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How globalized gambling started driving our lives

This entry is part 4 of 8 in the series Deriving Capital's Future

Technological advance and productivity gains during the past 200 years have led, by the last third of 20th century,t o huge accumulation of capital in the hands of a very few. The market based allocation of resources model started taking more and more bizarre forms and now ends up as an organized gambling by the richest 1% with the lives of billions and the future of our entire planet.

Derivatives are central to this gambling in financial markets. Through this gambling, the rich siphon away more and more wealth from nations and peoples.

To make sense of medical insurance, vehicle insurance, home loan rates, interest rates, stock prices, currency movements and a whole lot of modern capitalistic attributes driven by these financial gambling, understanding the logic of derivatives is imperative.

Read on for the 4th part of analysis of derivatives market by Dick Bryan and Michael Refferty. This was originally published in Socialist Register. We are publishing the tamil translation of the same along with the English text (for reference) for our readers.


Derivatives on money

insuranceDerivatives relating to commodity production and trade have a long history. The era of financial derivatives awaited the last third of the 20th century. Prior to then, many sorts of insurance markets developed rapidly in the 19t century, but commodity money in the form of gold and/or silver saw fairly stable exchange rates, and hence no demand for exchange rate hedging. Similarly, modest use of debt by industrial capital and moderate changes in interest rates saw little need for interest rate derivatives. The same could be said, broadly, of the post-Second World War Bretton Woods Agreement, where fixed exchange rates and national capital controls occluded the development of financial derivatives: both the need and the legal conditions. Indeed, many forms of derivative began life or were resurrected as an attempt to escape the constraints of national capital controls, and in so doing contributed to the de factor breakdown of the Bretton Woods regime.

Derivatives relating to money (currencies and interest rates) emerged from the 1970s. From the formal end of the Bretton Woods Agreements in 1971, the world’s exchange rates progressively floated, many national capital controls were lifted and international price stabilisation schemes were abandoned. The free-market economists, who provided the intellectual foundations to floating rates and open capital markets, had argued that floating rates would be stable because they would reflect ‘fundamental value’: roughly, the ‘real’ performance of each national economy. This performance would change gradually and accordingly exchange rates would shift only slowly. It is a conception of markets that was, no doubt, misconceived theoretically but, more critically, it played out empirically quite differently. Foreign exchange markets were not stable: indeed they became highly volatile and beyond prediction. Moreover, the concurrent growth of Eurofinance markets meant that borrowing and lending was occurring at a rapidly-increasing rate across nations, and at interest rates and exchange rates that differed from those of ‘official’ markets.

bretton-woods-systemThe combination of volatile exchange rates and increasing development of global debt markets saw the growth of foreign exchange and interest rate derivative markets to provide private hedging against these new exposures to the uncertain future value of different forms of money. Increasingly, the precise modes of calculation they required and generalized also revealed opportunities for arbitrage across spatially differentiated markets. Developments in computer technology and the ‘science’ of derivative pricing models were integral to this expansion.

Accordingly, from the early 1980s markets trading financial derivatives grew rapidly. They grew as sites of hedging, where capital could trade the risks and uncertainties of future exchange rate and interest rate movements – movements that could have profound impacts on profitability. As highly liquid markets trading price exposures not underlying assets, derivatives provided fertile space also for speculation. Not just hedge funds, but industrial corporations and financial divisions too have, on an increasing scale, maintained financial divisions through which they trade in open positions, all with varying success. How large a proportion of the market is made up of speculation is difficult to measure. Hedge funds are widely castigated for their role as speculators. It is worth recalling that, although they have been growing rapidly since around 2002, in 2006 they still held only 2.5 percent of all funds under management.19 Yet as active traders, hedge funds account for significantly more than 2.5 percent of transactions – the figure in some markets has been as high as 50 per cent of transaction.20

The growth of derivative markets from 1987 to 2009 is shown in Figure 1. It shows data for the three largest derivative products: derivatives on money (interest rates and currencies), credit derivatives and equity derivatives. They are shown as a measure of the value of outstanding contracts at year end.21 The figure shows an aggregate rapid rate of growth to a value of almost $415 trillion in 2009. Despite popular predictions in the height of the crisis, that derivatives generally had turned toxic, we see that they continued to grow, albeit at a slower rate. Credit derivatives are a notable exception, to be considered shortly.

Figure 1 – Global Financial Derivatives Market, Notional Amounts Outstanding, 1987-2009, US Dollars, billions

derivatives-figure-1With the most critical risks for the global expansion of capital relating to the uncertain value of money across space and time (exchange rates and interest rates),23 it is not surprising that the predominant trading activity and growth over the past 3 decades has been derivatives on money: interest rate and exchange rate futures, options and swaps.24 Indeed, so great is the dominance of derivatives on money that Figure 1 it has been necessary to present money derivatives on a different scale from the other derivative forms. In 2007, for example, the outstanding value of derivatives on money (almost four hundred trillion dollars) was 6 times the value of credit derivatives and almost 40 times the value of equity derivatives.

beyond-bretton-woodsBy 2009, with credit derivatives halving, that dominance was even greater.

Derivatives on money are reasonably straightforward. But our earlier definition(s) of derivatives were framed so as to engage innovation in the way the logic of derivatives is applied to wider social and economic life. While interest rate and exchange rate derivatives remain quantitatively dominant, there were concurrent developments in the other forms of derivatives. These were the acts of segmentation, quantification and commodification we referred to earlier. They have become more conspicuous and extravagant in the imagination of new ways to identify and segment risk. In financial markets where institutions are looking for yield and to diversify asset portfolios, these new products were especially attractive. We can classify them in two categories : derivatives on assets and derivatives on income streams, although many derivative products work to blend these attributes.

From analysis of derivatives markets  by Dick Bryan and Michael Refferty. originally published in Socialist Register vol 47 in 2011

Series Navigation<< A cut from our electricity bill goes to gamblers!They own your loans, your income and your life – how to take it back? >>

Permanent link to this article: http://new-democrats.com/deriving-capitals-future-part-4/

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