For some time now I have been talking to my kids about the key strengths of democracy: a written constitution, basic rights and freedoms, the social contract and the rule of law. Ignorance is our greatest weakness. Unless we can understand and respect these fundamental foundations of the free world as well as how and why they were enshrined, we will not be able to see what needs to happen now to restore order, hope, common sense and sustainability to our system.
A few players and institutions have been able to rape the free world over the past couple of decades aided and abetted by falling taxation, a revolving door between government and investment banking, and disregard for principles of fairness, equality and the rule of law. The fuel for this destructive period has come from endless amounts of leverage courtesy of derivatives. The people designing, selling and commanding derivatives have been able to siphon out cash and liquidity and leave the rest of us with literally hundreds of trillions of IOU’s.
In just the past decade, the size of derivatives—financial instruments derived from or notionally based on tangible assets— have grown from an estimated 250 billion dollar market in the early 2000’s to now over 1.2 quadrillion dollars today. As a point of reference, all of the tangible real estate on planet earth is worth about 75 trillion dollars. 1.2 quadrillion dollars is the same as 1200 trillion. The entire global economy is about 60 trillion dollars. By building derivatives on derivatives, leverage on leverage, financial architects have been able to engineer seemingly endless amounts of credit providing liquidity to a world of endless desires, endless acquisition, and endless want. But life is finite, and so is planet earth. It is time to admit and embrace this.
Derivatives have allowed our collective debt to expand toward the infinite universe. Next they will be offering us derivative contracts based on a notional value of the planets in outer space. Actually given these numbers, I guess we have already mortgaged our own galaxy. Now we are working on a neighbouring solar system in the Milky Way. Of course that sounds crazy—but this is where we are.
We must rein in derivatives. We must start bringing the leverage back from the stratosphere. We have long passed the point of all reason. The world is now stifled by payments to service debts we can never repay. By enforcing transparency regulation, and practical limits on derivatives and leverage, we will end the ever expanding plague that is eating us. The endless line of credit must be closed or we can never find our way back to solvency. Once the line of credit is capped the zeros must start coming off, losses must be shared and leverage levels move back toward earth. Lines of credit for governments, banks, individuals, and businesses will all be lowered and capped. The destructive genie will be forced back into the bottle. Bad debts—those that should never have been lent, and that never could be paid—will be written off. Asset values will undoubtedly be written down. Balance sheets will once again reflect reality and reinstate adherence to the normal accounting rules which have evolved to serve transparency and fair disclosure in sound business for centuries. Assets will be valued based on free market transactions again, not model value gobbly-gook. Honest hard working business people will be measured and rewarded on respectable, objective standards. Fraudsters will be arrested and disempowered.
This next article may be hard to get through. Not because it is poorly written, it is excellent. It is one of the most articulate summaries I have read to date on what has happened in the world over the past 30 years to bring us to where we are today. It is hard to read because it is brutally honest and painfully true. But we owe it to ourselves and each other to read and comprehend. We have all participated to various degrees in facilitating this period of destructive history whether through actions, apathy or our own lack of discipline. Only in seeing the error of our ways and rebuilding our rules, governance and fiscal discipline can we find our way to a bright and sustainable future. Read: The Greek bailout provides an opportunity for privatization grab. Courtesy of John Mauldin, who writes the opening comments.