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Originating the Derivative
The duality of the concrete and the abstract characterizes the capitalist social formation. — MOISHE POSTONE 1993:152
Anyone who wants to understand the present political economy, but does not understand the derivative and its markets, can only by taken seriously by those equally in the dark. Indeed, the longer one circles the financial crisis' aftermath the more the political economy of the present comes into view. — EDWARD LIPUMA 2015
Of all the dodges of discourse, the science of allusion holds a special place. The writer scientist depicts one reality by allusion to another. And so the derivative is said to be like something else, in the process losing the fact that its power to impose a logic on our lives derives from an existence that refuses to reference anything but itself. — A memory paraphrase of RANDY MARTIN, 2013
What Is the Derivative?
If we are determined to understand finance we must engage the derivative. If we are called on this account to unlock the derivative and its logos, it is necessary to begin at the foundation. To analyze the derivative socially, to theorize its design and the agency that it commands, to produce knowledge that enhances our vision and illuminates what remains problematic and unknown, begins with the simple, not so simple, question of what is the derivative. There is a more pragmatic way to articulate this question: namely, why should derivatives trade and why trade derivatives? The foregone ideological answer is money and profit, animated by the gods/demons of avarice. But the answer is a kind of cultural self-deception, albeit a very necessary one, in that it substitutes a functional precondition (credit money), a contingent result (making a profit), and an animal spirit for an accountable explanation. And so our ideology, beloved for its earthly grit and simplicity, ends up presupposing what needs to be explained. For the real question has another more inherently social form: what is the derivative and its markets such that capitalism with derivatives is transforming who we are?
If I start at the conclusion this is my answer. The derivative is not a thing: like the book you have in your hands or the chair you may be sitting in. It is, first of all, relational as its very essence, more like the relationality that underlies friendship or enmity than like a book or an armchair. Going further, derivatives are relations about relations. Specifically, their relative volatility in relations to the volatility of their underliers; for example, the volatility of the relationship between the dollar and the euro. The heartbeat of derivative trading and thus a derivative's replication is the magnitude and velocity of its volatility.
Like writing seriously about humor, capturing the derivative bet can be a tricky proposition. A liquid and legible style does not easily cotton to its inherent complexities. Nonetheless, the basic idea behind the derivative is compelling simple. There are only two moving parts: a bet on a relationship and a tango with time. The players define the bet in a contract in which the score depends on what happens — that is, the volatility or the price movement — to some other underlying asset(s), such as interest rates or the exchange rate between the dollar and euro. This bet is played out over some specified period of time determined in the contract. Time counts because the wager is on what the values of the underliers will be sometime in the future. Observe that the wager is on what happens to the relationship between the underliers — its relative variance or volatility — rather than what happens to the underlying assets themselves. And that it concerns what happens to the relationship of the underliers only over the specified time.
Given the contract's design features it is possible to offer a non-financial example: suppose I wager that it will on average be warmer in Chicago than in Boston in the month of January 2018. Now even if Chicago happens to have the warmest January on record (say 37 degrees) I would lose the wager if it were still warmer in Boston (say 39 degrees) and even if beginning midnight February 1 temperatures in Boston fell instantaneously to record-setting lows. For the outcome of the wager turns entirely on the relative change or volatility in the relationship between underliers over the specified time period. The financial term of art is underlier, though it is architecturally more accurate to view the underlier's interrelation as unfolding in its own relationship with the derivative. As constituted, the derivative creates a something akin to a capital meta-market in a parallel universe which, given the enormous monetary force driving the derivative markets, can exert a gravitational-like pull on the underlier's market.
As an aspect of capitalism's social evolution and the evolution of economies more generally, the derivative cannot help but stand in a historically specific relationship to the commodity. It is clear that the production of goods and services has existed always and everywhere before the derivative. And that capitalism has produced commodities since its inception. From this perspective, the derivative resembles a luxury good in the sense that hedging commodities with derivatives can be a helpful accessory to other technologies for managing risk, such as a downdraft in a good's price in the interval between a producer's investment of capital and the sale of the finished good. But production does not need the derivative to be successful. Nonetheless, the globalization of production and with that the amplification of the transnational flow of capital has resulted in the ascension and the empowerment of derivatives. A world in which there is heightened connectivity linked to increasing state fragmentation is part and product of the reformulation of the relationship between labor and capital. And thus between production and circulation, security and risk, subjective freedom and objective domination, the politics of the nation state and forms of deterritorialized governance. If we synthesize and theorize the inflow of evidence from the perspective of a social and historical reading of the derivative the following conclusion takes shape: the derivative markets are the historically determined yet arbitrary means by which capitalism assigns value to capital at risk when it evolves a transformed platform for self-expansion whose mainspring is the circularization of nation-state–based production.
What this means historically is that the derivative and its markets are separating circulation from production even as they are simultaneously generating new modes of connectivity and mutual dependence. It also means that derivatives whose success turns on assembling and circulating aspects of capital are neither dependent on, nor limited by, the structure of production. A kind of unlimited inc., derivatives have evolved to specialize on speculative wagers on assemblages of nomadic and opportunistic capital that circulate on markets of their making. The design of a derivative contract thus has no necessity; for it arbitrarily pairs and temporally brackets two arbitrarily selected aspects of capital to create a relationship. The derivative thus has no intrinsic value other than as an instrument that interconnects with parallax derivatives to generate a globally fluid market for capital, as a (re)source for collateralizing parallel wagers and thus for amplifying leverage, and as an instrument whose forecast of the future helps create the future it forecasts. This latter convergence can and does occur because a market's participants believe they can obtain a preemptory reading on the future price of an underlier (e.g., petroleum, exchange rates) by monitoring the relationship or volatility spread between a derivative's price and that of its underlier. This dynamic imbues circulatory capital with a self-referential and reflexive dimension: for the volatility of a derivative can induce volatility in its underlier which can motivate an amplification in a derivative's spread by, for example, reducing the number of participants in its market. Duly reflecting the extrinsic character of its value, the derivative contract is a determinate form vulnerable to all the uncertainties the world may throw its way. Thus formulated, a derivative wager epitomizes a speculative ethos because it stages a head-on collision between the deliberate and accidental, between a culture of calculation and the illegibility of chance. The present form of the derivative is how we — that is, metropolitan capitalist societies — have chosen at this point in their evolution to chance the capital in capitalism.
The basic idea of the derivative is the promissory gift. If one agent meets certain conditions he/she will receive some wealth from the counterparty. The idea stretches back mytho-historically to the Code of Hammurabi and the testament to the genesis of Jewish peoplehood. And so it has been noted that in Genesis (chapter 29) Jacob purchased an option costing him seven years' labor that granted him the right to marry Laban's daughter Rachel, though as circumstances turned unexpectedly, his prospective father-in-law reneged, thus producing an outcome whose surface appearance not only resembles a derivative but the first default on a derivative. The underlying difference is that where in gift based societies the concept of wealth and the agreement's annulment are founded on direct social relations (i.e., marriage), under capitalism both the derivative's pricing and the outcome of the wager are mediated by abstract risk. It is precisely this difference that is capitalism's signature: the duality of concrete and abstract. That the surface form of the derivative parallels the reality of the promissory gift imbues the former with a certain legibility. The overt form of the derivative contract fits a traditional slot in our understanding even if its underlying design represents a dramatic departure. Indeed, defining, as is often done, the derivative as nothing more than a financial contract is like describing the Venus de Milo as a double amputee.
That said, the derivative relationship opens the door to nearly endless possibilities because there is an extraordinary assortment of potential underliers. Especially a capitalist economy whose global flows of capital are transcending, eliding, and discounting national frontiers, generates a continuous and expanding supply of underliers. The only limits are the imagination and creativity of the financiers, their collective willingness to risk capital for speculative purposes, and the capacity of the new derivative to generate a constant supply of tradable volatility. What we now know is that new derivatives create new volatility and new volatility creates new profit opportunities. It goes without saying that trader's trade, their sensibilities so hyper-directed to a market's unfolding that they neither need nor imagine a definition of the derivative. There is, in fact, a famous scene in Michael Moore's movie, Capitalism: A Love Story, in which traders are flummoxed when he asks them to define the derivative for him. It has, accordingly, been left to analysts to come up with a definition. However, attempts to craft anything resembling a definition of what a derivative is seem to invariably fail, mainly because they assume that its design is somehow invariant and rule governed. This nature of the error is not accidental: it follows from capitalism's social epistemology which tends to treat a contract about a practice as the pairing of two object categories. But to the contrary, the derivative is a generative design scheme, evolved for responding to, anticipating, and sometimes engineering shifts in the character of the global financial markets. Where derivatives are concerned, the cast of characters is expansive, transient, and unruly, but choreographing their entrances and exits is less important than apprehending what all derivatives have in common: a generative scheme based on (1) a time dependent wager on volatility, (2) the division and reassembling of capital, and (3) an amalgamation of variable and incommensurable forms of risk into an abstract cipher that functions as a social mediation. Let me underline, the relationship of a derivative to its generative principles is more like that of power and money than that of vessel and water. The orchestration of these features — their structural assertion if you will — and the sociality that underpins it necessarily imbues the derivative with a logos whose form and effects are greatly removed from those of production. This generative scheme is the deep structure for the construction of an enormous number of derivative forms whose surface features differ, frequently dramatically so. Thus, for example, this scheme underlies collateralized debt obligations, interest rate swaps, and cross-currency contracts, three derivative types whose surface features are very different. This generative scheme constitutes the deep performative subject of derivative driven capital (Lee and LiPuma 2002). As Konings (2015) notes, apprehending derivative capitalism is difficult "unless we pay attention to the plasticity of its financial assemblages" (p. 271). That derivativesare products of the animation of a generative scheme means they are relational objects; they cannot, accordingly, be adequately captured or conceptualized through the fabrication and use of a thingly definition. I will try to make this become increasingly evident in the succeeding chapters.
As a political economy, the derivative is transformative because its economy is circulatory, contingent, and expansive, catapulting the economy it is generating beyond the conventional ways and means by which the nationalized production economy has sought to enclose itself. For a derivative driven economy, the most commonplace economic measures, such as gross domestic product — the total sum of nationally-produced/exchanged goods and services — is meaningless on every count. For derivatives, there is no cumulative sum of nationally produced/exchanged anything. Derivatives as an economic totality represent an indeterminate disparate aggregate, of globally-dispersed and replicating, abstract-risk-based contracts. What this indicates theoretically is that it is only relationally that analysis can apprehend what is a derivative; that is, in respect to the co-features of their production.
The Crisis of Economy
Martin has argued that the economic crisis manifests "a crisis of economy" in that it underlines the extent to which its exclusion of the political and its linkage of commodity production to national identity are being disrupted by the advance of the derivative (Martin 2013:102). More, a rupturing of the economic membrane consistent with nation-state-based production is necessary to its realization. This appears in several ways, first of all in the character of the crises it precipitates. In contrast to production, its systemic problems have absolutely nothing to do with an unwanted and unnecessary internal imbalance between production and demand. Rather, systemic risk is always present and systemic demise always possible because the derivative's replication and reproduction turns on the permeability and destabilization of its markets by (often unforeseeable) exogenous forces. In contrast to labor based commodity production, which has always sought ways to shelter itself from foreign competition (e.g., through laws that regulate the international transit of commodities), the economy of the derivative is necessarily an economy that must be constantly breached and compromised in order to sustain its very existence. Absent the production of volatility, the derivative and its markets could not exist. The reason is that it is volatility that motivates replication and thus circulation and as Bryan and Rafferty (2015) have noted "if they [derivatives] stop circulating, they become valueless" (p. 5). Because profits in derivative markets only derive from pricing volatility, they require a constant if measured supply of variance. More precisely and more socially, they require the social world to continually destabilize the market by introducing an array of exogenous disruptive forces that create inflections in the underlier's value. The financial community relies on models and forms of technical analysis which recognize the role of exogenous forces, but typically in ways that materially disguise their origination in the social. Financial economic reports typically conceptualize these exogenous forces on the image of natural phenomena. They see them accordingly as contextless forms of risk rather than as contingent consequences of the sociopolitical conditions of their production. They nominalize the forms of risk as discrete, independent, free-floating essences (such as counterparty, legal, or liquidity risk) that are inherently exterior to the social. The market replication of the derivative also assumes the presence and potency of relational concepts, such as a community of willing partners (i.e., counterparties), that the contract's technical pricing model excludes. Behind the backs of financial analysts and their technical models, the derivative composes itself and its market as dimensions of a space that is social, relational, and encompassing.
Excerpted from "The Social Life of Financial Derivatives"
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Table of ContentsAcknowledgments ix
Prefacing a Theory of the Derivative 1
1. Originating the Derivative 27
2. Social Theory and the Market for the Production of Financial Knowledge 81
3. Outline of a Social Theory of Finance 116
4. Temporality and the Financial Markets 144
5. Theorizing the Financial Markets Socially 170
6. Rituality and the Production of Financial Markets 199
7. The Specualtive Ethos 229
8. The Social Habitus of Financial Work 267
9. The Social Dimensions of Black-Scholes 304
10. Derivatives and Wealth 336