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Economic Globalization and Speculation Coming Home to Roost

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With the current economic crisis which seems to be spreading across the world we are dealing with far more than a "subprime" crisis, or an attempt to "quarantine "toxic debt." There is a much bigger avalanche waiting to come tumbling down. Namely the derivatives market now estimated to be over $1 quadrillion (that is 1,000 trillion) in global derivatives holdings. That makes the current $700 billion bailout look like less than a drop in a very large bucket.

As the long predicted crash started unfolding, I have been nagged by a long sequence of events that seem to be culminating at the current moment. There have been significant structural changes in the U.S. and elsewhere that have impacted both labor markets, and capital. In terms of labor markets (also known as workers) the transitions have been stark. In the United States we have watched the long term decimation of the manufacturing sector and a transition to a "service" economy. I remember the concerns in the 1980's about the transformation of the U.S. economy from a production economy to a consumer economy. This trend was accelerated with broad implementation of corporate-driven globalization and formalized by the passage of NAFTA (North American Free Trade Act) and the rewriting of GATT (General Agreement on Tariffs and Trade).

These two international trade agreements were structured along similar philosophies. Namely the removing of "boundaries" to trade, and enhancing the "boundaries" around workforces. Those boundaries were national boundaries and national sovereignty. We saw the exportation of U.S. job (outsourcing and off-shoring) accelerate. We also started seeing the merger mania of the 1980s which have continued to the present. In fact, they are a prominent feature of the current crisis.

Other nations, in a competitive and revolving fashion, became the cheap, exploitable labor force for a global economy. China, maximizing on its single most abundant resource (people) successfully positioned itself as the cheap workforce for global corporations searching to always maximize profit. (Now they too import even cheaper labor).

All along this path towards removal of boundaries, there has been increasing financial and investment penetration in an increasingly intertwined global financial market.

Facilitating what might be framed as an integration of financial and corporate markets, the U.S. (and other nations) have engaged in almost three decades of deregulation and the removal of other boundaries and barriers - particularly in the "financial" areas. Insurance companies become investment marketers, banks become investment bankers, banks cash in on the lucrative credit market, credit card companies start offering mortgage financing. Functions and institutions that once had high barriers between them with regulation and oversight, became increasingly deregulated and shadowy. They pushed for, and got passed, barriers against predatory lending - like those pesky bankruptcy laws.


I can't help but thinking that (in part) we are seeing the "jobless recovery" of the 2001 recession coming home to roost. Lots of folks wrote about the jobless recovery including myself (What Jobs? What Recovery?) and even Ben Bernake (The Jobless Recovery). Most of us, myself included, focused on the restructuring of the economy at that time as a major component of what was going on. However, it was also clear that money was flowing from somewhere into the financial markets. Wall Street was recovering - the people (and workers) were not. This money flowing around was symptomatic of the liberalization of investment restrictions which was a major feature of international globalization.

Unfortunately while there was money being brought into the market, much of it was "little people's" money (i.e. money from state and corporate retirement funds). The little people's money provided grease for much bigger financial fish, and "derivatives" took a whole new life and growth spurt.

What the Hell are "Derivatives?"

Wikipedia defines derivatives:

Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The main types of derivatives are futures, forwards, options, and swaps.

The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a wide range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), residential mortgages, commercial real estate loans, bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) -- see inflation derivatives -- or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs. Unregulated Credit derivatives have become an increasingly large part of the derivative market.
If you don't feel particularly enlightened, you are not alone. One of the best articles I have found on the current derivative situation was written by Ellen Brown and published at Global Research. In "It's the Derivatives, Stupid! Why Fannie, Freddie, AIG had to be Bailed Out," Brown states:

The Anatomy of a Bubble

Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world. Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can "hedge your bet" that something you own will go up by placing a side bet that it will go down. "Hedge funds" hedge bets in the derivatives market. Bets can be placed on anything, from the price of tea in China to the movements of specific markets.

"The point everyone misses," wrote economist Robert Chapman a decade ago, "is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing."1 They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve "risk management." Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.2
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars - that's 1,000 trillion dollars.3 How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don't have, and that is where the huge increase in risk comes in.

Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the "protection buyer" gets a large payoff from the "protection seller" if the company defaults within a certain period of time, while the "protection seller" collects periodic payments from the "protection buyer" for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger's example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling "protection" on a risky BBB junk bond. The premiums are "free" money - free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.

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Rowan Wolf is an activist and sociologist living in Oregon. She is the founder and principle author of Uncommon Thought Journal, and a Senior Editor for Cyrano's Journal Online with her own page being CJO's Avenger.
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How do you think the world and governments should ... by Rowan Wolf on Tuesday, Oct 7, 2008 at 10:07:13 AM
I have no idea how any government can fix this bec... by Pat Dazis on Tuesday, Oct 7, 2008 at 1:38:29 PM
I agree that the people are likely to take a bath ... by Rowan Wolf on Tuesday, Oct 7, 2008 at 2:29:25 PM
It is my understanding that CDSs are the "ins... by Bernard on Tuesday, Oct 7, 2008 at 2:43:13 PM
Thanks for the addtional explanation and insight. ... by Rowan Wolf on Tuesday, Oct 7, 2008 at 2:53:06 PM
Laws have been tweaked over the years to permit al... by P. Orin Zack on Tuesday, Oct 7, 2008 at 2:44:49 PM
Helping the occupationally displaced is a humane s... by Rowan Wolf on Tuesday, Oct 7, 2008 at 2:55:32 PM
Thanks for the excellent and believable analysis o... by Irvthom on Tuesday, Oct 7, 2008 at 3:32:01 PM
Irv, I'd be honored. You have my permission.... by Rowan Wolf on Tuesday, Oct 7, 2008 at 9:19:06 PM
is a fitting description. The coming 10 years... by jeff prager on Tuesday, Oct 7, 2008 at 4:25:47 PM
Naomi Klein was horribly right in her book.  ... by macdon1 on Tuesday, Oct 7, 2008 at 11:56:56 PM
I thought I was the only one wondering how in eart... by Lover of Truth on Wednesday, Oct 8, 2008 at 1:29:15 AM
I don't even want to read your article, RW.&nb... by GLloyd Rowsey on Wednesday, Oct 8, 2008 at 6:45:07 AM
IF YOU CONTROL THE MONEY OF A COUNTRY YOU CONTROL ... by rich racer on Wednesday, Oct 8, 2008 at 6:54:33 AM
What to Do about The Troll under The Bridge? Po... by boomerang on Wednesday, Oct 8, 2008 at 8:56:28 AM
What's a troll look like, boomerang?... by GLloyd Rowsey on Wednesday, Oct 8, 2008 at 11:55:03 AM
 THEIR ARE INVISIBLE TO THE NAKED  EYE.... by rich racer on Saturday, Oct 11, 2008 at 4:43:11 AM