It’s time to revisit an old prediction. Years ago I speculated that the structure of the derivatives market was inherently inflationary. The premise was that the massive run up in commodities prices between 2002-07 and right after the crash was a function of the market structure not market forces.
If I was right, then the collapse in oil prices we are experiencing now should be enough to cause an economic avalanche as over-leveraged derivatives reverse that inflationary trend very suddenly. In other words, over the next couple of months we should see a surprising collection of otherwise healthy major financial institutions announcing losses that start relatively minor and keep adjusting higher and higher until they become incalculable.
At first glance it looks like I was probably wrong. For starters, the collapse in gold prices this year should have been enough to expose this problem, though gold is certainly a more niche market with fewer broad economic implications.
Also, there are no early warning signs of trouble. No banks adjusting their earnings projections or major hedge fund collapses. At least not yet.
We have seen a remarkable increase in hedge fund failures, but those appear to have more to do with consolidation than bad bets. It looks like lots of people are abandoning smaller hedge funds for larger ones.
We’ll see, but at first glance it looks like my take on the structure of the derivatives market may have been off.