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Are you shell-shocked? Are you wondering what’s really going on in the market? The truth is probably more frightening than even your worst fears. And yet, you won’t hear about it anywhere else because “they” can’t tell you. “They” are the U.S. Federal Reserve and the U.S. Treasury Department, and they can’t tell you what’s really going on because there’s nothing they can do about it, except what they’ve been trying to do - add liquidity.
Source: Comptroller of the Currency
So, is it a stretch to say that the current production of the financial-ized U.S. economy “is” derivatives? So what share of this notional should we be adding to U.S. reported GDP [approx 13 Trillion] to adequately account for Derivatives?
As it stands now, only revenue [8 – 12 billion per annum in fees] generated from trading these “off balance sheet” instruments is attributed - counted in bank revenues. But as we have learned in recent times; when things go awry with these instruments – many TRILLIONS of losses quickly materialize and migrate to these banks' income statements, negatively affecting GDP. Amazingly, folks who trade these instruments are widely referred to as “smart money”, but the empirical evidence “screams” that these derivatives instruments are bought and sold [conjured] into existence by individuals who do not fundamentally know what they are worth.
The dichotomy arises due to the manner in which mark-to-market accounting rules are applied – losses being crystallized and ‘counted' on the income statement [negatively affecting nominal GDP] while gains are left to accrue off-balance-sheet where they are NOT MEASURED [no affect on measurable GDP], because doing so would be construed as a taxable event. This is and has been the root of a major dilemma in the accounting treatment of derivatives for YEARS. The fact that derivatives are treated in this fashion is not sound from a purely economic perspective but rather traditional from an accounting perspective.
The observable implications are that these instruments always have had MUCH greater impact on nominal GDP than the current “practice” of recording trading fees as revenue only. It's all about gearing and the point from which you measure your base. Remember, for the past 15 years – right up until Q2/08 - these outstanding notionals have done nothing but mushroom – and in the past few years, leap by as much as 20 to 30 TRILLION in notional in a given year: