Sunday, September 11, 2011

Sun Post #2: The Great Greek Domino (updated)

Over the counter (OTC) derivatives and credit default swaps (CDS) are mysterious terms that have been brought to the forefront since the 2008 Financial Crisis.

But it's important you understand what they are and what their implications are for the economy, monetary policy and their impact on Silver and Gold.

A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.

Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange.

Facilitating liquidity and mitigating credit risk is what derivatives are all about.

Products traded on the exchange must be well standardised to transparent trading.

But there are non-standard products ttraded in the so-called over-the-counter (OTC) derivatives markets.

OTC derivatives have less standard structure and are traded bilaterally (between two parties). OTC derivatives are significant in the asset classes such as interest rate, foreign exchange, equities and commodities.

They have become a crucial part of the world of global finance. The OTC derivatives markets have grown exponentially over the last two decades and have been driven by interest rate products, foreign exchange instruments and credit default swaps.

The notional outstanding of OTC derivatives markets has risen to the point where they totaled approximately US$601 trillion at December 31, 2010.

If something were to occur where payouts had to be made on only a small portion of this US$601 trillion total, the outcome could be catastrophic.

Many believe OTC derivatives and credit default swaps are financial instruments which are out of control.  Warren Buffet once called them "financial weapons of mass destruction. Time bombs that could harm the whole economic system".

Are those 'time bombs' about the detonate?

Enter the rapidly evolving sovereign debt situation in Europe.  Suddenly Buffet's famous derivatives statement is brought into sharp focus.

Europe is preparing for a domino to collapse that could set these "financial weapons of mass destruction" into motion.

Today the German newspaper der Spiegel announced that the German Finance Minister is preparing for a Greek bankruptcy.
  • "German Finance Minister Wolfgang Schäuble, who is reportedly doubtful that the country can be saved from bankruptcy, is preparing for the possibility of Greek insolvency. Officials in his ministry are currently reviewing scenarios for handling such a situation, exploring what it might mean for the rest of the euro zone."
The key concern of a Greek bankruptcy is that it could trigger a massive credit crunch larger than the one triggered by the collapse of Lehman Bros in 2008.

Credit lines provided to countries like Spain or Italy could evaporate if investors stop lending them money after a Greek bankruptcy.

Then there is the question of what happens to all the trillions in other interconnected debt.

Tonight every one's attention is focused on remembering the 10 year anniversary of the terrorist attacks of September 11th, 2001.

But tomorrow attention will return to Europe and the impending collapse of the Great Greek Domino.

The focus will be preventing these 'time bombs' from destroying the entire economic system.

 Can you say: "Ramp the paper money Printing Presses up even higher?"

Sure you can.

It is inevitable.

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  1. Inflation or default, one way or the other we will pay for the criminality of Lloyd Blankfein, Jamie Diamond and the other reprobates. They put 100's of people like these in jail during the S&L Scandal, which totaled about $500B. The bonuses of these Wall Street crooks alone was $142B last year for running bankrupt financial institutions that have lost trillions. It's the biggest crime in history, aside from the Iraq war lies.

  2. Where did all the money go?