It’s (Almost) All Derivative

16 Sep

Last week, I penned my first article on “derivatives”.  My observations and conclusions were unsettling, but flowed from a definition in Wikipedia that struck me as amazing:

Derivative:  A financial instrument which derives its value from the value of underlying entities such as an asset, index, or interest rate—It has no intrinsic value in itself.”

Financial Madness [courtesy of Google Images]

Financial Madness
[courtesy of Google Images]

The reason a financial instrument is called a “derivative” is that it “derives” its perceived value from some other source.  The reason a derivative’s perceived value is “derived” from some other source is that the derivative is, by definition, intrinsically worthless.

If a financial instrument had intrinsic value, it could not be a derivative.   On the other hand, if a financial instrument is a “derivative” its apparent value is only “derived” from some other source and that derivative is and must be intrinsically worthless.

Over the past several years, the world’s total sum of officially-recognized derivatives has ranged from $700 trillion to $1.4 quadrillion—and yet, all of those derivatives are, by definition, intrinsically worthless.

We live in a world where there there are financial instruments with an apparent value of over $1 quadrillion that are nevertheless known to be intrinsically worthless.

The mind gapes.

Vast Variety?

According to Wikipedia,

“Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations of these.”

For some, that description is comforting since most of the varieties of derivatives seem remote from our daily lives and we therefore need not study the concept of derivatives too deeply.  Derivatives appear to be limited to fairly exotic transactions that are too removed from most people’s lives to be deemed as particularly relevant.  Because the nature and complexity of derivatives seem so confusing, most people are discouraged from studying the subject.

Derivatives are presumed to be somewhat like astrophysics—an important science for astronauts, but largely irrelevant for 99.99% of the world who will never go into space.

Not Rocket Science

In fact, the fundamentals of derivatives aren’t so hard to understand.

In fact, I begin to see that derivatives are so omnipresent, that the financial world (especially those who make, sell and profit from derivatives) don’t want the world to understand that virtually all of our perceived , paper wealth is “derivative”.   The Powers That Be don’t want us to understand the extent and fundamentally simple nature of derivatives because, if we did, we’d realize that virtually all of our paper wealth is derivative.

To understand that virtually all of our modern wealth is “derivative” is to understand that virtually all of our modern wealth is “intrinsically worthless”.  The cash in your wallet, the retirement account that gives you pride, most of your investments, your credit cards, debit cards, checking accounts and savings accounts; and most of your equity are all derivatives and therefore, by definition, “intrinsically worthless”.

Most of us have spent our lives working, slaving, fearing and fighting to pursue measures of wealth that are derivatives and therefore intrinsically worthless.

Would you have worked so hard if you’d known all along that most of your accumulated wealth was no more intrinsically valuable than Monopoly “money”?  Would you have been so tempted to lie, deceive or exploit if you’d known all along that the “money” you were fighting for was intrinsically worthless?

The seemingly confused and incomprehensible nature of derivatives isn’t accidental.  Those who make, sell and profit from derivatives don’t want you to understand that your derivatives—stocks, bonds, cash, etc.—are intrinsically worthless.  If you understood, you wouldn’t value your derivatives, you wouldn’t want them, you wouldn’t buy them.  And therefore those who profit from our investing in derivatives would be out of work and having to make do without two or three corporate jets.

Without our unwitting confidence in derivatives, those who control us by teaching us to lust for derivatives would lose their power and capacity to rule us.

If we were wise enough to grasp that all derivatives are intrinsically worthless, and if we were wise enough to see that virtually all of our wealth is derivative and therefore illusory, would the bankers of the world lose their capacity to control us?  If we had enough sense to reject that which is “intrinsically worthless” and pursue only that wealth that had intrinsic value—could we regain our former freedoms?


However, so long as the “intrinsically worthless” nature of derivatives remains obscure and and even unbelievable, we can be easily induced to spend our lives pursuing things that are known and designed to be intrinsically worthless.

You can’t grasp this concept without feeling shocked.  All of our lives, we’ve been hoodwinked by derivatives.

My Definition

For me, a fundamental understanding of derivatives is found by simply rewording the definition previously seen in Wikipedia.  Once the definition is rewritten, it’s easier to see that derivatives are omnipresent and far more relevant than most people imagine.

My definition of derivative is:

Any financial instrument that has a perceived value, but no intrinsic value.”

I haven’t really changed the Wikipedia definition; I’ve just expressed it differently.

I’m simply saying that, first, every “financial instrument” has some perceived value.

Second, I’m saying that if a financial instrument is seen to have no intrinsic value, it must be a derivative.

If you’ll apply my definition for a while, you’ll see that virtually all paper or digital financial instruments are derivatives.   If so, virtually all modern financial instruments are, by definition, intrinsically worthless.

Again, the mind gapes.

All Paper Debt-Instruments Are Derivatives

All forms of paper wealth are “derivative”.  All you have to do is objectively examine any paper debt instrument and you’ll see that (excepting the negligible value of the paper, ink and plastic security strip) each such “piece of paper” is intrinsically worthless.

Take a $100 bill in your right hand and a $1 bill in your left.  Compare their size and weight.   They’re identical.  Both have a perceived value and are therefore financial instruments, but which one has more intrinsic value than the other?  Which, in fact, has any intrinsic value?  Neither.  And yet, the piece of paper marked “100” is perceived to have 100 times as much perceived value as the piece of paper marked “1”.  (The fact that the two virtually identical pieces of paper have two distinctly different values is evidence that they are “derivatives”.)

Pick up a US Treasury denominated “$100,000”.  Pick up another denominated “$500,000”.  Which one is bigger or weighs more?  Neither.  Which has true “intrinsic value”?  Neither.  Because they’re both financial instruments without intrinsic value, they are derivatives.

Similarly, your paper (and digital) dollars clearly have no intrinsic value.  But they do have a perceived value that’s “derived” from something other than the paper and ink.  That means your fiat dollars are derivatives.


If your currency is a derivative, it’s intrinsically worthless.   If your perceived wealth (stocks, bonds, cash, retirement funds, etc.)  is derivative, it is therefore illusory and subject to “magically” vanish at any moment.

You may find that insight scary.  If your fear is too great, you might turn away from the truth.  You might laugh at the idea that your cash and your retirement funds are derivatives.  You might smirk that, of course, your paper wealth has real value.  It couldn’t possibly be “intrinsically worthless”.

But defining a paper debt-instrument as an asset is consistent with my definition of derivatives.  A debt is an absence of value—a negative value.  There is no positive intrinsic value in a paper debt-instrument.   And yet, our monetary system treats paper debt-instruments as “assets”.   We’ve given our debts a perceived value derived from some other source.  But those debt-instruments are clearly without any positive intrinsic value.

Therefore, according to my definition (and Wikipedia’s), all paper debt-instruments are derivatives.  They have a perceived value that’s derived from something else, but remain intrinsically worthless.

The perceived value of our debt-instruments is derived from the debtor’s promise to pay the debt.  The value of the debtor’s promise is derived from his life’s potential capacity to repay the debt.   But no mere promise can be construed as a tangible value.  If the debtor dies or goes bankrupt, his promise to repay the debt will be worthless—as will the debt-instrument which has no intrinsic value.

Financial Sorcery?

The derivative process is a kind of reverse “magic” act where the magician (banker) stuffs one live rabbit into his hat and then pulls out 100 “paper” (“derived”) rabbits that are accepted by the audience as being as real and valuable as the original rabbit.  But if you’re even called on to make a rabbit stew with a paper rabbit, you’ll see that the 100 “derived” (paper) rabbits are not equal to even one real rabbit.

Thus, the process of “derivation” can be described as a kind of financial sorcery.

OK—describing derivatives as “financial sorcery” may be going too far.

But if derivatives aren’t evidence of abracadabra! sorcery, they’re certainly evidence of illusion.   If not, how do you explain the presence of up to $1.4 quadrillion worth of “derivatives” in the world when the world’s Gross Domestic Product is only about $70 trillion?

How can we explain that the officially-recognized sum of derivatives is somewhere between 10 and 20 times the world’s total annual production?  That ratio can’t be real.  It must be illusory.

That illusion is made possible by the fact that the derivatives have no intrinsic value—which would be limited and precise.  Without an intrinsic but limited value, a financial instrument can be presumed to have any value we assign to it   One intrinsically-worthless piece of paper can be presumed to be worth thousands, millions or even trillions of dollars.

According to the Boston Consulting Group’s 13th annual Global Wealth Report, the world’s total financial wealth (stocks, bonds, cash, etc.) is about $135 trillion.  How do we explain that the total sum of derivatives ($700 trillion to $1.4 quadrillion) is somewhere between five and ten times greater than the size of the world’s recognized financial wealth?

Part of the explanation may be that the distinction between “financial wealth” and “derivatives” is arbitrary and meaningless.  Most of both classes of wealth are “derivatives”.

Pick up a paper stock certificate.  Hold it in your hand.  Inspect it for “intrinsic value”.  It has none.   Yet it does have a perceived value.   No intrinsic value + perceived value = derivative.

Same thing is true for commodity certificates, bank accounts, retirement accounts, and virtually all paper financial instruments.  They have perceived value, but no intrinsic value.  That makes them derivatives.

Therefore, the world’s total wealth is not $135 trillion in “officially-recognized” financial instruments like stocks and bonds.  Instead, the total financial wealth consists of that $135 trillion in “officially-recognized” derivatives plus the other $1.4 quadrillion in “unofficially-recognized” derivatives.  Thus, the world’s total financial wealth works out to be about $1.54 quadrillion in derivatives—and every bit of that $1.54 quadrillion is intrinsically worthless.

The world’s paper wealth is intrinsically worthless.   The whole, damn financial system is only an illusion.  More, it’s an illusion that’s become so irrationally large that not even “magicians” like David Copperfield or Barack Obama can’t sell it to the audience.   That’s why most of the world has stopped buying US Treasuries (derivatives; irrational illusions) and the only remaining buyer is the Federal Reserve (the magician’s helper).

All of which may explain the derivatives’ seductive appeal.  The financial institutions that are empowered to make, sell and profit from derivatives can attach almost any price (perceived value) they please to any intrinsically-worthless piece of paper.   That power can generate virtually unlimited (but illusory) perceived value and perceived wealth.

The world’s major financial institutions aren’t spinning “money” out of thin air—they’re spinning derivatives.  More, they’re spinning an irrationally large supply of derivatives.

Under the Law of Supply and Demand, whenever the supply of anything becomes excessive, the price of that thing must fall.   Sooner or later, the world will realize that the $1.4 quadrillion worth of derivatives is an irrational over-supply and the price (perceived value) of derivatives will fall.  Virtually everyone caught holding paper derivatives will lose his assets.

Nothing New Under the Sun

Although the explosion in the supply of derivatives is recent, derivatives aren’t a recent invention.  By my and Wikipedia’s definitions, we’ve had derivatives (paper debt-instruments, promises to pay, paper or parchment deeds to land or other properties) for thousands of years.

So, I’m not writing this article to complain that derivatives are necessarily bad.

I’m writing this article to explain that:

1)      Virtually every paper financial instrument is a derivative and therefore intrinsically worthless.

2)      Derivatives aren’t some exotic variety of financial instruments that most mortals will never see or encounter.

3)      Instead, we deal with derivatives every day.  Every time you touch a dollar bill, a credit card, a check, a bank loan or a retirement fund, you’re touching a derivative.

4)      Thus, derivatives aren’t rare; they’re as common as corn cobs—except that corn cobs have some intrinsic value while derivatives do not.

5)      The supply of derivatives has grown so enormous that it’s become irrational.

6)      Being irrational, it seems certain that the entire derivative “illusion” will collapse in the foreseeable future.

7)      In the event of such collapse, those holding paper financial instruments (that are derivatives and therefore intrinsically worthless) could suddenly see their “illusory” wealth vanish.

Seeking Intrinsic Value

So, how do you protect yourself from a financial system composed of an irrational supply of intrinsically-worthless derivatives?

The answer’s obvious. You convert your derivative wealth (cash and credit) into physical things that are tangible and therefore have intrinsic value.

A bushel of corn has intrinsic value.

An acre of land has intrinsic value.

Tools, cars, firearms, bullets, water all have intrinsic value.

Anything physical has some intrinsic value.  Anything that you can own and possess that has physical substance will have an intrinsic value that can’t magically “vanish” if our derivative world collapses.

But, a bushel of corn is not a financial instrument.  Neither is an acre of land, a car or a rifle.  Yes, they can be traded in a barter system, but none of them can be truly described as “financial instruments”.

If you want a financial instrument that is not intrinsically worthless . . . if you want a financial instrument that is not a derivative . . . If you want a financial instrument that will survive the coming crash in derivatives—I can think of only two possibilities:  gold and silver.

Gold and silver are both recognized as “monetary metals”.  That makes them “financial instruments”.  Both are “liquid” in that they are easily traded.  Both are capable of storing your wealth over long periods of time.  Both have intrinsic value that’s been universally recognized for several thousand years.

Physical gold and silver that you can hold in your hand can’t be derivatives.   They can’t be intrinsically worthless.   They are therefore the only financial instruments that will survive if and when our “derivative” monetary system collapses.


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8 responses to “It’s (Almost) All Derivative

  1. Martens

    September 16, 2013 at 4:48 AM

    While only a minor, if not trivial, detail in an otherwise excellent blog post, the definition of “derivative” you got from Wikipedia is a bit off (as that source can sometimes be on technical subjects). But since I’m sure you strive for accuracy in this blog, I’ll point it out.

    Black’s Law Dictionary, 7th edition, emphasis added:

    derivative, n. A volatile financial instrument whose value depends on or is derived from the performance of a secondary source such as an underlying bond, currency, or commodity.

    This is how the term “derivative” is normally used in the financial world. When the nominal value of piece of paper X is derived from the performance of this-or-that asset Y, X is called a “derivative” and Y its “underlying asset”.

    A lottery ticket that just hit the jackpot is also an intrinsically worthless piece of paper. But since its nominal value does not depend on the change in value of any asset, the winning lottery ticket is not a derivative.

    Near the bottom of the page, among the references, the Wikipedia article does get around to a correct definition by quoting the Department of Treasury (emphasis added):

    “A derivative is a financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity, credit, and equity prices.”

    Hope that helps.

    • Jetlag

      September 16, 2013 at 10:02 PM

      That does help, thanks.

      I appreciate the time and effort you contributed in bringing much needed clarity to a subject of relevance to everyone’s financial future.

  2. pop de adam

    September 16, 2013 at 11:47 AM


    I have noticed that some of your recent articles have focused on these things called derivatives. There is a mention in the 16th amendment of sources and that which is “derived” from them. I am far from certain, but perhaps the this amendments’ purpose was to rein in those practices that most distort the volume of currency circulating.

    If I were to author my own design for a fiat currency one of the practical limitations I might consider is a good estimate of all those goods and services already available for exchange to begin with. To go far beyond that it would seem to only distort everyones day to day use of the currency. By saving a person is able to store their and potentially everyone’s labor, I don’t think this is in itself a bad thing since we can only speculate upon what tomorrow might bring. While these derivatives are reaching sky-high numbers they often are seen inversely affecting the value of the base unit of currency. As the S&P, Dow Jones see an increase in numerical numbers if the underlying value of them hasn’t seen much difference than the only thing that has seen real change is that the unit of value they are computed from has become smaller making that number increase.

    Suppose that a group of wealthy people for some strange reason liquidated their fortunes(Bill Gates, Warren Buffet et al) and just to be contrarian, really did attempt to buy up all production, leaving everyone else without. Prices would sky rocket as producers attempted to gather up as much of this windfall as possible, those who were not in on this would be forced to either pay up or go without.

    I was on the web reading a headline about how California has passed a $10 an hour minimum wage into law, while there were the usual celebratory comments and a few pointing out how this may price some people out the labor market completely, one comment that stood out: “meanwhile, everyone who is making more than minimum wage has just taken a pay cut.”

    • Adask

      September 16, 2013 at 11:57 AM

      There’s never a truly “free” lunch, is there? One way or another, we always pay for whatever we got. We might not have to pay for a generation or more, but there’s always that day or reckoning.

  3. Steve

    September 17, 2013 at 4:47 PM

    Isn’t gold and silver more or less intrinsically worthless as well? Although they have some unique scientific properties, I cant imagine it being practically useful in day to day life.
    I realise it has a direct value exchangeable in just about all nations but isn’t it too a derivative? Without someone else’s desire for the gold or the paper dollar, the items arent going to improve my lifestyle like a house, solar panels, car, etc. would.

    • Adask

      September 18, 2013 at 2:04 AM

      The truth is that all economic “values”–including gold and silver–are “derivative” in the sense that those values are “derived” from the public’s need or want for the particular substance or product. Intrinsically, gold is just another chunk of metal–except for the fact that the gold is highly valued by the public and has been highly valued by the public for several thousand years. The value of the gold is derived from the public’s need/want for gold.

      But I suspect that the real difference between intrinsic value of gold/silver and the extrinsic value of paper derivatives is that, while both are ultimately based on (derived from) the public’s needs and wants, whatever value gold or silver may have, that entire value is intrinsic within the gold or silver. With paper derivatives, whatever value they may be perceived to have, that value is ultimately outside and extrinsic to the derivative. Relatively speaking, it’s like the difference between holding $1,500 worth of physical gold in your right hand and holding a bank account book in your left hand that says you have $1,500 in the bank. In the first instance you have the value in your hand; in the second instance, you have only a paper promise in your hand that, if the bank is open, you can take out your $1,500.

      My gold and silver theoretically “derive” their value directly from the people and the free market. No one intervenes between me and that free market. No one person controls or dictates the value of my gold or silver.

      But when I hold a paper-derivative in my hand, the value of that derivative does not depend directly on the free market, but is subject to being set or controlled by some third-party intervenor who has a personal interest in controlling whatever “value” may or may not be perceived to be in my “derivative”. The value of my derivative is not simply dependent on the public and free market, but is instead dependent on the say-so of someone in a position of power like Ben Bernanke, Barack Obama, or the President of Bank of America.

      There are no clear lines here. There are differences in degree. The value of gold and silver is more “intrinsic” because there are fewer layers of control that determine that value. The value of derivatives may be more “extrinsic” because their perceived value is set by third parties.

      Look at the current $1.5 quadrillion in global derivatives. That perceived value does not exist because the public and/or free market says so. It exists because because a limited group of self-serving individuals have taken some pieced of paper, written some words and symbols on them, and arbitrarily and irrationally declared that those pieces of paper are worth billions, trillions, and even a quadrillion of dollars.

      This is equivalent to me writing a check for $1 billion. I might like to value my checks at $1 billion each, but no one else should. But if they do accept my check as being worth $1 billion, that check would be a “derivative” in that it’s perceived value ($1 billion) is based on/ derived from my solitary determination that the value is “real”.

      Again, the concept of derivatives is not black and white. It’s confusing. That’s true. But even that confusion supports my fundamental argument: derivatives are a kind of fraud that’s so irrational that it must ultimately collapse. If the “value” of something is possibly non-existent, what is its value? In the end, real value probably depends on public confidence. There has been great public confidence (value) in gold for several thousand years. That public confidence/value is likely to continue for several more centuries. There is virtually no public confidence (value) in derivatives. The only value that’s perceived in derivatives is there because some very shifty, smooth-talking snake-oil salesmen say it’s there. Without public confidence, derivatives have no “value” that can be described as “intrinsic,” “real” or likely to last for more than a few more months or years.

      Again, none of this is clear–certainly not to me. But as we wrestle with the concept of “value,” our understanding becomes less confused and our confidence in “derivatives” diminishes.

  4. Truth seeker

    September 19, 2013 at 9:07 PM

    Maybe today’s decision from the Fed about not allowing a tapering and continue to buy more toxic paper is a testament to your view on derivatives, and specifically your view about why they decided to purchase MBS derivatives.

  5. FrankM

    September 21, 2013 at 9:20 AM

    Shades of 1929 !!!!!


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