Many economists would agree that the incredible stock market performance of the past decade and excellent economic growth would not have been possible were it not for the five fold growth in derivatives. The history-blind bulls will counter these numbers by pointing out that the notional dollar value of derivatives is merely the gross value of the underlying instruments, that the amount of actual capital at risk of loss is but a small fraction of the notional amount. Well, they're right. Never has the system had so much at stake in a highly leveraged game. Mortal man may believe he is in control for a time, but the forces beyond human control are always more powerful.
Economic history is littered with examples.
Two of the fundamental underpinnings of the U.S. stock market boom of the past decade have been the virtual unlimited flow of foreign capital to our markets and the asymmetrical Federal reserve policy of providing liquidity when markets are in distress, but failing to drain when they are euphoric. The two may be more related than we can know. While the Fed might appear to be powerful enough to continue its one-sided market support policies for as long as he wants, the real test of such power will only come when the flow of capital stops or reverses. Future historians may look back at this period as a fluke, an accidental confluence of bizarre circumstances which allowed for the temporary suspension of sensible capital account balances. Three of those unusual circumstances may be nearing an end, and if so, the unlimited amount of credit creation and liquidity infusion may also be nearing an end.