Debts & the Financial Bubble

“The truth is that nobody really knows. There are many different agencies and exchanges, which report statistics and an ever-expanding list of derivative financial instruments. The BIS publishes estimates of the total size of the market in its annual report, but its data are incomplete and six months out of date when they appear. Because derivatives contracts are denominated in a variety of underlying currencies of financial assets, the standard measure of size is the notional, or contract, amounts are one way of measuring the outstanding stock of derivatives, they are not necessarily meaningful measures of the actual risks involved. The degree of risk for many derivatives varies both by the type of product and by the type of risk being measured.

The BIS end-year data show the aggregate size of the main financial derivatives markets (interest rate, currency and equity options, futures and swaps) as $1.1 trillion at end 1986, S 4.2 trillion in 1989, $ 6.9 trillion in 1991 and $ 7.5 trillion in 1992. However, the Federal Reserve Board of New York published data in July 1995 showing the total derivatives market value as $10.2 trillion in 1990,  $ 14.0 trillion in 1991, $ 17.3 trillion in 1992 and $ 25.1 trillion in 1993. The difficulty of measurement has not eased in recent years. The BIS estimated that the total outstanding notional value of derivative products was about $ 55.7 trillion at end March 1995, comprising exchange traded derivatives of $ 8.2 trillion and OTC derivatives of $ 47.5 trillion. Unofficial estimates suggest that this figure had swelled to between $ 50 trillion and $ 100 trillion by the end of 1997 in round figures, the latter figure represents a 40 percent annual compound growth rate since 1990.”

“One of the most important insights into the 1990s concerns the substandard economic performance of most developed countries in the west. During the 1980s, rapid debt growth was an expression of confidence in our economic future; there seemed to be plenty to show for all the borrowing. In the 1990s, the borrowing binge has been no less frantic, but the economic returns are much reduced. The huge expansion of public debt has not been associated with a noticeable improvement in economic performance. All that the Anglo-Saxon and some continental European countries have to show for the credit expansions of the 1990s are the huge improvements in the valuation of their bond and equity markets. On the contrary, the increase in overall indebtedness has constrained and complicated national and personal economic life. A turning-point in the exposure of our foolish attitudes to debt will be an open admission of economic failure.”

“The story of the western financial system since the early 1970s is one of debt addiction. In the Anglo-Saxon countries, access too affordable forms of borrowing has risen exponentially, encompassing the young as well as the old, the feckless as well as the astute. In other developed countries, conservative attitudes to personal borrowing have been negated by profligate attitudes to public debt. Even as the agonies of Japan’s debt-induced calamity are being re-expressed in East Asia, western governments insist that all is well. However, the absence of serious inflationary problems during the 1990s does not prove that the debt addiction has been broken. Rather, there is persuasive evidence that the problem has migrated elsewhere. Over-emphasis, too the point of obsession, on the inflation objective has blinded governments and their central banks to the risk of widespread debt default by borrowers. The unpreparedness of the western world can be understood only in terms of ignorance. Most of those under 50 years of age hold only a small proportion of their assets in the form of cash and deposits. They do not appreciate how fragile the financial system has become, nor how easily the investment gains of many years could be forfeited. One day the mist will clear and the collective delusion of effortless wealth creation will be shattered. Until that day, we are living on borrowed time.

 “The credit and capital markets have grown too rapidly, with too little transparency and accountability. Prepare for an explosion that will rock the western financial system to its foundations.”                                    

Excerpts from Debt and Delusion, Peter Barberton, Allen Lane/The Penguin Press, 1999, pp. 112-113

Source: Contemporary Economic Challenges and Islam, Khurshid Ahmed. Republished with permission.