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How much is $172 trillion worth?

by Migeru Mon Mar 24th, 2008 at 06:06:20 PM EST

Jerome a Paris:

The Truth and Consequences
Of $172 Trillion in Derivatives

Derivatives are essentially bets ... and ... debts.

...

But what was once a small sideshow in the traditional world of stocks, bonds and loans has become the towering center ring in the big-top: The derivatives market has now ballooned into a monster of unimaginable dimensions.

At U.S. commercial banks alone, the total notional value of the derivatives is $172.2 trillion, according to the latest report by the U.S. Comptroller of the Currency (OCC).

How can there be $172 worth of derivatives? That's between two and three times the world's GDP and about 17 times the US' GDP. How did it come to this and what can happen if they are found to be worthless?

I don't pretend to have an answer to those questions, especially the one about what comes next, but below the fold I take a stab at illuminating the issues so we can have a discussion.


Take Micro$oft, a large and liquid stock. The following is from Yahoo! Finance:

As of today, Micro$oft's shares are worth about $29 per share. The market capitalization of $271bn corresponds to 9.3bn shares outstanding. Each day, 93M shares change hands (this is a 3-month average). That's 1% of the shares outstanding. It means that the average holding period of a share is 100 trading days, or nearly 5 months.

Now, suppose I have 90 shares of Micro$oft. For how much can I sell them? For $2600 and change, you say, ignoring commissions. Okay, that's good for two Illinois-shaped corn flakes. I'm happy.

Suppose now I have 9 thousand shares of Micro$oft. For how much can I sell them? For $260k, more or less. Maybe I can buy a house with that. Or maybe that's what I did with the equity I withdrew from my home (more about this later).

Say, what if I have 900 thousand shares? How much are those worth? Well, $26M. Maybe I'm a pension fund manager and that's how much of my portfolio is in Microsoft. You get the idea.

Let's multiply the holding by 100 again... Say I am a Micro$soft executive and I have 90 million shares of Micro$oft, how much are they worth? Do we have to go through that again? It's $2.6bn! Well, no. because 90 million shares is about one full trading day's worth of volume and if you try to move that amount of shares through the market you're going to move the market. Just by yourself, you'd double the market volume so maybe you'd make the stock drop by its typical daily range of about 35 cents per share. That's a loss of 32 million dollars right there! As soon as you start trading those shares people will pick up the trend and start selling into it to cut their losses, or hoping to buy again when it bottoms out. Your 100% extra daily volume will trigger a sell-off. The stock migh drop by, say, $2 - that's a $180M loss for you!

So, no, 90 million shares are definitely not worth 90 million times the share price, unless you can enter into a deal over the counter (off the exchange) with someone else who would like to own 1% of M$. And, most definitely, the entirety of the shares of Micro$oft are not immediately worth $271bn even though 1000-share lots (see the "bid" and "ask" in the Yahoo! Finance screen capture) can be quickly bought and sold at the share price.

If you want to quietly sell your 90 million shares you might want to set yourself a threshold of, say, 5% of average volume, and trade in randomly-sized lots through various brokers in order to pass unnoticed. This means it will take you 20 days (4 weeks!) to sell the stock and a lot can happen to the stock price in 4 weeks. So, not only you're exposed to the price risk over 4 weeks, but you also don't have all the money available now, not nearly.

However, one thing you can do is use the 90 million shares as collateral for a loan of $2.6 billion, use the money now and sell the stock over the next month in order to pay the loan back.

Maybe a bank will balk at your request for a $2.6 billion loan, so let's scale the example back a couple of notches, to 9000 shares for $260k. Say you want to use the shares as collateral to help you get a mortgage. The bank says "yup, 9000 shares owned outright, Micro$oft is solid and liquid, you don't have any other debt..., sure, we'll give you a mortgage for $260k." Now imagine across the US and the World, millions of people, fund managers and companies have been using their M$ shares as collateral for loans, or writing them as assets on their balance sheets. The $271bn of M$'s market capitalization, which are not liquid and would take 5 months to convert to cash, in which time the shares could well go from $30 to worthless, are being used as liquid assets as good as cash in countless financial transactions. All in one lump they couldn't be used in this way - they would have to be discounted at least by the 5-month interest rate. But in small pieces the entire amount can be used as if it were cash. What happens when everyone decides they need their cash now? Or, to make it a little more realistic, suppose that a bank has accepted M$ stock as collateral for 10000 adjustable-rate mortgages. What happens when raising interest rates force the holders of those mortgages to try and liquidate their stock? Can those 90 million shares be converted to $2.6 billion now? The bank can suddenly find itself with $2.6 billion of loans backed by crap collateral. What happened was that what looked to the bank as 10000 separately sensible transactions were in fact correlated and collectively were a bad idea. Globally, $271bn of perfectly good, sensible collateral for credit can be wiped out in this way.

And so, by the magic of margin buying and leverage we have ended up with $171 trillion of derivatives, which are, in small lumps, more or less liquid and more or less good substitutes for cash, more or less good collateral, and definitely written on the assets side of companies' balance sheets. What happens to the credit backed by these assets when everyone rushes for the exits? What happens to the companies whose balance sheets are kept technically solvent just by the value of the derivatives they hold? How much are these $171 trillion actually worth? As I said at the beginning, $171 trillion is 15 to 20 times the US' GDP. Does this mean it has to be discounted at the 15- or 20-year interest rate? That would make it worth a lot less, maybe only $60 trillion. But, in any case, this illustrates that when people talk about how much money there is in this or that asset class it is patent nonsense. Except, of course, that it can all be used as collateral for credit in a peacemeal fashion, and so multiplied by leverage even beyond $171 trillion. Remember Archimedes' dictum on the lever: "give me a fulcrum and I'll move the Earth".

How did we get ourselves into this, how do we get out, and how can we teach ourselves to stop thinking that there isn't liquidity risk involved in the actions of everyone else because our own transactions are minute? I don't know a whole lot about economics, but I know enough mathematics to know that mathematical economics is a load of crock. It it axiomatic in mathematical finance and mathematical economics that prices are linear, otherwise economists wouldn't be able to use linear algebra to prove nice theorems about finance.

Display:
You know it when you don't see it.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 24th, 2008 at 06:23:37 PM EST
Rec'd for great Clarence Thomas reference.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Mar 24th, 2008 at 06:57:14 PM EST
[ Parent ]
Quotable.

Is from you?

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Mon Mar 24th, 2008 at 10:22:21 PM EST
[ Parent ]
No, it's from second-in-command wingnut Clarence Thomas.  He said of porn, "I know it when I see it," during a Supreme Court case.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 25th, 2008 at 06:17:05 AM EST
[ Parent ]
Actually it was probably "said" (with the meaning of "first said") by Justice Potter Stewart back in the 1960s. I don't know if Clarence Thomas was quoting him, or whether the latter comment was made up by somebody, on the grounds that, unlike Stewart, Clarence Thomas may well have had a habit of seeing a lot of it...
by gk (gk (gk quattro due due sette @gmail.com)) on Tue Mar 25th, 2008 at 07:47:31 AM EST
[ Parent ]
Okay, fine, go and prove me wrong when I was all high and mighty with my meaningless Supreme Court trivia!

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 25th, 2008 at 11:08:58 AM EST
[ Parent ]
Yeah it was Potter Stewart (below) but I like Jerome's tale on it better!

The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Tue Mar 25th, 2008 at 08:17:37 AM EST
[ Parent ]
and a simple and appropriate explanation of what liquidity means and why it matters.

Thanks.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 24th, 2008 at 06:24:52 PM EST
With a hat tip to Drew for pulling my tongue on IM.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Mon Mar 24th, 2008 at 06:33:04 PM EST
Pulling his tongue, really meaning that I showered him in my staggering ignorance of today's finane, to which he responded by doing a great job of explaining the bizarre ways of Wall Street and the City to me.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Mar 24th, 2008 at 07:13:07 PM EST
[ Parent ]
Wait until we tell them about Legislative Proposal #1: Migeru's Death Knell for Monoline Insurers Act of 2009; and about Plan B: Recycling the Breakup of AT&T Bell before applying Legislative Proposal #1.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Mon Mar 24th, 2008 at 07:18:00 PM EST
[ Parent ]
I'm not enough of a mathematician to fully comprehend this, but it seems to be a bit like the reverse of Newtonian mechanics.  Newtonian mechanics works well at the macro level but breaks down at the level of sub atomic particles where quantum mechanics is required to explain observed behaviour.  

The linear mathematics Migeru refers to works well at the micro level, in a liquid market, but breaks down at the macro level when everybody, or a significant proportion (= <1% of the total population) are trying to do the same thing.  Its a bit like trying to approach the speed of light - prices inflate/deflate exponentially/astronomically as the total volume of transactions approaches total market size.

This isn't rocket science, and it should be possible to predict the behaviour of prices as the proportionate of the market seeking to liquidate/invest rises significantly.  It should also be possible to draft regulations which prevent the linear algebraic assumptions of "non-herd like" buyer/seller behaviour leading to inflated asset valuations and the "multiplier effect" that that can have on the total value of derivatives outstanding.

It should have been obvious to everyone - bankers, regulators etc. that there is no way that Derivatives valued at 2 to 3 times Global GNP can be outstanding at any one time.  So was everybody playing chicken?  Blinded by pure greed? Convinced they could defy gravity?  Or just playing with other people's money and banking fat bonuses all along the way?

It would be criminal for an individual business to inflate the value of their business for the purpose of persuading investors to pay unrealistic prices for their shares.  Somehow the rules of accountancy and book keeping are going to have to change to take account of the cyclical and non-linear nature of pricing behaviour in the real world.  At least Microsoft has a solid business model and fairly predictable costs and revenues, but these people knew they were trading in junk.

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 24th, 2008 at 08:06:59 PM EST
Thanks, Frank, that's a very good comment. And this is one of my hobby horses: linear algebra is used in many disparate fields of applied mathematics because it is convenient, not because it is the best model.

Frank Schnittger:

The linear mathematics Migeru refers to works well at the micro level, in a liquid market, but breaks down at the macro level when everybody, or a significant proportion (= <1% of the total population) are trying to do the same thing.
It is patent nonsense to value the whole by the price at the margin. What that implies for marginalist macroeconomics is left as an exercise for the readr.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Mon Mar 24th, 2008 at 08:17:16 PM EST
[ Parent ]
Migeru:
It is patent nonsense to value the whole by the price at the margin. What that implies for marginalist macroeconomics is left as an exercise for the readr.

Given that the price at the margin is determined by "scarcity value", pricing the whole lot as if 99%+ were not for sale isn't even pretend economics.

"When you have a hammer, every problem looks like a nail" seems like an apt aphorism for those whose maths extends only to linear algebra.

However the value of its simplicity lies in its utility as an ideology.  Every fool can explain to you how the "the market" works and how that is better than state bureaucratic allocation of resources.

It is the foundation stone for the neo-con political project where the freedom of the few to buy and sell at the margin is expressed as a feature of the entire system - when the reality is that most have very little they can sell or buy - and are forced sellers into a labour market regardless of the price available.

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 24th, 2008 at 09:28:38 PM EST
[ Parent ]
Frank Schnittger:
It should have been obvious to everyone - bankers, regulators etc. that there is no way that Derivatives valued at 2 to 3 times Global GNP can be outstanding at any one time.  

Not at all.

Let's take a nice little example in the Brent Crude Oil "15 Day" market in Forward Contracts for cargoes of  500,000 barrels.

A has rights to production and in January he sells a July cargo to B at $100/ bbl; in due course trader B sells a cargo at $105 to C; then a month or two later C at $95 to D, who sells to E and so on until K sells at $102 to A and A sells to X at $104.

Eventually the time comes when the July forward contract reaches the point when it goes into its delivery cycle, and what happens then is that "chains" of "nominations" form, and that "nomination" process is always great fun, as people who have sold "short" try not to be left still holding a nomination at 5 o'clock which they cannot pass on in time.

In which case a "distressed" seller who has been "clocked" needs a cargo to fulfil his contract and is fair game for being stuffed by a seller who has one.

So maybe 250 outstanding "open" forward July contracts are settled as nominations pass one way down chains, and the money flows the other way up them, with traders collecting profits, or suffering losses, along the way.

It wasn't unknown for chains to be over 100 links long and for "book-outs" to take place wherever nominations  went full circle, as in the example, from A back to A again.

Only the net (say) ten cargoes actually pumped out that month go to delivery and become "wet" so that tankers are chartered to arrive at the nominated "delivery window" at Sullom Voe. All the rest of the forward sales/ derivatives are cashed out.

Great fun.

Note that like the credit derivatives markets, the Brent 15 day market is a bilateral "Over the Counter" market with no central clearer standing in the middle to guarantee and settle trades.

The point is that although there may well be $172 trillion of derivatives out there, they will in fact - if they are all performed - for the most part net down to zero (unlike derivatives in real things like oil where physical delivery takes place in "money's worth" rather than money).

The problem is that no one has the foggiest idea as to which of these derivatives are going to be performed, and which are not, let alone who is actually holding the shit, who can stand the losses and who cannot.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Mar 24th, 2008 at 09:27:16 PM EST
[ Parent ]
ChrisCook:

The point is that although there may well be $172 trillion of derivatives out there, they will in fact - if they are all performed - for the most part net down to zero (unlike derivatives in real things like oil where physical delivery takes place in "money's worth" rather than money).

The problem is that no one has the foggiest idea as to which of these derivatives are going to be performed, and which are not, let alone who is actually holding the shit, who can stand the losses and who cannot.

So we have a large collection of assets which individually look like they have value (and sit on the assets column of balance sheets) but in the aggregate have no value at all? That's even worse than with stock shares. Or maybe not, maybe a share is an "option on liquidity" and has nothing to do with a proportional share of discounted future dividends, or with a proportional share of a company's net equity.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 04:25:36 AM EST
[ Parent ]
I once asked the guy sitting next to me how many June Brent cargos there were (about 1995 ish).  He said roughly 50.  "and I own 80 of them".  He had a fun month with that squeeze play.  15 day Brent was such a stupid contract.

Not a market for widows and orphans.  But it's not like people just get to walk up and start punting.  The credit groups were paid very well to try to keep a handle on who  we had too much risk exposure with and to demand margin from the poorer credit risks.

by HiD on Wed Mar 26th, 2008 at 07:32:26 AM EST
[ Parent ]
HiD:
The credit groups were paid very well to try to keep a handle on who  we had too much risk exposure with and to demand margin from the poorer credit risks.

Well I came into regulation in 1986, (and the IPE in 1990) people were still coming to terms with Brent credit risk after a few embarrassments which came about from trading with "tiddlers".

Btw this

Metallgesellschaft Case study

 is interesting in the oil market context....  

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Mar 26th, 2008 at 09:00:55 AM EST
[ Parent ]
that's the real problem.  People in the credit world assume Exxon or MG are too big to actually fail and give them open credit.  And then they really really F/up.

I got lightly singed a time or two by small players but no worse than a bad demurrage snafu.  part of doing business.  

Trading is not for the faint of heart or the risk adverse.

by HiD on Tue Apr 1st, 2008 at 01:45:59 AM EST
[ Parent ]
Short, sweet and to the point.

The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Mon Mar 24th, 2008 at 10:24:28 PM EST
A term that comes to mind when I think of situations like this is "transaction externalities", a character string that retrieves fewer than 100 links via Google. I will boldly and irresponsibly ignore whatever wisdom those links might yield, and instead spit out some thoughts on a  half-baked idea that has been nibbling at me, or vice versa.

Externalities are a standard justification for regulations that tweak or stomp on a market. In the discussions I'm familiar with, however, "externalities" result from actions -- emitting pollutants, creating knowledge, etc. -- but not from market transactions per se. (First problem: How clear is this boundary? Clear enough to be useful, I think). In this category I would like to include the creation of financial instruments, perhaps using the excuse that they are promises of transactions.

The simplest argument for the benefits of trade is that both parties have a (rational?) expectation of gain. The notion of transaction externalities complicates this.

Examples of what I think of as "transaction externalities":

  1. The transactions that led to the current derivatives nightmare created systemic risks: These are externalities in that they aren't reflected in the expected benefits to individual buyers and sellers.

  2. The purchase of gasoline by a US driver increases US dependency on Middle Eastern oil, and the perceived risks (and responses to them) have engendered enormous costs that are not reflected in the price at the pump.

  3. Shopping at a new Walmart, rather than a local or more responsible store, creates costs in the form of economic displacement, loss of valued local institutions, public health care burdens, etc., again not reflected in the immediate costs seen by the transacting parties.

Example (3), however, points to "transaction externalities" of sorts that tend to support broad and distasteful arguments against innovation and market adjustment. Somewhere in the implied spectrum of concepts are ideas that smack of sellers having a right to their customers continued business.

Is there a (semi-)coherent idea to be found here? Is there a sound part called "X" in the literature, or a bogus part that is called the "Fallacy of Y"? And what does "transaction externality" already mean, anyway? (I'm too lazy to read about it at the moment.)

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Tue Mar 25th, 2008 at 02:16:54 AM EST
I'm not an economist, but it seems to me that the most important "transaction externalities" are the legal, institutional and customary frameworks within which the transaction takes place.

No market is viable without a framework of enforceable laws - e.g. mortgage foreclosures, debtors courts - which immediately introduces all the costs of law enforcement - often largely borne by the state and not the individual buyer/seller.  It has often struck me that the most practical and effective way of halting wild speculation and the myriad transactions over the same set of commodities described above is to introduce e a transaction tax (or stamp duty) which would quickly make multiple transactions of the same asset uneconomic.

However the most important externality is probably trust - the belief that what you are buying is worth it because it is from a reputable source (or famous artist - see example above) and that debts will be repaid.  Why esle to people pay Billions for "financial advice" when all the evidence points to the "dartboard method" of stock selection being just as effective in the long run!

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 25th, 2008 at 05:37:21 AM EST
[ Parent ]
Great minds think alike - you are asking for a Tobin Tax, like the eponymous Bank of Sweden prize winner, and a buch of French lefties who founded Attac

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Tue Mar 25th, 2008 at 05:51:21 AM EST
[ Parent ]
An insightful diary!

It relates to another little conundrum I've been thinking about since I read a recent piece about art as a long-term store of value and the current activity at the major art auction houses.

In 2006 David Geffen sold a Jackson Pollock drip oil painting called 'No 5, 1948, for a bit over 140 million dollars. That is about the same as the 'value' of the contents of a fully laden Suezmax oil tanker.

Of course you will not get quite the same energy value if you burn a Pollock.

What DO you get out of it? How come an oil painting by an alcoholic, produced during a narrow period of 4 career years, is worth 140 million dollars 50 years after his death?

At the time of its production the painting was not worth much. Apart from the cost of a large piece of fibreboard,  a few gallons of industrial paint and the alcohol, (the down payment on his studio came from Peggy Guggenheim) where is the value?

With hindsight, one can say that Pollock had a unique set of experiences and influences that fed into Jack the Dripper's assault on painting. He worked from 1938  - 1942 supported by the Depression-derived Federal Art Project. He was also intellectually robust enough to figurehead the Abstract Expressionist movement, marry another important painter (Lee Krasner), and have Guggenheim as a patron. But 140 million?

No, the current price of a Pollock is not about the history of fine art - it has been talked up by a market of gallerists, critics and investors (and the media). The millions of words written about Pollock have multiplied his value. Pollock is a myth - like the 172 trillion derivative value.

And the only artefacts of this myth are a few paintings with complete provenance.

In 2006 a documentary, 'Who the Fuck Is Jackson Pollock?', was released which featured a truck driver named Teri Horton who bought what may be a Pollock painting worth millions at a thrift store for five dollars.

Pollock had a profound influence on art: but the monetary value of that that influence was 'talked up' - like the derivatives.

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 25th, 2008 at 04:58:21 AM EST
Economists like the art market because it plays to one of their homespun homilies: "Things are worth what someone will pay for them."

Once "officially recognised" by the bubble-world of curators, auctioneers, etc. Pollock, like other artists has scarcity value. Thus it becomes a positional good. There are so few Pollock's knocking around that they become positionally very expensive.

by Metatone (metatone [a|t] gmail (dot) com) on Tue Mar 25th, 2008 at 05:45:27 AM EST
[ Parent ]
Can you use your Pollock as collateral for a loan with which you can then buy more  Pollocks?

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 06:15:17 AM EST
[ Parent ]
What's the Pollock futures market like?

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Tue Mar 25th, 2008 at 06:50:40 AM EST
[ Parent ]
A load of Pollocks?

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Tue Mar 25th, 2008 at 09:37:57 AM EST
[ Parent ]
Who the Fuck is Jackson Pollock? Well, Ed Harris, of course!

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 06:17:42 AM EST
[ Parent ]
All economics is story-telling. The object of the exercise is to get people to believe your story.

Sometimes physical stuff gets shifted around and/or remade, but that seems to be incidental.

I've been thinking about this for a couple of years now. Economic value is based entirely on narrative and belief. If I believe a product is scarce I'm more likely to pay more for it, even if in reality supplies are plentiful.

Brand management is the business of telling stories to make useless products look more appealing.

What auction houses, critics and gallerists do now is mostly brand management.

The same thing happens with items owned by famous people. If I buy a guitar owned by Eric Clapton, it's certainly not going to make me sound like Eric Clapton. It's not going to put me on Eric's Christmas card list, or get me invited to any of his parties.

So where's the 'rational' value? Nowhere.

The only thing that makes that guitar more valuable than any other Strat is the story linked to it.

If people don't know the story, it's just another guitar.

If someone swapped the guitar for an identical-looking guitar, it would still have the same story value even though in reality Clapton had never been anywhere near it.

People pay for the story, and the mojo it implies, not the object.

In anthropological terms, it's pure fetishisation. The object becomes imbued with imaginary manna which it only holds because of its symbolic associations.

And that's economics. It's about status, and power, and relationships, and mojo. It's not about stuff, or managing stuff intelligently.

Which is why it's such a totally fucking stupid way to run a real economy.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Mar 25th, 2008 at 06:49:24 AM EST
[ Parent ]
Although provenanced Strats from the right manufacturing periods have increased in value about 10-12%  year on year - no matter who played them or owned them. So it is not just another guitar ;-)

But I agree with the fetishization. I'd add that the narrative has to be shared to be powerful.

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 25th, 2008 at 07:32:59 AM EST
[ Parent ]
Sven Triloqvist:
Although provenanced Strats from the right manufacturing periods have increased in value about 10-12%  year on year - no matter who played them or owned them. So it is not just another guitar ;-)
And why is that? is it because of the way they sound, or is it that once the 10-12% trend established itself it becomes a self-fulfilling expectation for both buyers and sellers?

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 07:42:15 AM EST
[ Parent ]
Don't forget that provenanced Strats from particular periods also have a rarity value.

Once you're only talking about 10% a year there are an awful lot of "provenanced" items (particular children's toys, etc.) that come out of mass manufacturing that show these gains, so long as there aren't many of them surviving...

by Metatone (metatone [a|t] gmail (dot) com) on Tue Mar 25th, 2008 at 08:09:43 AM EST
[ Parent ]
Please note, I'm not saying this is anything other than insane, just pointing up that scarcity turns things into positional goods.
by Metatone (metatone [a|t] gmail (dot) com) on Tue Mar 25th, 2008 at 08:11:29 AM EST
[ Parent ]
I heard of someone who goes to book signings and keeps the books on the off chance that the author becomes big in a few years' time. Imagine a signed copy of Harry Potter's first edition!

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 08:43:54 AM EST
[ Parent ]
Harry Potter First Editions - Harry Potter at Catch The Snitch
An unsigned first edition copy of "Harry Potter and the Philosopher's (Sorcerer's) Stone" may be worth between £3,000 and £4,000. A signed copy may be as much as £10,000. One of the first edition "Harry Potter and the Philosopher's (Sorcerer's) Stone" hardbacks was sold for £10,575 at a Sotheby's auction in early 2002


Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Tue Mar 25th, 2008 at 08:51:50 AM EST
[ Parent ]
One of the toughest jobs I ever had was leading a team to design and build a website to market and sell rare Scotch whiskys.   Not being a Whisky drinker I had to do a tasting course and also visit various distlleries around Scotland talking to the Distillery Managers etc.

On the blind tasting course - attended by quite a few master distillers, very few had any consistent ability to tell the main brands apart - whether it be a £200 rare malt or a £30 standard bottle - and some even had difficulty recognising that one of the drinks thrown into the blind tasting was a brandy.

Yes we could tell the major differences apart - the cask strength, degree of peatyness etc. but very very few can really appreciate the the minute differences which can lead to huge variations in price.  Its not about the liquid itself, its about how people want to badge themselves - as connoisseurs  and as different from the hoi polloi.

I'm sure I've upset a few people here!

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 25th, 2008 at 12:04:56 PM EST
[ Parent ]
Beware a nocturnal visit from the Shìth of the Caol Ila cult ;-)

You can't be me, I'm taken
by Sven Triloqvist on Tue Mar 25th, 2008 at 12:15:30 PM EST
[ Parent ]
Caol Ila?  It's only a pale shadow of Lagavulin in any case.....

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 25th, 2008 at 12:24:41 PM EST
[ Parent ]
Oh yes, the price expensive whiskys are to (at least) 99% status consumption. An obvious indicator is that single malt are valued higher then blended. Blended is more work and - skilled work at that - producing a richer variety of flavours. But single malt is better for scarcity in that you have a particular malt and a particular age. Not as good as wines from a particular grape, particular place and particular year but better then nothing.

IIRC, whisky was made an object of high status pretty late - 1900ish or so. Before that it was simply the booze made and drunk in particular regions.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Tue Mar 25th, 2008 at 06:35:27 PM EST
[ Parent ]
I always thought that whisky had become popular in England when Napoleon blockaded the UK and cut off the Cognac supply, which was before that the source of booze for the English gentry...

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Wed Mar 26th, 2008 at 09:56:20 AM EST
[ Parent ]
For the afficianados (read Pilkkunussijat), there were certain early periods when everything about a Strat was perfect - the neck, the wood used, the nuts, the pick-ups, the people who made them by hand etc. You are meant to be able to hear or feel this difference.

I have never been able to tell the difference, because I never really played the guitar. As a producer there are so many other things to worry about soundwise - especially the competence of the player. But I've certainly seen guitarists fall in love with a guitar as they start to play it. What is it that they feel? I don't know. I guess it just feels 'right'.

All Strats have been serial numbered. There are lists of all these numbers. Even parts like the neck may have a pencilled number or mark on the invisible part of the join to the body. But there are quite a few fakes out there. They are unlikely to fool real experts because of serial number duplication, but for neophytes to the arcane world of Strats, a 'distressed' Strat made up of bits and pieces can pass for genuine.

This is rather similar to the junk bond packages. Crap with a fake AAA rating.

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 25th, 2008 at 08:14:09 AM EST
[ Parent ]
In fact this might be time to review 2 movies:

'F for Fake', Orson Welles' brilliant obfuscation.

and

'13 conversations about one thing' directed by Jill Sprecher - "philosophy illustrated through everyday events" (Roger Ebert)

If you seek them out out your video rental store,  I guarantee it will be worthwhile effort ;-)

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 25th, 2008 at 08:56:59 AM EST
[ Parent ]
Sven Triloqvist:
I have never been able to tell the difference, because I never really played the guitar. As a producer there are so many other things to worry about soundwise - especially the competence of the player. But I've certainly seen guitarists fall in love with a guitar as they start to play it. What is it that they feel? I don't know. I guess it just feels 'right'.

Nothing sounds quite like a real Moog modular. I can certainly hear the difference, and if I could spend £30k without blinking I might even consider buying one, even knowing that it's not going to stay in tune and will need constant maintenance.

There's a difference between genuine musicality and random mojo. There's quite a bit of overlap with legendary instruments - qv branding again - but it's not quite the same as the stratospheric mojo associated with celebrity.

Even without celebrity, instruments are a lot like clothes. You don't just buy them for what they do - make a noise, keep you warm - but because they dramatise your disposable income and style, and make you feel a certain way about yourself.

This - illusory - feeling of crafting your own narrative is what drives economics, advertising, and not a little politics.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Mar 25th, 2008 at 09:25:59 AM EST
[ Parent ]
When I get my hands on one of these babies, I can spend all my free time picking apart my millions of Acid samples ;-)

You can't be me, I'm taken
by Sven Triloqvist on Tue Mar 25th, 2008 at 10:42:17 AM EST
[ Parent ]
I'll be getting that in for review when it's out. One of my editors was blown away by it at Frankfurt, but enthusiasm was tempered when he found out they've been making similar claims for at least five years now.

We'll see.

The current Melodyne is pretty good - very impressive time-stretch, but a slightly awkward interface. I think I've only ever used it once, for picking the notes out of a bass line loop.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Mar 25th, 2008 at 01:41:08 PM EST
[ Parent ]
If we're talking gear prOn - what I really want is one of these.


by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Mar 25th, 2008 at 01:46:23 PM EST
[ Parent ]
If I had any musical training whatsoever, that sounds creative.

You can't be me, I'm taken
by Sven Triloqvist on Tue Mar 25th, 2008 at 02:13:13 PM EST
[ Parent ]
and apologies for thread hijack...

You can't be me, I'm taken
by Sven Triloqvist on Tue Mar 25th, 2008 at 02:20:01 PM EST
[ Parent ]
Your conversation is actually a useful detour around the notion of "value."

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Mar 25th, 2008 at 02:46:12 PM EST
[ Parent ]
It is always easier for me to apply insights to what I know. It's a kind of lateral thinking.

But 'value' is an underlying central theme of ET IMO.  It is what connects all the diaries together, although some of us come from a toally different direction. Multidisciplinary or Transdisciplinary - take your pick.

Although discredited by 'Time & Motion' excesses, OR (Operational Research) iss till the best method for seeing the forest from the trees - as I am know you Miners have been taught ;-)

You can't be me, I'm taken

by Sven Triloqvist on Tue Mar 25th, 2008 at 03:11:30 PM EST
[ Parent ]
Japan has a good share of peculiar TV shows. In one of the shows (not so frequent) celebrities basically have to distinguish real of fake things: say, one item is an expensive abstract painting, other is scribbled by a studio worker; you take your choice and go to room A or B. Or you distinguish real or fake diamonds, expensive or cheap wine, etc. Not an easy task!

(I tried to google "japanese show real fake" for a search, the first hit was this: real or fake orgasm...).

by das monde on Thu Mar 27th, 2008 at 01:19:15 AM EST
[ Parent ]
That link is probably NSFW. OTOH, given the amount of socialist writing around here, ET is probably not safe for work either...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 27th, 2008 at 08:48:38 AM EST
[ Parent ]
I agree, the link is dangerous for work - irresponsible from me. No more tests like this...
by das monde on Thu Mar 27th, 2008 at 11:45:45 PM EST
[ Parent ]
So, realistically, how many Illinois-shaped cornflakes could we buy with all these derivatives?

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 25th, 2008 at 06:20:15 AM EST
45 billion?

However, at those volumes Illinois-shaped cornflakes lose their scarcity value (see the parallel comment thread on Jackson Bollocks).

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris

by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 06:25:11 AM EST
[ Parent ]
I think we should first make everybody aware that the number is misleading !!

"derivatives" is a broad category of contracts, which includes the "plain vanilla interest rate swap". And I can assure you (and you can double-check in the reports of the Offices of Thrift Supervision and Comptroller of the Currency) that between 80% and 90% of the notional amount you quote is just "plain vanilla interest rate swaps".

Why so much ?

  • because they are long lasting contracts (each signed remains outstanding for several years)
  • because all banks and brokers use them extensively to manage the Asset-Liabilities of their balance sheet (ALM). And I mean very extensively, all future cash flows tend to be hedged against rate moves (the losses resulting from a motion of the rate curve are spread between all market participants, and it's a 25-years system that works very well, fully tested).
  • to the extent that 80% of the positions in a typical trading portfolio are just plain vanilla IR swaps.

It is very easy (and desirable !!) for the notional amount of IR swaps to reach the value of all outstanding debt on Earth, because all debt is on the book of a bank, which practices ALM to spread the IR risk with colleagues. And all outstanding debt is worth something on the same order of magnitude as all existing assets, which is much bigger than world GDP (many assets amortize over much more than a year, real estate being the most typical, so accumulated wealth is much large than one year of output). Of course, this value is somewhat magnified by the marginal pricing effect, and US RE will take many, many years to recover in value precisely because of this effect.

What everybody should understand is that there is very little risk involved with plain vanilla swaps. The swings in their market value is near-linear, well understood, and there are MtM and monthly netting agreement between all major parties. One big boy's collapse will NOT trigger a domino effect through vanilla swaps (it could through credit default swaps, but that's another story).

Remember how a plain IR swap works:
Two parties swap the cash flow associated with a theoretical debt of N $ (N is the notional), whether it's a fixed rate or a variable rate (with a set calculation formula).
They never exchange the notional.
The book value at signature is adjusted to zero, it moves negative or positive only when IR change (and remains typically within a few percents of N).
The total amount of netted cash that will change hands between the two parties is also like a few percent of N, over the many years the contract will stand.

Pierre

by Pierre on Tue Mar 25th, 2008 at 09:14:26 AM EST
Right, I suspect a lot of people who brandish these astronomical notional values do so because they have a reason for stoking fear of financial armaggeddon. For instance, the article I quote Jérôme quoting ends like this:
Your Best Defense and Offense

I sent you a Money and Markets flash on Friday afternoon with some specific steps to take:

Step 1. If you own vulnerable assets, don't be afraid to dump them. If you're taking a profit, pay the taxes. If you're taking a loss, bite the bullet and move on. In either case, just sell. And if you have a personal adviser, be sure to work as a team to reduce your exposure.

Step 2. Get your money to safety as quickly as possible. Years ago, for maximum safety and liquidity, short-term U.S. Treasury bills would have been all you needed. Today, given the threat to the dollar, we feel you need a prudent balance among:

Step 3. For protection -- and profit -- seriously consider inverse ETFs. For months now, we've been sending readers a link to my special report on what they are, who they are and how to use them. We've posted it prominently on our Web page. And we have made it free.

Did you use it to build a firewall of protection around you? If so, great. If not, what are you waiting for?

The title is How to Protect Your Stock Portfolio From the Spreading Credit Crunch.

To review it now, along with the accompanying list of inverse ETFs, just pull it up on your screen with this link:

http://www.moneyandmarkets.com/files/documents/
MAM767_Special_Report.pdf



It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris
by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 09:43:25 AM EST
[ Parent ]
Well, the advice isn't so bad, except for the firesale part. Also, a bit late to get into the gold bandwagon. Definitely still time to enter reverse index trackers (I've been in for a year now, with delta=-2 multiplier, yeepeeeh !!)

Pierre
by Pierre on Tue Mar 25th, 2008 at 09:52:30 AM EST
[ Parent ]
Well, first get into reverse index trackers, then firesell.

In fact, if the guy has himself been in reverse index trackers, to tell his readers to sell everything seems not entirely disinterested advice.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris

by Migeru (migeru at eurotrib dot com) on Tue Mar 25th, 2008 at 09:55:52 AM EST
[ Parent ]
I thought I knew how hedge firms worked - well sort of - but what's with this reverse index tracker crack?

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Mar 25th, 2008 at 04:05:40 PM EST
[ Parent ]
OK, rewind:
An ETF is a fund whose shares trade like stocks, but which has a "value target" that is very well met (and a usually a sponsor bank that holds & adjusts bid/ask order on the market to keep the share value in the target range).
All sorts of ETF exists, with target values usually replicators: they replicate the quote of a well known index or economic indicator (DJIA, S&P, Gold ounce, Front Month Crude Oil, etc...)

The reason they are reliable in their replication is that very stupid failsafe strategies enable them to do so (like: buying physical oil and gold to replicate commodities, buying the whole basket of stocks to replicate a stock index).

Now actually sponsor banks have smarter ways of replicating, with options of rolling maturities (there is less locked capital involved). E.g. if you buy both put & call options of same strike and maturity, you have made a "converse" or "synthetic forward" of the underlying: the portfolio value varies just like the underlying, save for an additive constant. With listed options on major indexes, there is no liquidity issue.

Thinking of it, they realized you can buy more complicated combinations of liquid options, so has to have any kind of delta you want (well, low delta value have a more reliable targeting). Delta being the partial derivative of the value of the fund, with respect to the value of the underlying. E.g classic ETF have delta=1 (for 1% change in value of the underlying being replicated, the fund portfolio changes of 1%), but reverse ETF have a delta<0: they go up when the index go down (of course, they also go down when the index is up).

I hold a leveraged reverse ETF with delta=-2. Every time CAC is down 1%, I gain 2%. In this case, "leverage" does not imply debt. It is only delta-leverage, and it is achieved by picking puts and calls in different parts of the (strike,maturity) space than a classic ETF.

Pierre

by Pierre on Wed Mar 26th, 2008 at 06:29:50 AM EST
[ Parent ]
Thanks for this explanation.  To put it in really layman's terms, you are using part of your funds to lay a bet that the market will go down.  When the market does go down, you win your bet, and this compensates for the losses you suffer in the rest of your (non-inverse portfolio).  If the market goes up, you lose your bet, but this is compensated for by the gain in the rest of your portfolio.

So basically it is a method of dampening the volatility in share prices, and reducing your overall exposure to risk (and reward).  It allows you to to keep your investment in the market even when you think it is likely to go down in the near term.

Given that much of market volatility is driven my market sentiment rather than real changes in the performance and prospects of the underlying companies, it seems a sensible strategy to adopt - particularly if you think the risks remain on the downside.  

Of course the $Million question is now - is the balance of probability - now on the up or on the downside - particularly in the Euro area.  I remain a bit of an optimist that the Euro area can adjust and prosper at a reduced rate of Growth - whereas the US still has some way to fall before there is any sustained bounce.  Is that similar to your reading?

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Mar 26th, 2008 at 08:16:36 AM EST
[ Parent ]
Except right now I'm all short/bearish. I have no other equity investments, all the rest is medium term fixed income. I don't think European economies can really decouple, firstly, and secondly even if the shock is dampened compared to the US, it will still be a meat grinding in the euro stock market, for the following reasons:
  • one third of euro large caps are financials, with US credit exposure,
  • the industrial euro large caps are globalized companies with revenues in dollar, so their P/E in euros is bound to degrade,
  • one third of capitalisation of euro large caps is US mutual/pension funds and banks, which are about to become net sellers for the first time in 50 years (lock in the gains including forex, pay the retirees, the 401k raiders, repair the balance sheets...)


Pierre
by Pierre on Wed Mar 26th, 2008 at 08:54:52 AM EST
[ Parent ]
Agreed on all of the above, but where are the Chinese and Oil exporters going to put all their loot - the stuff they used to put in dollars? What about smaller caps and those Euro companies with almost no direct US exposure?

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Mar 26th, 2008 at 09:45:45 AM EST
[ Parent ]
Small caps are not part of the headline indices.

In addition, if the financials do poorly it will strngle the credit for the real economy.

It'd be nice if the battle were only against the right wingers, not half of the left on top of that — François in Paris

by Migeru (migeru at eurotrib dot com) on Wed Mar 26th, 2008 at 09:52:06 AM EST
[ Parent ]
if so you have to re think your analysis a bit. (at least this bit:
How can there be $172 worth of derivatives? That's between two and three times the world's GDP and about 17 times the US' GDP. How did it come to this and what can happen if they are found to be worthless"

For example Microsoft options.  There are a gazillion open, but for every long there is a short.  The liquidity trap still exists though as if someone does a Kerviel and has a huge wrong position (and done away from regulators and/or with insufficient credit checking/margining) big enough to sink the bank, you can destroy the system.

by HiD on Wed Mar 26th, 2008 at 07:26:30 AM EST


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