Saturday, September 22, 2012

ETFs as Weapons of Mass Destruction

Majia Derivatives were at the heart of the financial crisis that began in 2007. One might argue that the effects of the crisis -- including privatization of government holdings and services and the downsizing of average citizens’ savings and incomes -- stem from financial firms’ strategic warfare with derivatives. Derivatives are indeed weapons of mass destruction, as described by Warren Buffet.  

       As 2012 comes to a close, the western financial system faces new shocks from derivatives. This time the derivatives at issue are not simply derived from mortgage backed securities and other types of consumer debt. This time the derivatives at issue are derived from European sovereign bonds – such as Greek bonds – and from food and oil commodities. Max Keiser and Stacy Herbert recently explained the systemic risks of ETFs, which appear to pose the same sort of risks as collateralized debt obligations here.

The rise in popularity in a relatively new form of derivatives known as Exchange Traded Funds (ETFs) amplifies risks for the global economy.  Assets in EFTS have doubled since 2007, reaching $1.2 trillion in 2012 (Bigda & Wang, 2012). ETFs are believed to be contributing to rising commodity prices in a context of widespread global impoverishment and crop failures.

 ETFs are derivatives contracts that operate in a similar fashion to a mutual fund except ETFs holders, unlike mutual fund holders, do not actually own the underlying stocks. Instead, ETF holders own derivatives contracts based in equities. Some ETFs track mutual funds, but many track commodity markets in energy, grains and water and may be derived from future contracts (see “10 Best Energy & Commodity EFTS” 2012). Investment Guru Jim Rogers recently noted that investors will increasingly pile into commodities using ETFs due to shortages but that their positions do entail actual ownership of assets: “A huge amount of money will come into commodities the next decade as people learn about supply shortages. Very few people are invested in real assets” (“Jim Rogers,” 2012).
ETFs may introduce unseen risk to investors while adding or even creating commodity bubbles that threaten the global economy. Chris Cook (2012a, 2012b) argues that ETF positions are maintained by computer programs – particularly using high frequency trading - and are therefore not transparent to holders. Furthermore, in a September 2012 interview with Max Keiser, Cook explains that ETFs are almost always positioned “long” in orientation, meaning the ETF contract presumes that the underlying commodity will necessarily rise in price (Cook, 2012b). Because EFTs are long in orientation they have the capacity to create bubbles because their “financialization” of markets has destroyed pricing mechanisms, as explained here by Cook in The Financial Times:
First, the presence of generally “long only” passive and risk-averse investors in markets – whose motivation is to avoid loss rather than to make speculative transaction profit – has largely destroyed the price formation mechanism and has thereby financialised those markets where they have become predominant. (Cook 2012a
Cook concludes his analysis by stating that he believes EFTs pose the “next great regulatory accident waiting to happen....”

ETSs introduce additional system risks by inflating basic commodities such as energy and food. ETFs based in food commodities were seen as a primary reason for the 2008-2009 food bubble that further impoverished millions of people globally (see Kaufman, 2010). Food inflation during that period was caused primarily by global speculators fleeing financial markets into commodities. New ETFs offered investors an easy way of entering commodity markets, distorting pricing and creating a bubble in food staples. The result was millions of people starved in the developing world, according to Kaufman in his 2010 essay in Harper’s MagazineThe Food Bubble: How Wall Street Starved Millions and Got Away with It.” EFTs contributed to global hunger and starvation in the period from 2008 to 2010.

The World Bank reported in February 2009 that up to 53 million more people would be mired in poverty due to soaring food and fuel prices catalyzed by the financial crisis as investors left debt-backed stocks and piled into commodities (“Economic Crisis Set to Drive,” 2009). The increase in food prices was expected to bring the total number of people living on less than $2 a day to over 1.5 billion. In September of 2012, Paul Moore, former head of risk of HBOS, stated during an interview with financial journalist Max Keiser that he believed the banking crisis drove 100 million people back into poverty around the world (Keiser Report “Semaphore of Fraud” E325, 2012 Sep 2012).

Now ETS are producing new global commodities bubbles as investors fleeing uncertainty over Eurozone conditions eye global crop failures as a speculative opportunity. Indeed, 2012’s poor crop conditions are expected to produce above average global fund inflation for 2013 (Pleven, 2012). EFTs invested in food commodities will simultaneously become more desirable and drive up prices that are already rising because of corn, soy, and wheat crop failures in the U.S., Europe, and India. More people will starve because of the inevitable food bubble, producing more global unrest. Demonstrations by impoverished populations will be met with force and rising authoritarianism will become further entrenched. Austerity will become more widespread.

Financial derivatives alone did not produce hunger, impoverishment, and austerity; but, by financializing debt and equity markets, derivatives introduced unprecedented volatility in the global economy. Derivatives make it possible for financiers to profit from volatility, amplifying it still farther. Derivatives open up new forms for speculating on stocks, bonds, and contracts; thus, derivatives have enabled financialization of basic commodities, such as food and energy. Derivatives therefore contribute to and even produce asset bubbles that essentially worsen impoverishment and may drive governments into more debt, rendering them vulnerable to enforced austerity measures that privatizes assets and collapses domestic economies. Derivatives are truly weapons of financial warfare.


Bigda, Carolyn and Penelope Wang EFTs: Why so Complicated? Money Magazine (2012, September 1),
Cook, Chris interviewed by Max Keiser in Keiser Report Depression, Debt and Doublespeak (E342) September 2012
Cook, Chris Exchange traded funds’ vices far outweigh their virtues. The Financial Times (2012, September1o)
“Economic Crisis Set to Drive 53 Million More People Into Poverty in 2009 – World Bank.” United Nations News Center 13 February 2009. 10 May 2009
Kaufman, F (2010). The food bubble: How Wall Street starved millions and got away with it. Harpers (
Moore, Paul. Interviewed by Max Keiser Report Semaphore of Fraud E325, (2012 September 9),
Pleven, L. (2012, August 24). The Dark Clouds Hanging Over Crops. The Wall Street Journal, C1.
Rogers, Jim. Use Commodity ETFs to Profit from Supply Shortages. ETF Trends (2012, June 27),

1 comment:

  1. The real price of gold.

    Thank for all that work. It appears we are going to be taught a nasty lesson when all these fantastic financial products roll over. It seems the reports you mention might be comments on the ending action.
    Right now, we have got bonds, commodities and the stock market all ready to roll over at the same time.

    Therefore, I remain optimistic. The real cool thing about the market is that there might be a self-corrective mechanism in it. ie. Rules which are governed by truth and reality. The test I am using is the real price of gold gold/commodities) not the nominal price. The increase of real price of gold (ie. gold remains strong / commodity prices down) will lead to a reliquification of the corrupt and rotten banking system after a period of time and perhaps a new beginning for us.
    Have you considered the real price of gold before?


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