<DrumBeat: July 8, 2009 The Oil Drum Peak Oil Day - July 11>

77 comments on CFTC - Futures Position Limits on Energy?

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Neil1947 on July 7, 2009 - 6:53pm Permalink | Subthread | Comments top

Nate,
global notional derivatives are in excess of 1,000 trillion, while global GDP is only $55 trillion
Is this relevant? By the nature of derivatives they are bets taken against each other, they are not physical products, when the 1000 trillion are added together, won't they become close to zero?

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Nate Hagens on July 7, 2009 - 7:02pm Permalink | Subthread | Parent | Comments top

No
a)they can be created just by a penstroke (via fractional reserve banking) - that used to allow 10:1 leverage on its own but de facto it is much higher than that due to dropping required reserve percentages, reducing the categories of funds needing a reserve and allowing funds to be swept from a reservable category to a non-reservable category overnight.

b)furthermore, if you and I each put up $5,000 margin for an oil futures contract, and you go short at $65 and I go long at $65 we collectively have $10,000 of capital controlling $130,000 of ostensibly offsetting positions. In theory - if oil moves $30 per barrel (up or down), one of us wins money from the other - but what if after your $5,000 is burned through, you walk away, owing the futures brokerage/exchange $25,000. Someone, either me or the brokerage is out $25,000. Multiply this example by millions of counterparties and positive feedbacks worldwide and you have recipe for disaster.

It is possible though that a large % of those contracts offset, but not likely. No one knows.

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Neil1947 on July 7, 2009 - 7:50pm Permalink | Subthread | Parent | Comments top

Nate,
Doesn't that mean that the counter-party risk is the $5,000 capital the contract buyer outlays not the $30,000, in other words in aggregate not the 1000Trillion but the actual amount of "non-leveraged" investment.? Surely it's possible to estimate this from the leverage ratio of specific investments?

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Nate Hagens on July 7, 2009 - 8:00pm Permalink | Subthread | Parent | Comments top

Not possible, but we have alot of clues. Here is equity as % of assets for some major banks at end of 2008:

I am in the (minority) camp that believes we have significant deflation before inflation -quant easing is drop in a bucket compared to credit destruction in real economy.

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Neil1947 on July 7, 2009 - 8:13pm Permalink | Subthread | Parent | Comments top

Nate,
Thanks, that very interesting, if those derivatives are not hedged or poorly hedged it's easy to see big financial problems quickly developing.

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PeakPlus on July 8, 2009 - 1:50pm Permalink | Subthread | Parent | Comments top

Hi guys,

Nate, I'm on your side. Japan's been "printing money" for almost 20 years now and know nothing of inflation. The deleveraging continues. It will take a long long time for paper money to catch up with "digital" money, especially with the demographic and peakoily situation.

Welcome to Kondratieff winter. Like in Narnia maybe a winter that will never end...
Well, will take a while to be played out:-(

Cheers, Dom

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css1971 on July 8, 2009 - 2:42pm Permalink | Subthread | Parent | Comments top

a 0% interest rate isn't printing money.

while true
do
 let MONEY = $MONEY + ($MONEY * $N)
done

Choose your value for N. Inflation can always be made to win in a fiat system. All it takes is for someone to stand up and say "I am going to make your money worthless.", then actually start doing it.

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PeakPlus on July 9, 2009 - 5:41am Permalink | Subthread | Parent | Comments top

"0% interest rate"
You're refering to Japan, right?

You're right, hyperinflation sounds so *easy*, but...

Please explain how to add money to the system in order to create price inflation (central bank / treasury). Why isn't it working right now?

Where did your $MONEY come from to multiply with inflation ($N)??

Fiat is not Fiat, meaning, it is not just "printed" without obligation. Instead, it is "borrowed" into existence. In the (Central Bank's) books "new" money looks like this:
Debit = Credit

Looking at your equation let's define:

$MoneyB + $NewDebt = $MoneyA + $NewMoney

Now, like a good Enron, wie act like we don't have any debt or say that our debt is part of the economy too and redefine: $MoneyB = $MoneyA + $NewMoney + $NewDebt, which will end in bankrupcy if there's no wealth behind that new debt. But that's not our question right now.

What we like to do in our economy is forget that the new debt ever has to be paid back:

$MoneyB = $MoneyA + $NewMoney

If this were the case, then inflation would be easy to produce. Then your equation could make sense. But what's happening now is not only new debt but also "deleveraging" ($DebtRepaid) and/or "defaulting" ($DebtDefault). Meaning:

$NewMoney = $NewDebt - $DebtDefault&Repaid
meaning:
$MoneyB = $MoneyA + $NewDebt - $DebtDefault&Repaid

Which tells me that inflation will ONLY occur if we make more debt than what is being defaulted and deleveraged.

Or is there a fault in my logic?

Cheers, Dom

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olepossom on July 7, 2009 - 10:10pm Permalink | Subthread | Parent | Comments top

IF you see John Mauldin around the fire in that camp, tell him Goober sayes hey. But that is pretty much what he said today: things are going to deflate for quite awhile. I want to believet that, but it is hard to reconcile delation with a debtor dominated democracy. Can't happen for very long, before the government just starts handing out money.

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WeekendPeak on July 9, 2009 - 1:45pm Permalink | Subthread | Parent | Comments top

Nate,
The net of all derivatives/oil contracts is ZERO. For every long JPM has there is a short somewhere (and vice versa of course).
Bringing the number of "paper barrels" in line with the number of physical barrels doesn't change that. The only way to make a tight link between paper and real barrels is to not allow offsetting transactions / netting but to require physical delivery of every contract. Obviously that would cause trading, and therefore to some extend price discovery, to grind to a halt.
WeekendPeak

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Nate Hagens on July 9, 2009 - 5:56pm Permalink | Subthread | Parent | Comments top

the net of ALL derivatives may be zero on paper but is not zero in reality, because much of the capital used by investment banks was penstroked into existence. It is not about oil contracts so much as it is about TOTAL claims in our system compared to real things. I talk about this all the time and must not be making myself clear - half the people get it right away and others continue to think it is a zero sum game - it isn't. The proof is that if it was announced that all derivatives/credit/loans/futures contracts etc. were to be settled next week, the world would be bankrupt (creditors far outweigh the amount of capital in system). It is true for oil and probably true for a large % of interest rate swaps etc. that they could be offset, but not the whole system - I doubt anyone knows how deep the system is in hock until we have a 'cancel all debts' jubilee.

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Dryki on July 7, 2009 - 9:33pm Permalink | Subthread | Parent | Comments top

Neil1947, you are quibbling over a detail irrelevant in the big picture

a system whose claims on the future are higher than its real assets.

The best governments can do - within the current paradigm - is print money to plug the holes on the balance sheets. That's not enough, however, to keep business running. The bankers know they cannot make loans expecting them to get paid back from real wealth; the only way they can make money now is to extend the printing and looting.

The pledges - the loans and bonds and social security and whatever - exceed Gaia's blood. Smart traders shut down or game the system.

cfm in Gray, ME

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hightrekker on July 8, 2009 - 1:42am Permalink | Subthread | Parent | Comments top

Exactly! These claims violate basic laws of the universe.

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andrew on July 7, 2009 - 9:27pm Permalink | Subthread | Parent | Comments top

Nate,
There is a possibility of systemic risk higher than just the percentage of non-offset contracts.

What if Neil1947 had also taken out a contract with me with him long at 60 (5k margin also), hedging the risk (and limiting his payout if the price does rise).

Neil would consider himself "offset" -- theoretically he can't loose (or gain) more than 5k.

The problem is if I then reneg on the 20k difference that the large swing puts me out, Neil is then suddenly exposed to the risk, possibly causing him pass this loss onto you.

These "offset" contracts are only as good as the person at either end of the chain (mitigated by the margin at each step of the chain, and the cash reserves of each player in the chain).

The problem is that it is this extra systemic risk which is quite hard to quantify - what is the correlation between bankruptcies of non-offset traders, and people who hedge themselves? -- i would imagine quite low, until a critical threshold is reached which burns through the intermediate cash reserves, then it would become highly correlated. To my (non economically trained -- i've a BSc, not a Becon) mind this would seem to be the largest non-linear risk within the current financial system. We've haven't seen this happen within mortgage securities; there wasn't much hedging, just complete on-selling, with the insurance companies having insufficient capital to cover the difference in value.

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robert2734 on July 8, 2009 - 2:02am Permalink | Subthread | Parent | Comments top

On an exchange traded contract, the exchange takes the credit risk. The exchange also sets collateral levels and maximum daily price swings. They'll sell out your position long before you owe them 20 grand you don't have.

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Engineer on July 8, 2009 - 9:14am Permalink | Subthread | Parent | Comments top

Maybe. This assumes that the market is moving slow enough that they can keep up. In a rapid dislocation, they might not be able to find a buyer before they are under water. Even with max daily swings, if they can't find enough buyers at the right price, someone is going to eat a real loss.

Think market panic.

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77 comments on CFTC - Futures Position Limits on Energy?

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