Trading in derivatives has become the biggest bubble of all - growing to $480 trillion, face value, or 30 times the size of the U.S. economy. If growth continues at the present rate, in a couple years the derivatives market will be a quadrillion-dollar market.
Other economies put their mathematical whizzes to work on engineering problems - building newer, faster, better technology. But in the U.S. of A., during the Degenerate Empire Period, people who are good with numbers go into derivatives trading. There, they devise marvelously complex Frankensteinian trading instruments, such as the CPDO, the Constant Proportion Debt Obligation. We don't know what it is, a type of CDS (Credit Default Swap) we guess; but it is completely invented by the mind of man...completely out of nature. Still, it is part of the same evolutionary chain that has brought us such wonders as I.O., Neg Am mortgages, congressional redistricting, and reality TV.
But of all of these monsters... the derivatives market must be in a special category. Whenever higher math and greater greed come together, there is bound to be entertainment. The quants at big investment firms invent these things...give them a jolt of juice...and then these abominations spring to life. The next thing you know, there are billions...trillions in CPDO and other contracts, many in the hands of buyers who didn't quite understand the elaborate equations behind the contract; and many - and here we are just guessing - who will be surprised when they find out how the things actually work.
As we understand it, a fellow who is good with figures can devise a way to at least partially protect his own investments. A fellow who is especially sharp can also figure out how to make more money than his slower-moving peers, from time to time. But no financial wizardry...or any complex instrument...can protect a whole market. The more people that climb on board the great ship - $1 trillion might be a small party; $480 trillion must be a crowd - the more un-seaworthy the vessel becomes.
We can't wait to find out what happens.
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About the Author
Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
