Correcting my limitless lack of knowledge, one post at a time.
Monday, May 31, 2010
Readers of this blog may be excused if they think my ignorance has recently grown so slight that I've had to resort to decoding British and Irish slang. Sadly, this is not the case. Today, I will branch out into the rarely visited world of finance--well, rarely visited by me--to explore the meaning of derivatives. No, not "derivative"--unfortunately, I'm all too familiar with this standard dismissal of much contemporary fiction. In literature, "derivative" is kind of a kiss of death adjective. In the world of finance, though, "derivatives", are apparently sometimes attractive. Lately, however, derivatives have been much in the news, and causing a bit of trouble.
I was, well, not comforted exactly, but relieved to know that there are a lot of other Americans who are clueless about this financial term. Now that it's clear that certain decisions in Congress will bode either ill or well for the derivative market, I thought it might be time to enlighten at least myself on what these blasted things are.
In literature, 'derivative' means something like 'stale' or 'a pale copy of the original'. I think the word means something much more neutral in other circumstances, maybe 'coming from'. In fact, now I think about it, it's probably a sibling of 'arrive'. The suffix 'rive' probably does mean something like 'come' or some sort of action word like that. We'll see.
Anyway, derivatives must have their basis in some other source. They must be dependent on some other financial vehicle for their existence. How they are dependent, I have no clue. From recent financial talk, though, I get the feeling that their presence is like the bottom part of an iceberg lurking under the water. Or are they not something so stationary, but really something more like a shark, that has to keep circulating to keep breathing?
...Well, just by chance, one of the first explanations I came across was a podcast by Christopher Hayes of the Nation, and the bonus was that I learned of his podcast show called The Breakdown, which attempts to enlighten us in short, not too taxing segments on various matters crucial to our time. If you'd like to cut to the chase--and I'd highly recommend it, actually--please check out his podcast on derivatives here . He speaks with Bart Chilton of the Commodities Futures Trading Commission and together they very helpfully break it down for us.
But if you must know, here is what I gleaned from all of it. Basically, the word 'derivatives' and the word 'futures' are interchangeable, at least in their economic sense. It's called a derivative because it derives its value from something else. Starting out as these ideas did in agriculture, that something else was a concrete thing. It's much less the case now. Anyway, it's all about trying to determine what will be the market value of something at some given point in the future. The analogy is again to agriculture, where a product is cheap at the time of harvest because its plentiful but more expensive later when it's not easily come by. It's all about what people think will happen in that future. You can call it guessing, you can call it speculating, you can call it gambling. But it is part of the way our financial markets run, and it's also one of the ways a market determines what's a fair value for something at any given time, and I think the idea I come away with is that we could not very easily get by without them.