Jeff Clark, Senior Precious Metals Analyst
SEP 15, 2017
The Derivatives Bomb That Could Wipe Out Your Wealth
As high and obscene as the US national debt is, it’s lint on your shirt compared to the size of derivatives.
Derivatives have become so large, so complex, and with a truly unknown level of risk, that the first failure could ignite a chain reaction that wipes out the wealth of most investors.
That’s reason #9 Mike Maloney says in his new video why he owns gold and silver: The current state of the global economy is so precarious that gold and silver will be one of the few assets left standing in the upcoming crisis.
A derivative is simply a contract between two parties, the value of which is based on an underlying financial asset. A stock option is a derivative, for example, because its value is “derived” from the underlying stock.
Farmers regularly use derivatives for hedging. The farmer locks in the price for his corn crop, for example, while the mill gets a guaranteed supply of crop. Sometimes gold miners do the same thing… though it’s usually viewed by investors as negative, management may think the price of gold will fall so will lock in a price now with the refiner, which in turn gives it a guaranteed amount of metal at some point in the future.
Banks have entered into the derivatives world, too. If all they did was what the farmer and miner do, the risk would be contained. But they’ve created such a complex financial daisy chain that the first failed contract could kickstart a massive ripple and quickly put the global economy in trouble…
Banks own lots and lots of mortgage loans. Bank X will hedge that risk with a derivatives contract with Bank Y. But then Bank Y thinks it has too much exposure to mortgages—so it takes out a derivatives contract with Bank Z. Bank Z “insures” Bank Y’s risk. It earns a premium for doing so, which is the motivation behind accepting these contracts in the first place.
So if you follow… Bank Z’s derivative hinges upon the mortgage loans insured by Bank Y, which in turn hinges upon the mortgage loan insured by Bank X. And on and on it goes. Multiply these hundred million dollar deals by thousands and thousands of contracts and you get a sense of how big this problem could be.
Well, here’s exactly how big…
As of the end of August 2017, derivative contracts exceeded a notional value of over $1.4 quadrillion. That’s a one with 15 zeros behind it.
Our debt load is a huge unsolvable problem, and so is the amount of global credit outstanding. Yet derivatives are so big that that debt load is barely visible on a chart.
How this could impact you and me is not just the complicated nature of derivatives, or how big they’ve gotten, or that many banks don’t fully understand their risk exposure, but by…
The Government Two-Step
Many analysts are convinced that in the next crisis, the US government will not let banks fail. That’s right, 2008/09 all over again.
Except this time the problem will be much, much deeper. The amount and value of derivatives is MUCH larger than in 2008. And the banks can’t unwind their derivatives because—you’re not going to like this—they’re not able to accurately value them. There’s simply too many and the daisy chain too big and complicated.
But here’s the thing… in the next financial crisis—and there will be another financial crisis, it’s unavoidable—traditional wealth won’t be destroyed by the turmoil in the banking sector. It will destroyed by the reaction of governments and central bankers.
If governments refuse to let the financial industry fail—and logic dictates that they cannot under any circumstances let that happen—and the problem is much bigger than the last financial crisis, then the level of intervention by central bankers and politicians will be on a truly unprecedented scale.
We don’t know exactly what they’ll do, but we do know they will react. We also know what some of the likely options will be—all of which will devalue the dollar bill in your wallet…
• More QE/money printing
• Helicopter money
• Massive expansion of credit
• Massive launch of government backed bonds
As Mike states in his video, the debt based global monetary system has allowed deficit spending, trade imbalances, and bubbles to persist and balloon to levels unprecedented in all of history. They threaten to take down the world economy.
However, Mike is very clear on who he believes will be the survivors: gold and silver owners.
• Mike has eight more Reasons he buys gold and silver. We’ll be releasing them over the next two weeks, so subscribe to our YouTube channel to receive them!