Currently, commodity price performance has lulled the speculative (and therefore, the mainstream) community into a sense of complacency. The speed with which accidents can happen and induce overall changes in sentiment is something that can only be imagined in the context of flash crashes. Outside of more circuit breakers, the HFT conditions that ultimately led to the May 2010 fat finger flash crash and its reverberating damage have not been resolved.
Perhaps the greatest errors made by modern and mainstream economists are the discounting of debt and the growth of the financial sector. Because debt is considered an asset and a liability, it is cancelled out of the monetary equation.
Servicing debt puts a drag on capital formation and allocation. Real growth and innovation slows, making debt service even more difficult. A debtor can default for a variety of reasons, but when the debt itself is used as collateral for more tiers of debt, the risk of collapse multiplies.
Modern economic models do not account for the risk or the drag associated with debt. And this, of course, becomes the fuel for the little spark that will no doubt ignite a fire for which we are collectively unprepared.
Exogenous versus Endogenous
Furthermore, economic academia consider financial market risk an outside concern and not central to the issue. This is another incredibly naïve assumption in risk modeling. It is perhaps the crowning example of the inefficiencies and utter detachment from the reality that exists at this level of academia.
That we are building so-called models of economies that have been entirely created and shaped by this invisible, very central force (the financial industry) is almost too absurd to believe.
Financial System as Proportion of the Total Market
Interest rate, equity, forex and energy futures have dominated in the aftermath of Bretton Woods.
Derivatives trading — mostly futures contracts on interest rates, foreign currencies, Treasury bonds, etc. — had reached a level of $1,200 trillion, $1.2 quadrillion, a year. By comparison, U.S. GDP in 2006 was $12.456 trillion.
For perspective, at $37 trillion, the U.S. bond market is about 2.6 times the size of the $14 trillion U.S. Stock Market.
Precious metals as a percentage of overall futures is tiny — yet they won't go away.
The metals still exert the all important barometer. Even though the mainstream loves to hate them, they still love to hate them for a good reason; otherwise they would be forgotten.
World markets are now tuned to this part of the information highway — a dark vacuum, absent any sign of human life.
What does $1 trillion per year look like without a black swan event, or even a series of smaller unplanned-for phenomenon?
How long can the repo machine keep going without good collateral?
It is impossible to precisely diagnose the event or chain of events, but we can sober to probabilities. And we can be certain that all natural systems abide by equilibrium — always returning back to them eventually.