Unstable Financial Derivatives are a Menace

The derivatives towers piercing the stratosphere above the surface of global finance are far less stable than real skyscrapers.

The Bank for International Settlements records that, at September 2011, the total amounts outstanding in exchange-traded and over-the-counter financial derivatives — futures, options and a vast array of sub-categories — totalled over $788 TRILLION.

One of the main ideas behind derivatives is to reduce risk by trying to offset it, but the trading figures point to jerry-built, leaky tower blocks of financial obligations, dwarfing the ‘real’ assets on which the risk offsets have been sought.

$788 trillion is $112,232 for every human alive at 12.55pm GMT today, February 14th 2012. This vast sum is predicated on nothing more than human guesses of likely future risks. The trades are based on mathematical models created by ‘quants’, clever young scientists and mathematicians who make a lot more money in finance than in science or mathematics. Their risk forecasts are  always subject to attack by ‘unknown unknowns’, factors that emerge, unbidden, as social, economic and political systems change.

$788 trillion — $788,000,000,000,000 — is an unstable tottering tower that a few little disturbances might topple: a bankruptcy  here, a change of government there, an unco-operative citizenry, a commodity price spike. That spike could so easily result from the intensifying struggle for resources that is inevitable given the speed of population growth. When I was at school in the 1960s the world population was 3 billion. Today at 12.55pm GMT it was over 7 billion, 7,021,986,350 to be exact.   The Earth is not any bigger. It has vastly more people, inconceivably more financial obligations, but less oil, less coal, less gas, less soil, less fresh water, than it had then.

The Bank for International Settlements publishes statistics on financial derivatives. The population clock on http://www.worldometers.info is based on United Nations data. 


3 Comments on “Unstable Financial Derivatives are a Menace”

  1. There is no denying that the derivative markets are large and possibly unstable. However, I think you may have over looked a few things.

    1. The derivative market (along with the whole finance/banking industry) is very regulated. The SEC has restrictions as to how can by what. Most derivative instruments require a deposit or proof that the parties involve can pay. This makes the market more stable.

    2. There are many types of derivates on both sides of speculation. Some people believe prices are going up, others believe prices are going down. This too evens out the market and makes it more stable.

    3. Population growth is irrelevant. The size of capital market across the globe has increased, thus the demand for derivative products has increased.


  2. Randel says:

    Unless Congress regulates financial derivatives, the global banking mess will actually continue. Derivatives have their place and can be used reasonably and rationally, but completely unregulated, they are another disaster ready to happen.

  3. Thank you for commenting. I would argue that regulation failed to prevent the banking debacle of 2007-08 and is not coordinated globally. I agree that derivatives could, if used carefully, offset financial risk but the scale of the sector is unnecessarily vast. I think population growth has relevance because the consequent pressure on resources of all kinds lead to large price disturbances, upsetting previous risk calculations and adding to financial instability.

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