EVERY now and then, we need to take a step back and look at the big picture.

TEXT/ILLUSTRATION: LARRY HAVERKAMP AND MAROO.

The world's wealth, for instance, stands at around US$200 trillion ($300 trillion). That is the value of everything everyone owns.

Two years ago, it was higher - US$250 trillion - but we lost US$50 trillion in the financial crisis.

By the way, 1 trillion is a really BIG number. It is 1,000 billion, which is four times everything we make in a year - four times Singapore's GDP.

The question of the day is: 'When will this recession end and GDP grow again?'

The official answer is: 'World economies will see gradual improvement from the middle of next year.'

The unofficial answer is: 'Who knows?' This recession is different from anything we have seen in the past. It is a beast that comes at us in the night.

Times have changed

In the US, it used to be easy to get a '100 per cent no-doc home loan'. The homeowner would put down no money of his own and provide no documentation.

If a bank was impolite enough to ask, 'Do you have a job?', the borrower could say, 'Excuse me. Are you prying into my personal life?'.

The bank would then back off.

Nowadays, US home loans require a down payment of at least 20 per cent, up from 0 per cent two years ago.

Company loans are tough to get too, which has brought some businesses - especially in exports - to a near standstill.

On the positive side, less debt means lower risks, so we will see fewer defaults in the future.

The problem is if a home or office building can't get financed, it won't be built. The same for a factory. Fewer things get made and GDP grows slowly, if at all.

It means, for the first time in history, our children may end up with lower living standards than their parents. We may have to go back to living 'the simple life'.

That was the name of Paris Hilton's reality TV show. Perhaps she can show us how to do it.

Good v bad risk

US$200 trillion in world wealth is small compared to the new centrepiece of this recession: derivatives.

They are US$1,232 trillion, which is - get ready - US$1.232 quadrillion. A quadrillion is 1,000 trillion, or 1 followed by 15 zeros.

By the way, did you know that a googol is 1 followed by 100 zeros? That's huge.

Back to derivatives.

In June 1998, the underlying value of privately traded (over the counter) derivatives was US$75 trillion.

Ten years later, it had grown to US$684 trillion.

The other half of the story is exchange traded derivatives like futures and options.

These come to US$548 trillion, bringing the grand total to US$1,232 trillion or US$1.232 quadrillion as of June 2008.

Here's how they work

Derivatives make it possible to bet on the rise or fall of interest rates, currencies, oil, food, metals and more.

Instead of buying gold, for example, you can make a bet with a counterparty that gold prices will go up. It is speculation (gambling) and it creates a new risk that wasn't there previously.

Derivatives can also reduce risk through hedging.

Do they reduce risk through hedging (good) or increase it through speculation (bad)?

We can get a hint by looking at the value of all derivatives. As explained, it stands at US$1,232 trillion, which is six times the US$200 trillion value of the world's wealth.

It shows that something besides innocent hedging is going on since there is not that much wealth in the world to hedge. Speculation is likely.

This speculation is crowding out 'good' risk. For example, a bank giving a car loan produces risk, but it is productive since it results in someone owning a car. It boosts GDP. (Good.)

Derivatives speculation also produces risk but it is not productive. It does not add to GDP or the world's wealth. It only shifts it around through counterparty bets that are won and lost. (Bad.)

The move from productive to unproductive risk is a new development. It is a dark force that is unique to this recession.  Back to Columnists