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by Al Martin

How Working Class Republicans Get Snookered by the Wealthy Republican Class

(6-12-12) In a column called “Collapse at Hand,” Paul Craig Roberts, the former Assistant Secretary of the Treasury under President Ronald Reagan, writes “Everyone wants a solution, so I will provide one. The US government should simply cancel the $230 trillion in derivative bets, declaring them null and void. As no real assets are involved, merely gambling on notional values, the only major effect of closing out or netting all the swaps (mostly over-the-counter contracts between counter-parties) would be to take $230 trillion of leveraged risk out of the financial system. The financial gangsters who want to continue enjoying betting gains while the public underwrites their losses would scream and yell about the sanctity of contracts. However, a government that can murder its own citizens or throw them into dungeons without due process can abolish all the contracts it wants in the name of national security. And most certainly, unlike the war on terror, purging the financial system of the gambling derivatives would vastly improve national security.”

      What’s wrong with this picture?

      This is simplistic and naïve and it is aimed at WKRs (pronounced “Wickers” i.e., Working Klass Republicans). First of all, no government including the United States government can simply “cancel” derivative contracts. They don’t have the power to do so.

      These derivatives are trans-national contracts so the United States could not unilaterally cancel derivative contracts that involve US financial instruments, either securities or debt instruments, or options or whatever, wherein the counter-parties are foreign national banks, governments, brokerage firms, insurance companies, pension firms, etc.

      So Roberts is simply playing to the WKR crowd. Why? Because it “sounds” good to the Unwashed. All it does is really discredit the person who’s writing something like this. After all he’s not concerned about it since he’s not a professional trader. He doesn’t manage a hedge fund or a financial institution that would be hurt by such a cancellation.

      If this were to happen, it would be absolute havoc and panic. You cannot simply cancel derivative contracts that have been written in order to hedge who knows what risk.

      Even with the recent problem with JP Morgan, wherein they will take at least a $2 billion loss, this whole derivative issue comes up again. Republicans keep wanting to vilify derivatives by attempting to simplify them for the WKRs – when in fact you cannot simplify them. There’s no way to simplify them other than to say – they’re bad because they represent an open-ended exposure for those who write them or for certain counter-parties. In fact they don’t represent an open-ended exposure. What they’re meant to do is to close that exposure.

      The $230 trillion number means nothing. All Roberts is repeating is numbers that have been put out by the US Treasury, involving domestic derivative contracts.

      Meanwhile we have the alleged Spanish bailout situation. We see that the rallies have reversed. Those people who took my advice -- published on Insider Intelligence on 6/10/12 -- and sold the rally, made a fortune. It should be noted that there is $700 billion outstanding in Spanish-related derivatives alone. If you look at derivatives globally, you’re talking about a number that is in the quadrillions.

      In essence Roberts is simplifying the situation. He’s KISSing it (Keeping It Simple Stupid) for WKRs. However it sounds good to the Unwashed because they have been taught to believe that derivatives are “bad.” That’s the pabulum that’s constantly fed to them – particularly from the Republicans. Even though it’s Republicans who are the prime manufacturers of the derivatives, but it’s the Wealthy Republicans and not the Working Klass Republicans.

      But if something collapses or doesn’t go right, they have to say – well these derivatives aren’t any good. The WKRs aren’t going to know the difference. In essence it gives them an out.

      What Roberts is saying, however, is dangerously naïve – and stupid. His target audience is obviously WKRs who are not involved in the equation anyway. Therefore you can say something that is naïve and stupid without damaging anything.

      So is this global derivatives situation like a Gordian Knot which cannot be cut apart? The thing is that it’s a necessary Gordian Knot, since it is the only way for governments, their treasuries, central banks, banks commercial and investment, brokerages, insurance firms, pension actuaries et al, as well as producers of every commodity – it is the only way they have to hedge their exposure to quantify their risk.

      What’s troubling is the leveraging aspect of derivatives because the leveraging is being applied to get a net long or net short exposure. That’s how derivatives have changed. They are no longer being used strictly for what they were meant to be used for, which is to hedge exposure, to guarantee delivery, to take in delivery of a certain commodity, to guarantee costs or performance or to be used as some sort of fidelity or guarantee instrument.

      The danger of derivatives, which is becoming more evident, is when they are misused, which has gotten so many banks in trouble. The misuse happens when they go beyond the realm of one for one hedging and using them to establish a net long or net short position – beyond that risk they are attempting to hedge.

      Meanwhile there is no underlying asset to cover it. Has this use of derivatives become a “bet” then? The word “bet” is simplistic in that it implies some sort of gambling, when in fact these firms use them to attempt to seek a profit in the market based on their view – whether something is going to move higher or lower in price at some date in the future.

      So what is the “misuse” of derivatives? The danger is in the so-called net exposure, either a net long or net short exposure in a particular market where the parties involved have gone beyond a one to one hedge. Hedging means one to one.

      But there are hundreds of instruments in the world of derivatives, even though “derivatives” are used as a generic term so the masses can understand just one word and they don’t have to understand all the various types of derivatives.

      Commodity futures themselves are classified as derivatives. When it’s a non-fungible item, it becomes a derivative -- if the item in question is either guaranteeing the purchase of an item or contract or instrument which is not deliverable, i.e. an issue which exists only in electronic form.

      From my perspective, derivatives are good and necessary. You couldn’t maintain a global economy without them because without them there would be no mechanism left to hedge risk. Also there would be no mechanism to ensure delivery and receipt of an item.

      The risk in derivatives lies in the net exposure of non-fungible items, which exist only in electro la-la-land.

      So how do you “fix” the ticking time bomb of derivatives? The first step comes in regulating derivatives and establishing a traded market for them.

      And what about the inordinate leverage that is part of the danger? Technically it’s a non-issue, since all governments, including the United States, already have rules that the allowed leverage is 12:1 -- vis a vis its net deliverable capital with a derivative instrument. The problem is that nobody is enforcing the rules.

      It should be noted that the Republicans in Congress have torpedoed every effort to regulate derivatives, to establish a transparent market in them, and to enforce leverage rules that already exist. The Republicans want to have it both ways. They complain about any regulation because they peddle this concept to the WKRs that all regulation is bad and big government is bad and let markets determine and set prices. It sounds good to the WKRs because that’s the pabulum they’ve been raised on.

      The Wealthy Republicans are right – markets should set prices, but derivatives aren’t even an established market. If you say that markets should set prices, you have to establish those markets and then regulate those markets, which is something that Wealthy Republicans don’t want to see done.

      The Democrats in Congress have tried every machination to make this happen, using the Volcker Rule and the Sarbanes-Oxley rules. There was a push on numerous occasions to try to develop some market in these things, to make them less opaque, and to force those who trade them too maintain a bid and ask. That’s what transparent markets are all about – a maintained bid and ask by those who are making a market in the instrument. The problem is that Republicans want to keep them in a so-called “dark market.”

      The rally in the markets this past week due to the bailout offered to Spain was short lived -- and the issue was derivatives again. Everybody is so short the markets. Derivatives are causing a contraction in global financial marketplace liquidity. That is true. The reason that is happening is because anybody with any brains is short everything -- short equities, short commodities, short real estate.

      You have to create the longs on the other side to accommodate those shorts. And the longs have been created essentially by the Unwashed. That’s why every effort has been made to bring in the Unwashed. That’s what the shills do in financial media, and the Unwashed are told to always be on the long side – and to keep on buying. There is a desperation to do that by unsophisticated “investors,” while anybody else who has any brains is short.

      The Wealthy Republicans need the WKRs to believe the lie and come in with their $20,000 accounts and get long something. Now every country is suffering from the same problem – net redemptions month after month in common stock mutual funds.

      That’s why the WKRs are slowly getting ground out. It’s just another mechanism to transfer money from the hands of the WKRs into the hands of the Wealthy Republicans, which is the natural cycle. The problem is that we are now nearing the end of that cycle and the markets are getting increasingly less liquid because there are so many so-called “big shorts,” or large-scale shorts, in the markets -- without enough longs to offset them and carry the bid.

      And that’s where the Working Klass Republicans come in…

    * AL MARTIN is an independent economic-political analyst with 25 years of experience as a trader on NYMEX, CME, CBOT and CFTC. As a former contributor to the Presidential Council of Economic Advisors, Al Martin is considered to be a source of independent analysis for financially sophisticated and market savvy investors.

After working as a broker on Wall Street, Al Martin was involved in the so-called "Iran Contra" Affair as a fundraiser for the Bush Cabal from the covert side of government aka the US Shadow Government.

His memoir, "The Conspirators: Secrets of an Iran Contra Insider," ( provides an unprecedented look at the frauds of the Bush Cabal during the Iran Contra era. His weekly column, "Behind the Scenes in the Beltway," is published weekly on Al Martin, which also publishes a bimonthly newsletter called "Whistleblower Gazette."

Al Martin's new website "Insider Intelligence" ( will provide a long term macro-view of world markets and how they are affected by backroom realpolitik.


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