Precious metals guru David Morgan returns to address the great threat to the global financial/monetary system from derivative risk. He sees the world at an unprecedented moment in history where the interconnected nature of the global economy makes all players vulnerable to the mind-boggling volume of outstanding derivatives, which makes the sum of all world equity plus debt look tiny in comparison (if you haven't seen it yet, look at this visual from The Money Project):
I want to give a very clear example that comes from gaming theory and I think this is a very concise and easy way for most people to understand our derivative risk exposure.
There are all kinds of gambling programs out there but one of the simplest ones before any computers was: you are at the roulette table (or you could be wherever, but roulette serves as the best analogy), and you bet a dollar on black and you lose. Then the next bet, you bet $2.00 and you lose. And then the next bet, you bet $4 and you lose. And the next bet, you bet $8 and you lose. The idea is that you keep betting on black, and eventually that's going to come up and you're going to win on the roulette table. The problem with that is this. You start to bet 2 4 8 16 32 64 128 256 and on and on, and what you are doing is you are betting $256. For what? To win a dollar. That is what you are doing. And that, Chris, I think is the best example I can give to the listeners about what we are doing in these derivatives.
This is based on simplified "delta hedging" which is fairly easy to understand. But now you've got these mathematicians out there writing these derivatives that make the example I just gave you look like child's play. That's literally a fact. And these things are so interdependent and there is so much counter-party risk - that is, of course the biggest, issue - If you win the bet in the derivatives market, what happens if the counter party can't pay you? That's what happened in 2008. People still don't realize how close we were to the edge at that point because banks were not trusting each other or each other's paper. So they weren't trusting their counter-party. What happened was the Fed came in and said: Well, Bank A you don't trust Bank Bs paper; Bank B you don't trust Bank As paper - here's what we are going to do: I'll take your paper. The Fed is taking these worthless mortgages and saying: We'll settle in T-bills. You like those things, don't you? The answer is: Of course. What is better than a T-bill?
So then they settled out and, of course, this is where this whole expansion of the Fed's balance sheet has taken place over the past several years. Everybody is happy because you have paper you can trust. But what happens when you don't trust government paper? And Chris, that is really what is happening now. If you look at the foreign markets ,what has been going on is they basically have been dumping the dollar. The exchange stabilization fund has come in and sopped it up so it's not transparent to the markets unless you really know how to dig deep.
We are, in my view, in a place where the world has never been. We are on the precipice of a situation that is global in scope and - for all practical purposes - is going to affect almost everybody on the planet.
In this podcast, Chris and David also discuss the upcoming Solutions Conference in Las Vegas on February 22, where they will both be featured presenters. Those looking for more information about attending that conference can find it by clicking here.
Click the play button below to listen to Chris' interview with David Morgan (49m:51s)