Derivatives’ Temporal Perversity

 

SECRET BASIC PLOT OF DERIVATIVES EXPOSED

Abstract: A ridiculously simple trick allows the financial plutocracy to make ever more money, hence gather ever more power.

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CRIMINALITY + RESPECTABILITY = PLUTOCRACY:

Is the present public-private financial system one of the largest criminal enterprise ever? It depends how one defines "crime".

Was the Feudal system a crime? Yes; it arose from the Roman republic, and clearly violated it. How? By putting most of the riches, and therefore, powers, in just a few hands. In the USA, in 2009, 25 hedge fund managers made more than a billion dollars of personal profits, each. Less well known is that, in the final analysis, they use public money to do so. The public would not be too happy if it understood that. The following is a contribution towards understanding the sticky plutocratic web the public finds itself ensnared with.

Of course, by the time the Feudal system violated civilization, the res-publica was a distant memory. The plutocracy had captured everything, even minds, and left them only sports to talk about, and a few little things below their nose. To subjugate people, one needs to overwhelm their mental defenses first, and put their minds inside very small boxes.

The modus operandi of the public-private financial system is still not understood. even the Nobel Prize level economist take a wide berth, lest they lose their credibility and profitable aura of respect. This helps to explain why Barack Obama did not do much against it. Neither Obama’s advisers, nor his critics (Stiglitz, Krugman, Johnson) have gone to the core of the problems posed by the private-public financial system, and deconstructed its logic. At the core of private-public finance is a bargain a la Faust, which is now violated by the plutocratic side. But here I will mostly talk about something more technical.

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HIDING DERIVATIVES BEHIND HARD, IRRELEVANT MATHEMATICS:

In this essay, we dismantle the fundamental reason why derivatives ought to be (mostly) outlawed, and not just vaguely tweaked (as Obama’s vaunted "financial reform" has it). It is not because slavery is technically possible, that it should be tolerated.

Obama gave a talk to the hyper rich at the home of Richard Richman. The worthy in attendance had paid $30,000, yes more than half the yearly average family income in the USA, to conspire together and hear from their public servant, the president of the USA that:

"Democrats, just congenitally, tend to get — to see the glass as half empty. (Laughter.) … If you get the financial reform bill passed — then, well, I don’t know about this particular derivatives rule, I’m not sure that I’m satisfied with that."

Obama cannot understand what derivatives are about. Nor do most people. Derivatives constitute a violation of the fundamental Faustian bargain of the state with banks. The reason why they cannot be understood is that derivatives have been designed to maximize wealth for the financial plutocrats, and this depends upon hiding their true nature.

When one searches for an explanation about what derivatives are, one typically hits haughty Partial Differential Equations (PDEs), describing some "options" trading. In other words, one is confronted to a level of complexity common people, including common lawyers such as the USA president, have not studied. Actually complexity of option trading is a bit reminiscent  of the level of complexity of Quantum Mechanics, which uses PDEs to compute probability waves.

99% of the population does not have a clue what a PDE is (a PDE is a way to relate rates of changes in various directions, or dimensions, it’s not witchcraft, but not far from it, because there is no general theory). The trick of hiding greed behind a PDE was so neat that the obsequious servants of plutocracy gave a Nobel Prize for it.

In truth, one can understand the basic mechanism for feeding greed at will through derivatives without much more than high school mathematics. (I already explained that in the past, but in a more cursory fashion.) So we will now review some high school mathematics to show that DERIVATIVE TRADING CAN CREATE MONEY FOR THOSE WHO PRACTICE IT WITHOUT ANY ADDED VALUE WHATSOEVER FOR THE PUBLIC, WHILE INDULGING IN THE CLEAR CRIME OF SUCKING MONEY OUT OF THE REST OF SOCIETY.

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WHAT IS A DERIVATIVE?

Financial derivatives are related to what is commonly called a derivative in analysis. Before understanding derivatives, one has to understand the function they come from. Derivatives, in turn, are themselves functions.

What is a function? Well, in mathematics something that allows to compute numbers, using numbers. At least that is the way Descartes thought of it, and he used algebra to describe said functions, starting "Algebraic Geometry".

Another way to look at the idea of function is to draw a curve "f" on page, with an x axis horizontal, a y axis vertical, and for each vertical line only one intersection (x, "f(x)") with f, where "f(x) is the height of the intersection point thus obtained. The simples f is a line, with f(x) = ax + b. More generally polynomial functions of degree n were contemplated: f(x) = a + bx + cxx + c xxx +… u (x^n). I don’t know how to write xy with this computer, and many mathematicians have opted for the subterfuge: x^y. So x^n is nx’s multiplied together.

In any case the derivative of a function f, df, is the curve obtained from f by looking at its slope, or rate of change, at every single point, creating a new correspondence between numbers and numbers. So if f is constant, in other words flat, the slope is zero, so df is zero. We have excluded above functions with infinite slopes. The slope of a line is constant, and for ax, it’s a. The slope of a(x^n) is: [an(x ^(n-1))].

Thus, in some sense the derivative of a polynomial f of degree n, being a polynomial of degree (n-1) is smaller than f (more exactly |f(x)|> |df(x)|, for x large enough). Also df is of lower degree than f, thus simpler. A lot of mathematics consists into studying the (hopefully) simpler df instead of f. This carries on in higher dimensions, with the study of differential forms and tangent bundles instead of studying directly the objects they came from.

A lot of the equations of physics are about rates of change. For example, the Maxwell equations of the electromagnetic field f reduce to df = 0 and *df = j. Not bad, since in their initial version, those equations covered an entire page, or so. (Here the differentiation operator d is a version of differentiation adapted to higher dimensions, namely the 4 dimensions of space-time, and * is another operator).

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BASIC NON TRIVIAL DIFFERENTIAL EQUATIONS: EXPONENTIAL, AND TRIGONOMETRIC FUNCTIONS:

Something natural to consider is infinite polynomial. An example is e(x) = 1 + x + x^2/2! +… + x^n/n! +…. This function, e, is called the exponential. As x^n grows in its general term, it gets divided fiercely by factorial n, n! = 1.2.3.4… (n-1) (n). Exponential is equal to its own derivative: de = e. some mathematicians have called it the most important function in mathematics.

e is related to the trigonometric functions, cosine and sine. clip_image002

clip_image003

The sine and cosine functions graphed on the Cartesian plane.

Both the sine and cosine functions satisfy the differential equation

ddy = y”= -y

That is to say, each is the additive inverse of its own second derivative. So this is true if y = cos(x), say. Now suppose y is different; y(x) = cos (ax). Then dy (x) = -asin(ax), and y”(x) = -a^2 cos(x). Thus the differential equation has changed. It’s now: y” = – a^2 y!

This is all high school mathematics, and does not fly very high. However this is the sort of trivialities that the extremely profitable financial "industry" of derivatives rests on. I am not sorry to make fun of them by exposing what they have been really up to, it’s purely intentional.

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THE NATURE OF THE TRICK WITH DERIVATIVES & HIGH FREQUENCY TRADING:

Functions found in nature, at the classical scale, tend to have derivatives commensurate with the functions they come from (a non rigorous, but crucial subtlety). For example, sea waves can have steep faces, and can even invert in a tube (something excluded in the simplest functions in calculus, as we held above).

However, the waves’ slopes are, in general pretty tame (not when the waves break, once again, because then they become fierce, very powerful). The third derivatives of waves are actually always very tame: if sea waves are coming 50 meters apart (wavelength 50 meters), the third derivative slowly goes from slight positive to slight negative, every ten seconds, or so, etc…

Now a financial market is also animated by waves. Waves of selling and buying. In a so called "trading" (by opposition to "trending") market, traders can hope to make money by buying and selling at opportune times. In the past such wave were constrained because people were buying and selling, and they need to eat, sleep, and rest. According to real time, or, one should say, animal time. Not so for computers; they go according to clock time, ever faster. (And we have no Quantum computers yet, where time may disappear all together.)

Sea waves of a given height cannot go faster than they do: their heights and speeds are strictly connected by what mathematicians call a bijection: to a particular height, a particular speed, and conversely.

If traders were buying and selling sea waves, there is an upper limit to how much money they could make in a given unit of time.

But modern traders are not just Masters of the Universe, they are Masters of Time. They have created a fake, derived universe, complete with fake, created time.

Traders, using electronics can trade more and more, and thus increase clock time as the computer makers say, and for the good reason that the traders use computers to do so. Hence they can augment the frequency of the waves they trade: up and down, ever faster. In other words instead of looking at cosine(t), where t is universal time, greedy traders look at cosine(gt), where g can be made arbitrarily large, and stands for greed. As g augments, frequencies go ever higher.

This pernicious activity has even a name: HIGH FREQUENCY TRADING. (It has other nefarious effects, because, done carefully, it allows big banks to control the direction of trading, but that is another story!)

Augmenting the frequency of the trading also augments the wave heights of the derivative (now -[g sine(gt))] and the second derivative, now [-g^2cos(t)!)]. So not only can electronic traders trade more and more, and make more and more profits, but they fabricate thus ever greater leverage for themselves!

What is going there? Very simple; instead of having a market normalized by reality, the reality of cosine(t)), with t as real biological time, which has ruled markets since ever, the electronic traders can now trade an arbitrarily large market, arbitrarily large market, by trading the derivatives. (Augmenting the frequency allows to augment the total volume of finance involved, which is now of the order of 20 times world GDP!)

This, of course, sucks money out of reality, and invest it in something which does not exist, except as a figment of imagination.

Thus unemployment is not just a question of having sent the jobs far away overseas, but also of having invested capital in the alternative, derivative universe.

Obama accuse the "professional left" –"you know who you are!", to get in the arcane details of derivative trading. But he is the one who indulge in it, why not understanding the math.

Instead there should be derivative trading only when proven safe and effective. Besides arbitrarily high "High Frequency" trading ought to be unlawful (as it puts ever more arbitrarily high amounts of money in ever fewer hands.)

In general, Obama needed a vision in finance, not tinkering. The vision existed before; F.D. Roosevelt OUTLAWED FINANCIAL SPECULATION BY BANKS. It’s only normal; banks have been given the astounding, very profitable privilege of creating most of the money. With the idea (that’s the Faustian bargain) that they, the banks, in turn, would finance profitable projects in house-management ("eco-nomy").So they were richly paid to do that. Instead they ran away with the money to a derivative universe.

With the derivatives and the like, banks divert their astounding privilege towards "plutonomy" (for wealth management) as the chief economist at City put it.

To ask to go back to FDR’s clear principle is not to ask much. FDR was from a plutocratic family, he was no foaming at the mouth Marxist. Actually Sarkozy, the conservative, right wing president of France echoed president Roosevelt by calling for the separation of banks and financial speculation.

In any case, we have seen that the fundamental mechanism at work with derivatives is a trick to take the money of the people, and leverage it ever more, for ever few.

But Obama, all engorged with himself, instead of being humble, celebrates "THE" " financial reform bill". He knows the title, and seems really impressed by it. It sounds magical: "historical health care reform": done! "Historical financial reform!": done!

But a big title does not make a big idea. To re-form finance, for real, one would need to achieve, at least the cognitive level reached in 1933 by FDR. Instead Obama chose as adviser Summers who believes that endless summers came to plutocracy when it created ever more money for itself, thanks to computers, and the TIME RENORMALIZATION TRICK I exposed above… with seed money provided by the central bank, that is the public. "I don’t make public policy" as Geithner, fifth in line for the throne, intone categorically. No need indeed: policy was made long ago, and nobody in the public noticed.

Creating ever more money for plutocracy is nothing new, and civilization’s greatest pitfall, ever since civilization appeared, and got stalked by the exponential function.

Plutocracy does not rule with the mind of the people, which is many, and thus clever, but with the mind of Pluto, which is lonely, and thus vengeful, vicious and dumb. Just one mind does not a civilization make.

Talking to elite plutocrats paying $30,000 per person to hear the president of the USA, close and personal, will not make any of that easier to understand for a president who runs on money like a jumbo jet runs on fuel. It just makes for the world’s most expensive brothel.

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Patrice Ayme

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Technical note; The preceding will enrage many a derivative trader. So they will say that I understand derivatives not, and the proof is that there are many other types. Well, not really, deep down inside. But when the plutocrat is forced to think deep inside plutocracy, all he meets is his master, Pluto. Hence his rage. (And when did you see a female hedge creature?)

I also suggested in the past to put a speed limit (for example with a tax ; Oxfam now concurs) and to differentiate between commercial operators (such as airlines buying futures contract on jet fuel) and speculators (who would get fewer privileges).

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Technical note on how derivatives and, in particular, futures, move underlying market: Krugman could not find a mechanism for that connection, and thus long argued it did not exist. But the preceding can be modified to make it so.

Suppose S is the total amount of money available in a field, say O (like oil). S will tend to go to the “overlying” derivatives market, because there is more leverage there. So instead of investing with, say S, with the underlying commodity O, if S is invested in derivatives, it will be like investing with 10S. On a market, that of the derivative, which is enormously more variable (for the temporal renormalization reason explained above), capable of (say) ten times the swings. Result: investing with the derivatives is just as if one were investing with 100 times the capital S one started with.

Now, of course, there is no more money to support the underlying commodity itself (because all speculators are invested in derivatives, since it is as they were 100 times richer). Hence small fluctuations in selling or buying of the underlying commodity will have a huge effects on O. And of course the buying, or selling, will be dominated by the psychological effect of what the derivatives, esp. the futures are doing. To do the detailed math of all this is just, well, details…

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6 Responses to “Derivatives’ Temporal Perversity”

  1. multumnonmulta Says:

    Patrice, since a trade implies a seller and a buyer, you’ve got to include (artificial) trends in your analysis, for that’s how money is made in final instance, out of the pockets of the more inertial investors, aka, 401k handlers and such.

    BTW, the conclusions of a commission studying the stock market (planned) hiccup on May 6 are supposed to come out nay day now. Check them out, I think, if the authors let it out, that was self-serving manipulation at grand scale.

    The suggestions in your last paragraph are spot on, “put a speed limit (for example with a tax ; Oxfam now concurs) and to differentiate between commercial operators (such as airlines buying futures contract on jet fuel) and speculators (who would get fewer privileges).”

    Obambi should not crow about his ignorance, but implement such common sense limits to madness.

    P.S. Your employing ‘subjugate’ reminds me of Latin.

    Like

    • Patrice Ayme Says:

      Dear mnm:
      I studied Latin all too long… six years. But translating Caesar left an imperishable impression. Maybe I shall talk about myself in the third person too…
      And the Tyranosopher observed that common investors have been making no money, for at least a decade, , nor are the 401ks and the retirement funds… There is no mystery; the capital has been going to the thieves… The plutocrats have invented the equivalent of a free energy, free money machine, as far as they are concerned; get money from everybody else. The worse is the gutting of the West’s industry (except the military-industrial complex). As I insisted, the reasons are exactly the same as with Rome.

      As far as Obambi is concerned, he is smart because very successful personally, the way he looks at it, in his psychological microcosme. He and his crowd are so exhausted by self advancing that they seem to have no other passion one can discern (oops, I guess I am talking too much, plzz ‘scuze mee). When nobody pulls the strings of the puppet, all the pupett can do is play golf on automatic, and when the teleprompter is blank, so is the mind.
      PA

      Like

  2. latte Says:

    “Plutocracy does not rule with the mind of the people, which is many, and thus clever, but with the mind of Pluto, which is lonely, and thus vengeful, vicious and dumb. Just one mind does not a civilization make.”

    what an inversion of Heraclitus’: “the many are bad, the good are few.”

    Not to mention a slander on alone-ness.

    Still, pretty cool post; I enjoy reading it. I think both of the inversions (in the pair which is maybe not a perfect opposition symmetric) have their respective veracities.

    Seems easier to me for us to define it (plutocracy) in a semantics borrowed from biology and refer to it as a parasitic growth which destroys the active potential of the host. Not original, but my favorite. That’s not very conceptually rich but it doesn’t need to be. Plutocrats typically are stark reflections of a tendency (what is called) a slave-triumphant, someone who appears as a Master but is actually quite at odds with the nature of actual power; hence the reliance on its representation. Visible wealth is a representation of power. Wealth generally is not power but instrumentalization of an external power. Taking us to the concept of Control, which again is not power but its regulation, instrumentalization, etc. Plutocracy is epiphenomenal to a societal disease, therefore not worthy of a primary definition in the scheme of things as in your Manichean schema (fascist/pluto vs demos). I tend to think of modern (and ancient) plutocratic extrema as typifying the higher Slave types, the most avid lickers of ass having made it to the top of a termite mound by such licking. As a conceptual personae it’s the complete opposite of an Aristocratic type, but for representations (ie ostentatious display wealth/status (status insecurities in particular are hilarious)).
    Of course that’s mostly borrowed from Deleuze (and horribly mangled I’m afraid).

    Like

    • Patrice Ayme Says:

      Dear latte:
      There is a very old theory about the seven stages of society, more than 22 centuries old. Massive reforms and revolutions associated to deliberate reflections happened, and foremost in Sparta and Athens, 26 centuries ago. Athens in particular tried nearly everything in a span of 150 years, from Draco to Pericles.
      I have a reorganization of the whole thing along ethological lines. Fascism is a direct instinct, and it’s very powerful, and it is activated by fear first, and greed secondarily. That makes it something which can be used by any political theory (left, right, progressive, reactionary, communist, etc.). In particular, fascism can be used by democracy: it is so well known that the fasces were symbolic of the Roman republic, and are, by far, the most prominent piece of the French republic coat of arms. The Spartan would have agreed, and the Athenians even more so.

      The Athenian Navy, a fascist device, was the very core of Athenian democracy. So, being aware of such facts, I may be less manichean than assumed at first sight.

      Democracy is the natural ethology of peaceful Homo Sapiens, because it maximizes brain power.

      As far as slandering solitude, it’s part of my mental breathing: expell what I need, to aspire it afresh. Creative philosophy without Tyranosophy is imposssible.
      PA

      Like

  3. Luke Says:

    This is a joke, right? That derivatives in finance have anything to do with derivatives in math?

    Reading this reminds me of timecube…

    Like

    • Patrice Ayme Says:

      Luke:
      Well, if you go tell a fundamentalist Muslim that the moon has to do with dirt, they will ask you whether you are joking (then they may take umbrage, and off with your head; go to North Warizistan to check the theory). FYI I have traded derivatives (very successfully) and I have studied a huge amount of mathematics at the most advanced graduate level.

      So, at first sight I do know what I am talking about, because I have a better background than 99.99% on each of these activities.

      I went straight to the essence of the problem of derivatives, and I know enough about people who trade derivatives, to feel fairly sure that they have neither the math, nor the physics (don’t forget i renormalize time!), to understand what I am saying. Nor do they have the motivation, because basically…

      The lichpin? Most derivatives’ trading is stealing the average citizen as if she was a baby holding candy. It ought to be outlawed. Maybe one ought to allow Peter Singer to define traders as “non persons”, and let him conduct “scientific experiments” on them?
      PA

      Like

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