Completely silly to put in the notional value of the derivatives market in there as most derivatives are designed and issued in a way such as the real value is none or cancelled out.
I think it's still relevant that they show it because it illustrates the irrationality of the situation we're in. I don't see how the notional value can fully cancel out unless it's possible to sell multiple contracts on the same underlying asset.
If you want to sell your house, you can't just sell it to two different people at the same time using different contracts.
Also, you can't sell your house to someone and also simultaneously rent it out to someone else either... Ultimately there can only be one legitimate contract over any given asset at any given time.
It seems that the financial system has legitimized scams by allowing people to sell rights to assets which they do not actually own under the pretext that they will make the transactions necessary to honor the contract 'if necessary'... But it has been proven time and time again that sometimes they cannot honor the contract due to systemic risks... So the contract is bs; people should not be allowed to sell contracts when they cannot provide 100% guarantee that they will be able to honor it... The looming collapse of the financial system is not an excuse to not honor a contract! People should not rely on taxpayer funded bailouts to protect themselves from systemic risks.
It makes complete sense to show the notional value because it shows the extent of the deception. It's not hard to imagine how a tiny change in consumer habits could create huge asset squeezes and liquidity shortages. The value is just not there.
In principle, the value of derivatives can represent nothing more than the value that people collectively place on options backed by the collateral of the options and the credit of the option guarantors.
This valuation, in the event that it is not a massive miscalculation by the market, reflects the sophistication of the market in being able to incentivize cooperative behavior like contract fulfillment, through phenonema like reputation, and mechanisms like reputation feedback.
Financial credibility extending to more sophisticated contracts is a genuine expansion of economic resources, that enables more effective economic coordination. It is not a scam, and the assets that emerge from it are not 'fake' wealth.
Frankly, this kind of hubris is dangerous. The point here is not that financial instruments are 'fake' wealth or 'nothing more' than the value that people put on real assets, that is the entire crux of the matter. You literally require expertise in higher maths to understand the valuations. And even those with that understanding sometimes fail to manage the risk. The guys who literally wrote the book on modern finance bought the global financial system to its knees b/c of their mismanagement [0].
The systemic risks that these insanely complex valuations pose to the economy are real and matter. I'm talking about food, housing, education, infrastructure, health care ... real things the matter for long term growth. This concept needs to be thoroughly appreciated. The notional values here are important b/c they are powerful indicator of the impact of default on the real economy [1]. The impact is in fact so great, that the Fed is willing to print trillions and trillions of $$$ to save financial systems from their failure. But a maxim of economics is that "There ain't no such thing as a free lunch." And right now our government is literally feeding the capitalists while watching millions of people go w/o food, housing, health care. It's egregious injustice and insult to people of Enlightenment everywhere.
The systemic risk argument is absurd. The risk posed by any financial asset is not distributed uniformly across the economy. Its impact on any party is proportional to their direct and indirect exposure to that asset, which is something that they control and have to take responsibility for.
In the absence of the government bodies that socialize the losses of irresponsible actors, those actors who take on imprudent risks would see the share of the financial market that they control steadily shrink at the expense of those who do not.
The suspension of this market feedback mechanism is what increases the risk of financial crisis.
For example, the FDIC has been found to stimulate risk-taking and thereby contribute to more systemic risk and more frequent and severe financial crises. [1]
For another example, in the wake of the 2008 financial crisis, well-capitalized players like Walmart, which was expanding its banking activity via its Sam's Club lending, were well positioned to replace the incumbent Wall Street firms as major lenders, but that was forestalled by Congress and the Federal Reserve socializing the losses of the major financial institutions with a bailout and prohibiting nonbanking parties from providing banking services. [2]
>>And right now our government is literally feeding the capitalists while watching millions of people go w/o food, housing, health care.
Agreed. The Central Bank is an engine for corruption and centralization of power. I disagree that the solution is more cookie-cutter rules that violate the freedom to contract and centralize power in the hands of powerful regulatory body subject to regulatory capture - which very well could have been the principal factor behind regulators stopping Sam's Club from expanding its lending activity, considering the banks' lobbying activity against it.
The solution is to stop creating moral hazard with a Central Bank that holds the exclusive power to create the national currency and allocate it to the private parties of its own choosing.
That's why I said "in principle". In practice, plenty of fraud/miscalculation/complicating-factors exist. I was simply arguing that derivatives are not, by virtue of their fundamental properties, illusionary or non-productive wealth.
They do mark the vast majority of it as "notional". As you say, that notional value is immaterial: it doesn't actually correspond to anything of value, more akin to you and I writing each other quadrillion-dollar IOUs.
It does, however, give a kind of hint at why derivatives have such an outsized effect on the economy. People treat that fake money as if a tiny amount of it were real -- like getting a bank to loan you ten grand backed by my quadrillion-dollar IOU. It can easily become a tail that wags a dog, especially since it's so volatile -- it can evaporate in an instant.
It's almost Heisenbergian -- the net value is indeed zero, but somehow it manages to make a tiny difference anyway. It's only important because it's so vast.
For stock options, a vertical spread is a combination of buying and selling a put or a call.
I could buy an AMZN call expiring next Friday with a notional value of $300,000 (100 shares at 3000 strike) for $6,250. I could simultaneously sell an AMZN call with a notional value of $300,500 (100 shares at $3005) for $5,855. My net debit would be $395 with a max profit of $105 if AMZN closes above $3005 a share at expiration.
In the above I bought a call from someone with a notional value of $300,000 and someone else bought a call from me with a $300,500 notional value. I paid $395 for this setup that has a notional value of $600,500, but the most I could ever get back is $500, the spread between the strike prices.
Many thanks, I think I can now understand the initial comment; in the derivatives market, the underlying value is decoupled from the actual money value of the transaction, and the latter is negligible with respect to the notional value.
1. Futures are contracts agreeing to buy or sell some underlying asset at a future date (or exchange cash as though you did). If I am long a future someone is by definition short that future. Therefore the total net exposure is always zero. It makes no sense to add my long future to your short future and decide that the total exposure is 2.
2. Swaps are contracts where we agree to exchange cashflows based on some reference amount. The most common types of swaps are interest rate swaps and an example might be a fixed-for-floating swap where you agree to pay me fixed interest (say 4%) and I agree to pay you floating interest (say 3 mounth USD LIBOR plus 200bps). The notional of a swap is the amount we use for the calculation of this interest payment. It really isn't an amount that's used for anything else - you don't owe me the notional and neither do I owe you that. It's just a multiplier we use when we transfer the net difference between the two rates. It therefore makes no sense whatsoever to add up the notional of swaps contracts. Also since we exchange the net difference the notional can be pretty large and the net cash payments pretty small.
3. Credit default swaps are similar to IR swaps except one of the legs of the swap pays out based on certain "credit events" (typically defaults and/or downgrades) on an underlying "reference obligation" (usually a corporate or sovereign bond, but can be an ABS or probably some other stuff). Since different CDSs are based on different underlying reference obligations, adding up notionals of different CDSs makes as much sense as if I say I have 10 dollars, 2 matchsticks, a ball of fluff, a ferarri and a dog so you say I have 15 things. Well I suppose so but it doesn't really mean anything since the things themselves are very different in nature.
When you apply this same standard to bitcoin and other cryptocurrencies, it becomes clear that it doesn't matter that only a few percentage of it is used in transactions because that's just the m0 supply, m1 for larger transfers, and m2 for large investments when desired. So it doesn't make sense for that to be an argument against cryptoassets as a money surrogate, when it actually is acting like all other currencies in that regard.
That doesn't mean there aren't stronger arguments, its just that people gravitate towards weak arguments.
Just giving money doesn't necessarily help; see for instance the failure of foreign aid to Africa: https://www.lejournalinternational.fr/Foreign-aid-is-hurting.... Supporting development requires creating the institutions and providing the education to support participation in the modern economy, as Asia has done over the past half century, lifting hundreds of millions of people out of poverty into first-world living conditions. Free money can actually be detrimental to this: for instance the https://en.wikipedia.org/wiki/Resource_curse , where countries with easy income from significant natural resource wealth actually experience worse development outcomes.
"[..] countries with easy income from significant natural resource wealth actually experience worse development outcomes."
They develop worse outcomes because all the profit goes to a few extractive elites in the country and in foreign powers.
Foreign aid has, I think, a very efficient path to try: just give unconditional money, not strings attached, to the poorest people of the country. You are helping the people that more need it, they know exactly what they need, and they will expend the money in the local economy. See for instance https://en.wikipedia.org/wiki/GiveDirectly
I think that’s akin to (pardon my analogy) feeding wild animals: Do it long enough and they become more dependent on you.
I think money is better spent on education and infrastructure, so that value can be created by them eventually, not passed to them indefinitely.
Another way to put it: What if your parents raised you exclusively by feeding you and giving you shelter? What happens when they die if you can’t feed yourself?
"I think money is better spent on education and infrastructure, [..]"
The problem that we are discussing here is, precisely, how to give education and infrastructure efficiently to people that live in some of the poorest places of earth.
As an example: Givedirectly[1] have a program that give direct transfer cash to the poorest people in Kenya, Uganda and Rwanda. They make research about how effective this is and you get some reports back about what people do with the money.
Do you know in what they spend the money? education and infrastructure.
The common themes are: paying the school bills so their children can keep going to school, a cow or seeds so they can start a small business, and (the one I never could predict from my urban European perspective) a metallic roof so water don't come into their house when it rains.
Even if some people could misuse the chance, and that's unavoidable, humans being so diverse, the important thing is the efficiency of the program in its totality.
This theory that poor people just would stay at home drinking the money can be tested. In most cases, the theory has been falsified.
Roofs aren’t infrastructure. Giving money to private schools just helps them raise the price.
We should sponsor public K12 education so that parents never have to “afford” sending kids to school and can work instead of having to care for their children. Then they can spend that money on fixing roofs and buying food.
This chart compares wealth and market cap in a way that makes literally no sense. This doesn’t represent the size of the money supply at all. A ton of things are double counted.
Under the Global Wealth heading, in the sidebar it shows a Chinese flag and next to it says "Wealth: $63.8 trillion; Number of Millionaires: 4,447 (in USD terms)". What is that second number? Surely there are more than 4,447 people in China with wealth greater than 1 million USD.
I remember the large size of derivative related to the normal economy from this visualization. If we ever get a derivative bubble in the future, we will probably need to rebuild the economy from the ground up. Why? Because the derivative market is so large in comparison to the normal economy.
