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The Risk of Collapse of the World's Economies

This is one of the more contentious risks to continuing our prosperous first-world standard of living. The two most often used problems in economics relate to Fiat Currencies and Derivatives and surprise, surprise both relate to the continued value of the US Dollar and its place at the pinnacle of world currency markets. To give you a quick example all the worlds oil is bought and paid for in US Dollars. It is estimated that if this were to change the US Dollar would fall by about 40 percent. Interestingly, IRAQ changed to the Euro in 2000 and contrary to expectation made a significant profit from doing so. This success led to other Arab nations also looking at swapping to the Euro, something the US could not allow, and is perhaps a significant factor in the US decision to remove Saddam.

All the around the world we are seeing the collapse of major institutions, HIH, Ansett, OneTel in Australia; Enron in the US just to name a few. Even venerable institutions like the AMP have seen their share prices plummet due to poor decision making. This may just be the tip of the iceberg and should the stock market 'bubble' burst the effects will be extreme. Interestingly, some papers by the IMF put the chance of the 'asset bubble' bursting at around 24 percent based on historical occurrences following a bear market.

There are many that believe, as we do, that the world is on the verge of a major depression and that the actions of the US and allied governments is like putting their fingers in the dyke, eventually the gaps will be too numerous and to big to plug and economies will collapse and be washed away.

Once economies start to collapse, war, famine, and disease will surely follow.

The only threat greater that economic collapse is that from mother nature herself.

For more information check out this site: D e p r e s s i o n 2 . t v

Keep an eye on the following charts - gold is normally seen as a safe place for your money in a depression so a dramatic increase in the price of gold is a good indicator of bad things to come:

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What is Fiat Currency?

Fiat money or Fiat currency (usually paper money) is a type of currency whose only value is that a government made a fiat (i.e. decreed) that the money is a legal method of exchange. Unlike commodity money or representative money it is not based in another commodity such as gold or silver and is not covered by a special reserve. Fiat money is a promise to pay by the issuer and does not necessarily have any intrinsic value. Its value lies in the issuer's financial means and credit-worthiness. Most currencies in the world as of 2003 are fiat monies.

What are Derivatives?

In finance, a derivative security or derivative is a contract which specifies the right or obligation between two parties to receive or deliver future cash flows (or exchange of other securities or assets) based on some future event.

Another way of defining a derivative is that it is a security whose value is determined (derived) from one or more other securities, commodities, or events. The value is influenced by the features of the derivative contract, including the timing of the contract fulfilment, the value of the underlying security or commodity, and other factors like volatility.

The payments between the parties may be determined by the future changes of:

  • the price of some other, independently traded asset in the future (e.g., a common stock)
  • the level of some index (e.g., a stock index or heating-degree-days)
  • the occurrence of some well specified event (e.g., a company defaulting)

Some derivatives are the right to buy or sell the underlying security or commodity at some point in the future for a predetermined price. If the price of the underlying security or commodity moves into the right direction, the owner of the derivative makes money, otherwise they lose money. Depending on the definition of the contract, the potential loss or gain may be much higher than if they had traded the underlying security or commodity directly.

Common examples of derivatives are

  • stock options,
  • interest rate swaps
  • futures
  • foreign exchange forwards or options
  • credit default swaps

Some less common, but economically intriguing examples are:

  • economic derivatives which pay off according to the state of the economy as measured by national statistical agencies
  • weather derivatives

Derivatives are one of the most rapidly growing and changing areas of modern finance. According to the BIS, as of December 2002 "total estimated notional amount of outstanding OTC contracts stood at $141.7 trillion."

The most common use of derivative securities is as a tool to buy and sell risk. For example, a farmer may seek to sell a future in a commodity such as wheat at a fixed price to a speculator. The farmer reduces his risk that the price of wheat will unexpectedly raise or fall, and the speculator assumes this risk with the possibility of a large reward.

Because derivative securities offers the possibility of large rewards, many individuals have the strong desire to invest in derivative securities. Most financial planners caution against this, pointing out that an investor in derivative securities often assumes a great deal of risk and therefore investments in derivatives must be made with caution.

Economists generally believe that derivatives have a positive impact on the economic system by allowing the buying and selling of risk. However, many economists are worried that derivatives may cause an economic crisis at some point in the future. Since with a derivative security, someone loses money while someone else gains money, under normal circumstances trading in derivatives should not adversely affect the economic system. There is a danger, that someone would lose so much money that they would be unable to pay for their losses. There is a danger that this would cause a chain reactions would create an economic crisis. In 2002 legendary investor Warren Buffett in an interview with the New York Times commented that he had accumulated his wealth without the use of derivatives and that he regarded them as 'financial weapons of mass destruction', an allusion to the phrase 'weapons of mass destruction' relating to physical weapons which had wide currency at the time. Although there have been instances of massive losses, most notably by Long Term Capital Management these have not have repercussive effects. In fact Federal Reserve Board chairman Alan Greenspan commented in 2003 that he believed that the use of the use of derivatives have softened the impact of the economic downturn at beginning of the twenty-first century.

This kind of investment gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in derivatives. Through a combination of poor judgement on his part, lack of oversight by management and unfortunate outside events, Leeson incurred a 1.3 billon dollar loss that bankrupted the centuries old financial institution.


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Last Modified: April 15, 2008
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