Zerohedge has a technical discussion of why hedge fund manager David Einhorn’s call to ban Credit Default Swaps is essentially a call to dismantle the entire fiat money system. Some of the details elude me, as they’re very technical, but the rest seems right to me. There’s no inherent difference between a credit default swap and, say, an interest rate swap, of which there are many more. So Einhorn’s demand is in effect a demand to ban all derivatives…
“Remember the liquidity pyramid?
As the graphic shows, derivatives account for 1,000% of world GDP, in essence allowing the world to believe fiat money is worth something only courtesy of financial sleight of hand which involved derivatives and securitizations. Yet all those calling for an end to CDS also have to realize that due to CDS intertwined nature, the world fiat system would need to do away with all derivatives (not just CDS), and when you do that you basically eliminate the other hybrid asset classes: securitizations being chief among them. What this would leave us with is a liquidity pyramid which ends with bank loans, which are much more manageable and whose risk can be controlled. It would also leave the world with a fiat currency system, which would lose about 10x of its value overnight, thereby leading to an instantaneous and global unwind of fiat money, and rolling waves of domestically denominated hyperinflation. A spectacular race to the bottom of the asset pyramid. And who will rather commit suicide than see that happen: why the Federal Reserve of course.
Which brings us full circle: an attack on CDS is an attack on excess liquidity, which is an attack on the global asset/liability imbalance (as world GDP and otherwise output has no chance of catching up with the liquidity that is currently available), which is an attack on fiat money, which is an attack on the perpetually low price of gold (because if and when derivatives and securitizations are done away with and tangible assets regain their true value, gold would go up by at least the same magnitude that fiat currencies are devalued), which is an attack on the heart of our broken financial system itself, and, an attack on the Federal Reserve, the Fractional and Central Banking System in principle. Well done David.
We hope Einhorn is successful in bringing more people to understand not just what the risk implications of CDS are (while also demonstrating the positive value that they do in fact provide in a rigged and broken capital market), but also what the underlying thematic subject of his attack really is: a busted fiat system. In essence, David believes in a fresh start. So do we, because on a long enough timeline…”
My Comment
Just to make it clear – I am myself not in favor of banning all derivatives. Why? Not because I think they´re profound innovations..or vitally necessary. But I think it´s the wrong way to go about tackling the problem. Banning one set of financial instruments will only prevent the smaller players from using them. The largest and best connected players will game the ban in some way, or make use of other sorts of compensating structures. A better way would be to undo the fiat money system altogether…
So my agreementis with Zerohedge´s assessment of the situation and not necessarily with Einhorn´s recommendation on that point.
Besides, Einhorn, who made his money off of CDS´s, is an odd person to be pushing a ban.
… which is an attack on Statism. Without the ability to magically create money at a whim, the State is almost negligible. [clink] A toast to optimism.
I wish.
Good message, but the messenger? Einhorn?
He made big money out of CDSs and now he doesn’ want them…sounds like Goldman revising regulations..after using them to their advantage..
So, yes, I agree. Maybe it’s a sincere proposal. And maybe it isn’t.
Let’s attack symptoms rather than diseases. That’s surely the road to a quick and sustainable fix!
(oh, wait…)
True- I don´t think banning is the way to go..I was assenting to the idea that fiat money needs to be reexamined (which is Dennis´point too)
Maybe I should put my comment up there..
I mainly posted it because I find it really odd that Einhorn is recommending this..
The reason I don´t agree with a ban is because usually its applied unevenly and the more powerful players than indulge in some other equivalent gimmick while the less powerful players are prevented from doing the same..
Lila,
I don’t agree with a ban because it’s not necessary, whereas ending fiat money and re-enabling free markets (by banning intervention) is necessary.
As well-intentioned as any “lesser evil” intervention may be, it will always play into the hands of the statists and the ones making the new rules. How naive does one have to be to not realize this yet (not pointing a finger at you)?
I am actually at the point where I may stop reading ZeroHedge because they’ve gotten entirely too self-righteous with their calls for Glass-Steagall, transaction taxes (Tobin Tax) and now a ban on derivatives… To rightfully call out all the disasterous interventions and their effects only to say “We need yet more” is so foolish I can’t bear to read it.
Not going to bother with another worn-out medical analogy. You don’t need to be a doctor, or even to play one on TV, to recognize an idea that is this stupid.
Hi Taylor..
Did you really expect Zerohedge to advocate anything else? Any blog sanctified by the MSM (and mind you, I like zero hedge, I just find some of the discussion a bit “stagey”…like all centrist liberal discussions…they always seem intend to end up fostering the status quo)
I tend to link stuff I find interesting..and I am willing to believe that derivatives are weapons of mass destruction.
I accept the precautionary principle and the principles based approach, such as Watsa suggests.
So rather than banning them, the best thing to do is to undo the system which
1. Gives anyone an incentive to come up with these things
2. Puts the power to use them destructively in the hands of only one set of players
Funny how liberals understand why bans don´t work in some other areas..
We need to reinstate professionals standard..
something clearly missing in all sorts of fields..from banking to journalism
Pingback: Deconstructing David Einhorn | LILA RAJIVA: The Mind-Body Politic
Dear Lila and other commentators/readers…
I’m not able to understand why a ban on derivatives(CDSes) leads to a 10x devaluation of fiat currency ? (I don’t have an opinion per se for now, but am trying to understand the issues).
Any explanatory comments that help me understand this better are appreciated.
Thanks
Anil
Hi Anil –
Here’s a very crude short explanation.
Derivatives:
CDSs are only one form of derivatives.
Derivatives magnify the movements of the underlying asset
Leverage
Most derivatives traded are highly leveraged – that is, with a small amount of actual cash, the borrower has acquired the ability to access borrowed capital and can control a much larger investment than he normally would.
Fiat Money (paper money)
Fiat money itself is a way of leveraging value – that is, despite very small underlying real value in the economy, the Federal Reserve is able to print paper money, which then also becomes the source of debt financing and leverage.
Take out derivatives and the debt balloon is punctured.
Hi mb4;
Thanks for writing. I understand (and agree) with all your statements until the penultimate paragraph, where one phrase in particular stands out.. (“..despite the very small underlying real value in the economy”)
Let me spend some time digesting that phrase – I need to ponder on that for a while to understand that statement better.
Many thanks again,
Anil
Hi Anil –
There’s a lot of confusion in the discussion of these things.
EG. People blame derivatives, but derivatives wouldn’t necessarily be a problem without leverage…
and what is leverage but a way of multiplying credit without increasing the underlying asset value..i.e. (in gross terms) without increasing the productivity of the economy.
We have a debt based economy in which the debt part keeps growing and outweighing the economy part..