What are derivatives and why we should know what they are.


What are derivatives and why we should know what they are.  

By Andrea Cecchi - 18/10/2020

Do you know what derivatives are?

No worries, most people don’t  what derivatives are . But it would be good to know, because everyday reality is permeated by it. What exactly do I mean by this?

Here’s  an example. Follow me in this brief reasoning. I will try to explain it as simply as possible.

We all use money on a daily basis for purchases. But just how does money come into existence?


 (re-read the above sentence several times until it sinks in)

Thus, we can say that money is a unit of debt.


1)      MY DEBT


Having understood this fundamental step, that is, that money is  debt, let's now move on to understand the next step: INTERESTS ON DEBT GROWS.

Why is it important to understand this?

Because the interest rate that the banks apply is calculated with a formula that is based on a derivative, for example the IRS (interest rate swap) and here it can become confusing and rather difficult to understand.

I'll give you an example: I take out a mortgage to buy a house and the bank pays me the sum by creating the money out of thin air with an accounting entry. “To determine what interest rate should be applied to a traditional fixed-rate mortgage, the percentage value of the IRS comes into play. The Interest Rate Swap is the agreement stipulated between the bank and a speculator willing to take a risk. These financial agreements determine an annual average figure ”. That money I get is my debt, but once I transfer it to the seller, that money becomes his cash with which he uses for purchasing. In the example of the sale of my home, my debt becomes the circulating liquidity that the counterparty can decide to put into circulation in the system, by spending it. On that amount , which is the money that we see with our eyes and that we touch with our hands, interest accrues (which we do not see), calculated according to the formula of the IRS, which is a swap, a derivative. So, every time we look at a $ 50 banknote, imagine seeing on the back, the ingredients, like those on the a pack of biscuits, “This banknote contains: paper, ink, debt, highly toxic derivatives and derivatives that can cause very serious side effects ".

So we can safely say that our everyday life is permeated in every aspect by very complicated financial transactions that are called derivatives. The interest rate derivative called IRS is just one of the many contracts that form the basis of all economic functions in the world. Below is an article that I’d  cut out from the Financial Times of June 29, 2007, when the subprime mortgage catastrophe was already boiling in the pot.

We can have fun doing a simple exercise: ask the people we meet if they know what a derivative is. (I also enjoy asking who knows the difference between debt and deficit). Nobody knows. Then imagine who could ever be able to competently list and explain the derivative contracts listed above, which are only a small part of a complex galaxy.

Given the transversal importance of derivatives, which are a primary component of the money we use and therefore of our lives, I think it is a good thing to have at least a little smattering of the subject and I hope to succeed with this newsletter.

I wrote about derivatives in my previous newsletters:

With this newsletter I hope to be able to explain the topic well. This is something that you absolutely must understand. So the following is very important because it is the foundation on which the whole global economic system is built: the mountain of derivative contracts! What is underway now is a maneuver called "GREAT RESET" with which the states of the whole world have agreed globally, with the excuse of the synthetic virus, to try to defuse the counterpart disaster due to the huge catastrophe that would overwhelm everyone in the event of deflagration of the neutron bomb contained within the world of derivatives. As when a nuclear reactor is about to explode, so-called "containment" procedures are put in place promptly. In our case, the containment procedures were the freezing of the basic real economy with lockdowns and the printing of unlimited money, to be thrown over the leaks of derivative contracts, precisely with the aim of obtaining containment.

So please! Follow me a little longer because it's worth it, so everything will be clearer and more understandable.

Derivatives are bets made in most cases with borrowed money.

They are bets, as we have seen, made on interest rates, but also on foreign currencies, on stocks, on the bankruptcies of individuals and companies, and even bets on bets.

Bets are placed by banks among themselves, between banks and brokerage agencies, between brokers and hedge funds, between hedge funds and banks and others.

They often have a high risk rate and are gigantic in size.

According to the Bank for International Settlements (BIS) the whole world is burdened by a stack of OTC derivatives of 640 trillion ( A figure closer to reality, counting all the contracts as a whole, would be, according to some analysts, to be 2.2 quadrillion or 2.2 million billion. If we consider even the single figure of 640 thousand billion, these already correspond to over 10 times the G.D.P. of the whole world. The fact is that no one knows how much the entire value is, they are estimated figures, because derivative bets are in most cases private deeds. For example, when the derivatives that drowned the bank of  Monte dei Paschi of Siena came out, we discovered that they were two privately written contracts between MPS and Nomura and MPS and Deutsche Bank that were inside the personal safes of the managers of the respective banks and no supervisory body was aware of it.

It all came out later after the fact. When the purulent lump had already burst. Just like the Dukes' bet in the masterpiece film “Trading Places”. (This film is fundamental. It suggests that in the highly speculative financial world, a bet that has an opposite outcome (Valentine instead of Winthorp) can have catastrophic ripple effects. In the film, having bet on Valentine involves, due to the daring vicissitudes of the protagonists, a reverse reading of the data on orange juice futures and the collapse of the Dukes investment house). The picture below shows the representation of an OTC contract. It's clearer now right?

But let's go back to the colossal numbers of the hyper - speculative world of derivatives. Derivative "fans" argue that these figures have nothing to do with the real risk they represent as the majority of players bet borrowed money. To better understand how they work, consider this example: a player goes to Las Vegas and wants to try his luck on the roulette wheel, but not risking all on one thing, so instead of putting money on random numbers, he bets a little on red and a little on black; a little on even, a little on the odd.

He rarely wins more than a fraction of what he has played, but likewise he rarely loses more than a fraction anyway.

Banks like Citigroup or Deutsche Bank also do the same thing with derivatives, but with some substantial differences:

1. You do not bet against the dealer. In fact, there is no bank to bet against, instead in the game of derivatives you bet with the equivalent of the other players around the casino table.

2. Even if the bets are balanced, this is not the case with the same player. To go back to the roulette example, if Citigroup bets red against one player, it can bet black against another player. In the end the bets are balanced (red = black), but the individual players are not… not at all!

3. As mentioned earlier, the stakes are frighteningly large, millions of times over all casinos in the world combined.

Here is the question that still has no answer:


What happens if the player doesn't have the money to pay the bet?

This statement does not come from a catastrophist bird of ill omen, but from the director of the International Monetary Fund, the speech he gave  speech in Washington:

 "The failure of Lehman is a signal that global collapse can come suddenly."

In the betting racket, the Mafia knows how to deal with the insolvency of losing players. In the underworld, betting revolves around bookmakers who are themselves part of an intricate system of subjects.

The system almost always works well but if one of the main bookmakers does not pay the supply chain is interrupted causing a chain reaction and everyone loses, both the losers and the winners, but what's worse, even the winners who were counting on winning from a part to make up for a loss elsewhere, they find themselves unbalanced and fall causing the whole system to collapse with them. To avoid this type of disaster, the Mafia knows exactly what to do and takes countermeasures very quickly. If a bettor doesn't pay, the first time he gets away with some broken bones in some dark alley, while the second time he might find himself at the bottom of the East River with concrete shoes. Unlike the Mafia, institutions such as the New York Stock Exchange and the Chicago Board of Trade operate legally but they also use “bookmakers” called brokers. Instant trading is banished ! But here's the trick. In derivatives, there are no brokers, no trading exchanges, no controls. In fact, of those millions of billions only 4.5% were traded on the stock exchange, the rest (+ 95%) are bets made directly between the parties: buyer and seller. In jargon we say “over the counter” OTC, which means at the counter, like in a bar, or in a clandestine gambling den. 100% of the world derivatives that B.I.S. claims to be 640 trillion are “over the counter” values. No stock exchanges, no controls, no rules. It is not simply a case of bad or non-existent discipline.

It is much worse, it is the equivalent of a conglomerate of players betting on the street without even a casino to keep order. The data provided by O.C.C. and by B.I.S., make us understand that if one of the players, even a less exposed player like Lehman Brothers, fails, this  throws the whole system into total credit paralysis. Deutsche Bank is enormously more exposed, which is why there is always an effort to Germany always and in every way possible. Why does Germany always get subsidized? Do you understand now why? Because if Deutsche Bank blows up everything else explodes!

That's why super investor Warren Buffett has called derivatives "weapons of mass destruction". If you count a dollar for every second, it takes 32 million years to get to one quadrillion ”.

We have now come to the end of this road. At the GRANDE CROCEVIA, as I wrote in the previous newsletter.

what  we are witnessing is the end of the previous monetary system and the changes taking place will be epochal. When technology has saved the elites, the day of judgment will come. Every man for himself.