• Home
  • Why Invest In Gold?
    • Gold IRA Investing
    • Gold Backed IRA
    • Rollover 401k to Gold IRA Account
    • Why Diversify Your Portfolio?
  • The Best Gold Companies
    • #1 Augusta Precious Metals
    • #2 Noble Gold
    • #3 Goldco Precious Metals
    • Birch Gold Group
    • APMEX
    • Lear Capital
    • Monex Precious Metals
    • Gold & Silver Inc.
    • Rosland Capital
    • Goldline
    • Blanchard Gold
    • JM Bullion
    • Swiss America
  • Gold IRA Guide
    • How To Select The Most Trusted Precious Metals Company
  • Bitcoin Ira
  • Thrift Savings Plans
    • TSP Fund Performance
    • TSP Advice
    • TSP C Fund
    • TSP F Fund
    • TSP G Fund
    • TSP I Fund
    • TSP S Fund
  • Blog: Risk to Reward
    • Augusta Featured Articles
    • Noble Featured Articles
You are here :Home Risk To Reward Financial Weapons Of Mass Destruction: $500 Trillion In Derivatives

Financial Weapons Of Mass Destruction: $500 Trillion In Derivatives

June 9, 2017

All the way back in 2003, the ‘Sage of Omaha’, Warren Buffett had this to say about OTC financial derivatives in Berkshire Hathaway’s 2002 annual report:

“I view derivatives as time bombs, both for the parties that deal in them and the economic system. Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them.

But before a contract is settled, the counter-parties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands. Reported earnings on derivatives are often wildly overstated. That’s because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

The errors usually reflect the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid, in whole or part, on “earnings” calculated by mark-to-market accounting. But often there is no real market, and “mark-to-model” is utilized. This substitution can bring on large-scale mischief.

As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. The two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.

In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

(Report PDF: BH2002)

Of course, Buffett’s warnings went completely unheeded and five years later we were in the midst of the Great Recession, the effects of which we have yet to fully recover from. And while experts agree that the cause of the Great Recession were varied and complex, there is no denying that the large amount of OTC derivatives on the market had a major exacerbating effect, if not being a primary cause.

Without derivatives such as the Credit Default Swap (CDS), the crisis could at least have been relatively contained. Take a look at the chart below, which shows how the amount of CDSs outstanding peaked right before the recession.

The graph was taken from a National Center for Policy Analysis paper exploring the role of derivatives in the financial crisis (PDF). The paper concludes that credit default swaps amplified the boom and bust in the property markets. However, other pundits have more strongly argued that derivatives were the primary culprit in causing the financial crisis. The paper by Hera Research goes on to note that regulators appeared to not have learnt their lesson, noting that even as national debt levels continue to grow, the amount of OTC derivatives far outpaces it.

That paper from Hera Research was written all the way back in 2010, while the nation was still in the midst of the Great Recession. Seven years on in 2017, little seems to have changed. In a May 2017 paper, the New York Fed had a conference on “Derivatives and Regulatory Changes” since the Great Recession. Here’s a telling excerpt from a report on said conference:

“Though the notional amount [of derivatives] outstanding has declined in recent years, at more than $500 trillion outstanding, OTC derivatives remain an important asset class.”

Ah yes, at $500 trillion outstanding, OTC derivatives are merely an ‘important asset class’. Understatement of the century right there. At the height of the financial crisis, the total notional outstanding amount of the OTC derivatives totaled $600+ trillion, so a reduction to the $500 trillion level seems barely noticeable.

The report, which seems to be vying for most understated report ever, concludes with the following line:

“Possible further innovations to market practice and regulatory landscapes warrant consideration, given that OTC derivatives remain a significant part of the financial landscape.”

A significant part of the financial landscape indeed.

You might have also noticed that in 2005, the total outstanding was only just above $200 trillion. When Warren Buffett made his declarative statement, the total outstanding was under $200 trillion. And now, total notional value of OTC derivatives stands at $500 trillion, with $222 trillion of it being held by the Top 25 US banks. This, coupled with slowing economic growth and the fact that banks are also facing slowing lending growth could result in another explosive cocktail. And we haven’t even recovered from the first one.

Despite high investor confidence and business sentiment, the hard data simply does not back it up. That’s why intelligent investors are diversifying their portfolio into assets which hold hard value, such as gold and silver. The value of these assets is not propped up by derivatives and if the financial weapons of mass destruction explode again, you will be better prepared.

--

One of the easiest ways to get started protecting your future is with a precious metals IRA.

To learn more about the benefits of investing in gold & silver IRAs and other precious metals, see our comprehensive gold ira guide And when you're ready to select a trusted advisor, see our list of top gold ira companies and get in touch with experts in the precious metals industry.

Share on Facebook Share
Share on TwitterTweet
Share on LinkedIn Share

Filed Under: Risk To Reward

« Silver Push To $20 In Last Half Of 2017?
Bubbles And Bankruptcies: An Explosive Combination »
« Prev
Next »

2020 Top Companies

  1. 1

    Augusta Precious Metals

  2. 2

    Noble Gold

  3. 3

    Goldco

  4. 4

    Birch Gold

  5. 5

    APMEX

All Rankings »

Popular Pages

  • Top Gold Companies List
  • Augusta Precious Metals Review
  • Gold IRA Guide
  • Noble Gold Investments Review
  • Why Invest In Gold?
  • Bitcoin Ira

Other Metals News

  • On Buying The Silver Dip: Corrections Should Be Embraced, Not Feared
    by The Doc on January 17, 2021 at 4:00 am
  • Is An Oil Price Spike The Next Blow To The Economy?
    by The Doc on January 17, 2021 at 1:00 am
  • Biden’s Banana Republic And The One Trick Up His Sleeve
    by The Doc on January 16, 2021 at 9:00 pm
  • Stimulus-on-Steroids Cometh
    by The Doc on January 16, 2021 at 5:00 pm
  • GOLD PRICE TARGETING $2690 AN OUNCE
    by The Doc on January 16, 2021 at 1:00 pm

Risk to Reward: Finance Blog

  • Trump vs. Biden: How Will the Election Results Impact Gold? October 29, 2020
  • Gold Favored by Hedge Fund Giant as Defense Against Economic and Social Tumult October 17, 2020
  • Gold Is Spinning Its Wheels Right Now – and That’s a Good Sign August 28, 2020
  • Diminishing Prospects for a Quick Recovery Bode Well for Gold June 16, 2020
  • Experts: Economic Recovery Loaded With Uncertainty May 15, 2020

Why Precious Metals?

  • Why Invest In Gold?
  • Gold IRA Investing
  • Gold Backed IRA
  • Silver IRA – The Case For Silver
  • 10 Reasons You Should Invest In Silver
  • Bitcoin Ira

Other Pages

  • Finance Resources
  • Affiliate Disclosure
  • Terms Of Service / Risk Disclosure
  • Earnings Disclaimer
  • Contact
  • About Us
  • Privacy Policy
[footer_backtotop text="Return to Top" href="#"]

Copyright © 2014 - 2021 : IRA Gold Advisor

Augusta Precious Metals
Noble Gold Explainer Video
How We Rank Our List

At IRAGoldAdvisor.com we like to say, “We don’t rank sites, YOU do!” We combine a number of “trust factors” from on independent consumer protection organizations to arrive at our ranking scores.

We believe that companies with a lot of happy clients (positive reviews) who are able to keep complaints low (few or no customer complaints), are most likely to provide you with the great service you’re looking for. Companies with those “stats” rise to the top of our list.

Some of our ranking factors:

  • Rating with Better Business Bureau & Business Consumer Alliance
  • TrustLink “Star” Rating
  • Number of Positive TrustLink Reviews
  • Number of Other Positive Reviews (BBB, BCA)
  • BBB Consumer Complaints (deduction)
  • BCA Consumer Complaints (deduction)
  • Negative Consumer Reviews (deduction)
  • Length of time in business

Don’t forget to bookmark our list page and use it as a handy resource to help locate a great gold company.

Menu Title
  • Home
  • Why Invest In Gold?
    ▼
    • Gold IRA Investing
    • Gold Backed IRA
    • Rollover 401k to Gold IRA Account
    • Why Diversify Your Portfolio?
  • The Best Gold Companies
    ▼
    • #1 Augusta Precious Metals
    • #2 Noble Gold
    • #3 Goldco Precious Metals
    • Birch Gold Group
    • APMEX
    • Lear Capital
    • Monex Precious Metals
    • Gold & Silver Inc.
    • Rosland Capital
    • Goldline
    • Blanchard Gold
    • JM Bullion
    • Swiss America
  • Gold IRA Guide
    ▼
    • How To Select The Most Trusted Precious Metals Company
  • Bitcoin Ira
  • Thrift Savings Plans
    ▼
    • TSP Fund Performance
    • TSP Advice
    • TSP C Fund
    • TSP F Fund
    • TSP G Fund
    • TSP I Fund
    • TSP S Fund
  • Blog: Risk to Reward
    ▼
    • Augusta Featured Articles
    • Noble Featured Articles