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Zero Hedge put out a piece yesterday entitled “The Elephant in the room: Deutsche Bank’s $75 trillion in derivatives is 20 times greater than German GDP.”

I would like to point out a few things that are obvious and a few that are not so obvious.  First off, this $75 trillion derivatives book is nearly equal to JP Morgan’s book so there are actually “2 elephants” in the room.  Both books are also virtually equal to the annual GDP of the entire planet including any unaccounted for basket weaving production in the Amazon.

Let’s take a look at this “size” from a few different angles.  DB’s derivatives book may be 20 times the size of Germany’s economy but JP Morgan’s is nearly 5 times that of the U.S.  JP Morgan also dwarf’s the Federal Reserve’s already bloated balance sheet by a nearly 20 to 1 ratio which put in easier to understand numbers…the Fed’s balance sheet is only 5% or 6% the size of JP Morgan’s book.

Yes I know, the apologists will say that it is “net” that counts and “gross” is just some type of fairy tale made up number that doesn’t mean anything…until it does.  “When” might the gross number actually count you ask?  EXACTLY when this so called “insurance” is needed to pay off!  Let me put this into a simple example for you.  Let’s say that you live on some beautiful beach area and everyone buys hurricane insurance…from just one company.  No one really worries about hurricanes anymore because everyone has insurance…but no one really checked to see how much money their insurance company has to pay claims with.  Lo and behold, a Cat5 hurricane hits and wipes everything out down to the foundations and even some lots themselves were washed away.  The insurance company cannot pay because they simply don’t have the money.  This is the case in derivatives where no one, not one single issuer has the actual cash to perform on their gross liabilities.  It is said that “net” is what is important but who or what firm can actually “settle” their portion to “net” out someone else’s book?

The above is as simple as I can make it but this is the case for our entire financial system.  The banks have hoodwinked everyone (including their depositors and I suppose each other) into believing that they are hedged, insured or whatever term makes you feel the coziest.  They are not.  They are “so not” that even the central banks themselves are completely dwarfed by the liabilities of the banking system.  Think of it this way, nothing matters right now because everyone “trusts” everyone else because everyone “insures” everyone else.  All that is needed is for one link in the chain to break and in the case of Deutsche Bank they have a little over $500 billion worth of deposits to make good on $75 trillion.  Did you notice that I said “deposits” as opposed to “equity?”  Deposits as in “liabilities,” not “equity” as in the bank’s capital.

It is also pointed out that another “safety valve” is that anyone doing business with Deutsche Bank can be really smart and “extra safe” by taking out insurance on them separately so that if there is a claim and DB fails, you can collect from somewhere else!  Makes sense right?  Heck you can even buy “bankruptcy insurance” (CDS) on the U.S. Treasury itself in case it was to go bankrupt.  Do you see how foolish this is?  Yet bankers say quarter after quarter, “Don’t worry, we are hedged against everything.”  Think about this and please forget about the $1.4 quadrillion in total derivatives, if the U.S. were to default on $17 trillion, who would, could, pay?  Heck, take some other little country like Italy or Spain, who could fork out just $1 or $2 trillion to pay for their default?  The answer of course is “no one” could, no one can and no one will.  I will also add that in many many cases, there are more CDS and derivatives in play than the actual entity have outstanding in debt.  In other words, if Italy for example were to go belly up on $2 trillion worth of debt there may be $5 trillion worth of contracts outstanding…does this amount of “insurance” incentivize anyone to “burn the house down?”

This is why I have said that “everything is worth nothing,” because once this chain detonates there will be nothing “financial” that is still solvent, nothing!  In case you haven’t made the connection yet, “everything IS worth nothing” right here and right now…and it’s been this way since well before 2008.  How can I say this?  Simple, there is a difference between “perceived value” and true value.  If you were to accept a $1 million IOU from an unemployed homeless person who has no job, no assets and no hope of either you would be a fool right?  Put another way, if you went under some bridge into a homeless tenement and saw a bunch of people living in tents, cardboard boxes and dumpsters, would you believe that each and every one of them were millionaires when they all showed you their $1 million IOU’s?  Of course not but this is the game, this is the scam…THIS is exactly what the banks are collectively doing.  It’s as if they are saying we are strong, we are safe…we are just as strong and safe as everyone else!

Of course another aspect is that for every “winner” there must be a “loser” because derivatives are a zero sum game but this doesn’t ever get spoken about.  It’s never ever spoken about because in today’s world there simply cannot be any “losers”…like Lehman Bros.  A “loser” would put blood in the water to be attacked and we cannot have this because then that one link in the chain would break and “netted out nets” would become gross for everyone involved.  The other thing that can never happen would be any tightening of credit whether it is to the system as a whole or to an individual player.  This goes back to Russell’s “inflate or die” again, for the system as a whole or for any single entity.

I have a few questions for you, have you ever wondered why the markets seem to act so differently today than they did in years gone by?  Is it possible that the derivatives themselves have and are being used to actually “price” the markets?  Could it be that the markets have to be “priced” because if they were not…there might actually be some unexpected “big losers” …somewhere?  And what exactly would it mean if some big bank like Bank of America, JP Morgan or Deutsche Bank were to get into trouble and actually default?  The answer of course is that derivatives far and wide would have to “perform” and the problem is that there is not enough money in the system for even 1 or 2% of them in the aggregate to perform.

Please understand that this was not meant to be a highly technical piece by any means.  I tried to make this as simple as possible because the concept that “everyone is insured because everyone insures everyone else” is false.  If you can grasp this then the term “everything is worth nothing” should then make perfect sense no matter how ridiculous it sounds.  Also please understand that when this does occur, it will happen faster than anyone can react to it.

P.S.  For those who would like to get more technical, Zero Hedge put out a great piece back in 2011 titled How US Banks Are Lying About Their European Exposure; Or How Bilateral Netting Ends With A Bang, Not A Whimper  which needs to be read several times to fully understand “net versus gross.”