resulting margin calls and liquidity crises destroyed first Bear Stearns then Lehman Brothers.
With a notional aggregate value of all derivatives on all financial markets around the world estimated to be in excess of a quadrillion dollars (no that is not a typo), a period of prolonged deflation is almost mathematically guaranteed to create fresh liquidity crises and rapid unwinding of derivatives positions at steep losses.
When the GFC hit, and news pundits were compelled to explain what happened, I remember that I was shocked to hear about collateralized debt obligations- because I was hearing of their existence for the first time! “CDOs! Why haven’t I ever heard of them before, and WHAT ELSE DON’T I KNOW ABOUT?”
I hope you will help keep us informed, Mr. Kust, of the financial shenanigans before they happen. Thank you!
That being said, I still encourage everyone to do as much of their own reading and research as possible--there's not a snowball's chance in Hell I am going to capture every crucial detail or even most of them.
Here’s another speculative question that maybe no one on the planet can answer:
I’ve read that there are trillions of dollars worth of derivatives and credit swaps that are expected to explode the economy in some really horrific ways. How would that whole scenario play out in a deflationary economy?
In a word: badly.
I've explored the surface of this issue somewhat already.
https://newsletter.allfactsmatter.us/p/powells-paradox-curing-inflation
In a deflationary cycle, particularly where there is asset price deflation, derivatives necessarily will lose value. As synthetic assets predicated on the values of other securitized assets, the loss of value on the underlying assets cannot help but transmit that loss of value into the derivatives markets.
We saw a microcosm of this when the 2003-2007 housing bubble burst sparking the GFC: as home prices fell and mortgages became unaffordable, the value of the securitized mortgages underneath the ginormous amount of derivatives generated by Wall Street collapsed, and took the derivatives with them. The resulting margin calls and liquidity crises destroyed first Bear Stearns then Lehman Brothers.
With a notional aggregate value of all derivatives on all financial markets around the world estimated to be in excess of a quadrillion dollars (no that is not a typo), a period of prolonged deflation is almost mathematically guaranteed to create fresh liquidity crises and rapid unwinding of derivatives positions at steep losses.
If that happens, it will not be a pretty sight.
News like a punch to my gut.
But jeez, you’re smart and knowledgeable! Thanks!
When it comes to the economy, it seems my fate is to be Cassandra warning against the treachery of the Greeks!
When the GFC hit, and news pundits were compelled to explain what happened, I remember that I was shocked to hear about collateralized debt obligations- because I was hearing of their existence for the first time! “CDOs! Why haven’t I ever heard of them before, and WHAT ELSE DON’T I KNOW ABOUT?”
I hope you will help keep us informed, Mr. Kust, of the financial shenanigans before they happen. Thank you!
I mean to publish all the information I can.
That being said, I still encourage everyone to do as much of their own reading and research as possible--there's not a snowball's chance in Hell I am going to capture every crucial detail or even most of them.