The Problem of Financial Derivatives

Financial derivatives are securities whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. The most common types of financial derivatives are futures contracts, forward contracts, options and swaps.

In order to understand the enormous size of these derivative (paper) contract market, please take a look on the following chart that originates from economist John Exter. All amounts presented are estimated approximations but should give you an understanding on how those "derivatives" relate to other existing assets of the world.

Warren Buffett has called derivatives as "Weapons of Mass Destruction"

Financial Derivatives


Another Picture That Says It All ...



Background

When the United States stopped backing dollars with gold in 1968, the nature of money changed. All previous constraints on money and credit creation were removed and a new economic paradigm took shape. Economic growth ceased to be driven by capital accumulation and investment as it had been since before the Industrial Revolution. Instead, credit creation and consumption began to drive the economic dynamic.

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