647,762,000,000,000 Reasons to Worry: The Derivatives Time Bomb


by John Galt
June 3, 2012 19:10 ET


The hits just keep coming and with $647 trillion reasons to worry, aka, the total notional derivatives now outstanding as of Q4 in 2011 per the Bank of International Settlements just released this afternoon and published officially on Monday (click here for the PDF of the full report).  The really, really good news is that our Federal Reserve has this completely under control and the trillions of dollars in Credit Default Swaps (CDS) and European Interest Rate Swaps will as always settle without concern.




Of course the problem is that as one can see in the graph above, the amount of Gross Credit Exposure has returned to 2008 levels, something the world might want to pay attention to. Once the lessons of the mistakes of the past are ignored, the risk factor increases proportionally and with Europe teetering on the edge of a Lehman event, the increase in interest rate derivatives might well indicate a new risk that has not been accounted for:


A sudden collapse of the Euro currency below the 1.20 or even parity level.


Such an event would make Lehman look like a picnic but there is more bad news beyond that as it is not just interest rate derivatives that have increased past 2008 levels as the chart above demonstrates, but some idiots placed bets on the currency markets which means that a collapse of the Euro creates an irreversible game of dominoes and destruction:


The good news is that the $23.235 trillion in Euro derivatives is down from Q3 to Q4 2011. The bad news is that since Dec 1, 2011, the Euro has plummeted in value:

Unfortunately for us common folk, no one has taken the time to explain the implications of a 10, 20, or even 30% decline in the value of the Euro versus the US Dollar in a compressed time period. This is one warning sign of many from the report but the other one is more mundane and ties to the Federal Reserve’s mandate, er, unwritten mandate to support the U.S. equity markets by laundering money through its member banks to purchase stocks and give the illusion of a strong economy.


Why do they need to do that?


This means that over $4 trillion are tied up in derivative contracts of every sort in the European and U.S. equity markets. Granted, this is the “notional” total but nobody has ever run a scenario, at least publicly, of what would occur when the major equity markets of the world collapsed at a 20% pace along with a credit event, aka Greek withdrawal from the Eurozone, and an economic slowdown in the Western world. This could indeed mean the worst is still ahead and the report also highlighted a major point as the Financial Times reported tonight:


Cross-border lending falls sharply

(Click on the link above to read in full; registration required)


Excerpted from the above article by Norma Cohen:


Data from the Bank for International Settlements due to be released on Monday shows aggregate cross-border claims, generally loans, of banks fell sharply, seeing a drop of $799bn from levels of the previous quarter, amounting to 2.5 per cent of lending.


Within that, the biggest drop came from lending to other banks which fell by $637bn, or 3.1 per cent.


Cross-border lending to banks in the eurozone periphery continued to contract sharply – commitments to Greece, Ireland, Italy, Portugal and Spain dropped substantially.


This means that the world is turning to the Bank of England which needs to reflate again to save the British economy which is flailing, the Japanese Central Bank which is trying to decontaminate a deflationary economic disaster expanded by the tsunami and Fukushima disaster, and the United States Federal Reserve which has no clue of a what course of action to take to prevent a short term sharp recession. Thus the logical conclusion is that the people who made the mess in 2008 and are supposed to fix this problem in 2012 still have no clue whatsoever for a solution to the problems in Europe and around the world.


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