A Brief Inquiry into the History, Logic, and Spatiality of Financial Derivatives

Jacob Ertel I Social Economics I Analysis I March 9th, 2017

Capitalism, at its most elemental, is a system of inherent volatility. The character of this volatility is contingent on how a state's political-economic institutions are able to mitigate risk by facilitating the movement of capital. How and where this capital moves is paramount in crisis obviation. Capitalism tends towards a range of interrelated crises-democratic, economic, political, social-but central to them all is the ongoing accumulation of surplus-value. The central risk here is that competition will result in an excess of capital relative to available opportunities to reinvest it. This excess can take a range of forms, from commodities, to money, to labor power (i.e., unemployment). States may attempt to resolve crises of overaccumulation in two ways. The first involves devaluating capital through inflation, commodity gluts on the market and falling prices, diminished productive capacity, and/or falling real standards of living for workers. The second method, known as the 'spatial fix', entails developing new markets in which to invest excess capital.[1] These terrains are often conceived as untapped geographical markets that may be turned into new centers of production, thus allowing for a temporary displacement of overaccumulation. Though productive forces remain indispensible to any mode of accumulation, advanced capitalism today may be characterized above all by an ongoing 40 year shift towards the primacy of the financial sector and the predominance of circulation over production.

Whereas the motive of the production process is the extraction of surplus-value through the exploitation of labor, the circulation process itself does not create value; instead, its profits generally derive from the redistribution of surplus-value. [2] This fundamental shift (the specifics of which will be discussed below) exposes more individuals and firms to financial risk than ever before. While capital seeks out new productive markets for reinvestment in all modes of capitalist accumulation, with financialization have come new kinds of spatial fixes that cohere with the unproductive, fictitious, and redistributive logic of circulation. As both social and historical constructions, the structures that facilitate the displacement of risk undergo periods of relative strength and weakness according to the dynamic between an economy's productive capacity and its exposure to risk. [3] When productive capacity is diminished, speculative capital flows increase as investment shifts from productive to financial capital in the attempt to ensure stability against currency devaluation. With the advent of derivatives, however, risk is not only circulated faster and further, but commodified itself. Building on financialization and derivatives literature, this essay suggests that we may understand derivatives as a spatial fix in their own right, which paradoxically both displaces and amplifies risk. Despite important qualitative differences from older, more established strategies of crisis displacement, however, derivative-based spatial fixes exemplify a core dynamic central to all forms of capitalist accumulation. It will be argued here that while on one hand financial derivatives constitute the separation of the sphere of circulation from the sphere of production and thus from physical localities, they are simultaneously inextricable from them. This tension between production and circulation may in part account for the unique form of contemporary capitalist accumulation.

This essay is divided into four sections. The first section addresses the technical aspects of derivatives: what they are, how they work, and some of the different forms they may take. The second section will present an abridged history of derivatives spanning from their agricultural origins to their current use in financial markets. The third section explains how derivatives are unique from other financial instruments, and asks what these differences indicate for the state of the global economy more generally. The final section analyzes derivatives with regard to two critical concepts in geographical political economy: spatio-temporal fixes and time-space compression.

What Are Derivatives?

At the most general level, a derivative may be understood as a kind of financial contract used to expose counterparties to fluctuations in the market price of an underlying commodity, asset, or event. [4] They may also be thought of as "bilateral contract[s] that [stipulate] future payment and whose [values are] tied to the value of another asset, index, or rate or, in some cases, depends on the occurrence of an event." [5] Whereas other financial instruments may involve an exchange of principal or title, derivatives exist in order transfer value between parties based on an underlying price change or event. In so doing, derivatives exist "to bind and blend different sorts of 'particular' capital together" [6] through securitization and risk commodification. A derivative contract entails that the claim on the underlying asset or the cash value of that asset must be executed at a definite time in the future. Capital is moved until the contract is settled. As opposed to insurance instruments, which protect individuals from risk by requiring policyholders to buy in with some sort of collateral (an 'insured interest') that they could lose in the context of the issuance of the policy, derivatives do not require this kind of collateral; anyone can trade in derivatives regardless of their relation to the underlying asset.[7] As such, derivatives operate solely according to these bilateral contracts between parties with differing perspectives on or vulnerabilities to risk. [8] This is the core feature of derivatives: that a plethora of risk may be traded independent the underlying asset. This development now often comes in form of cash settlement, which frees counterparties from delivering the underlying asset.[9] Cash settlement allows various characteristics of a commodity, asset or security to be separated and traded. In financial derivatives contracts, transactions are purely monetary and do not entail any change in ownership of the underlying assets. [10] Derivatives are assigned a notional value according to the multiplication of its spot price by the number of units of the underlying asset stated on the contract. [11] Pricing derivatives is determined by a rate of interest, specifically the London Interbank Offered Rate (LIBOR). LIBOR is set by an amalgam of banks in the derivatives markets, and is made through the evaluating the average of interest rates submitted by each of these banks daily. [12]

Derivative contracts are supposed to offset volatility in financial markets by separating assets themselves from their price's volatility. [13] This separation constitutes a way to hedge the risks endemic to financial speculation, as speculators believe they can diminish their exposure to volatile asset prices. Because any potential failure to execute a contract at full notional value may be hedged through another derivative contract (valued according to perceived chance of execution of the initial derivative contract), the aggregate value circulating through derivatives contracts is grossly disproportionate to the price of all the underlying assets being traded for. [14] Despite this risk-exacerbating practice, derivatives are generally considered relatively inconsequential to capitalist economies. Because they are not a "real input in the production process nor a means of conveying wealth," and since they "fixate on short-term capital flows rather than longer-term investment," traditionally liberal economic views do not take derivatives seriously as a global threat to the banking system, even with their ability to concentrate a large amount of leverage on a single instrument. [15] Yet whereas they are often considered economically marginal and unrelated to the real economy, in fact derivatives have become the largest industry in the world, such that they themselves are becoming key sites of asset price determination rather than the other way around. [16] What these more traditional views miss, then, is that derivatives are in fact related to the real economy, despite their relative degree of separation from the production process.

Derivatives can be traded either in regulated exchanges or 'over-the-counter' (OTC). Exchanges include institutions such as the London International Financial Futures Exchange and the Chicago Mercantile Exchange. Whereas derivatives traded on exchanges require money as collateral and for extra margin payments to be made against adverse fluctuations in the market, OTC derivatives are entirely unregulated. [17] Unlike exchange-traded derivatives, which entail a finite transfer of payment between parties, OTC derivatives contracts are kept open through clearing houses that continuously circulate debt instruments. The market for OTC derivatives has expanded drastically in recent decades, bringing with it new forms of risk and volatility. OTC derivatives are cheaper and more flexible than exchange-traded derivatives, but also they carry a higher degree of risk and are not easily sold to third parties due to their relative lack of liquidity.[18] This means that during volatile periods OTC derivatives are more likely to adversely impact the entire financial system. Yet OTC trading has been on the rise despite this predicament, with nearly one third of trading taking place in dealer-to-dealer transactions, and with each transaction tied to at least one dealer bank as a counter party. [19] Dealer banks are highly concentrated, with fifteen to twenty dealers controlling bulk of OTC trading globally.[20] The boom in OTC trading may be exemplified best by the growth of hedge funds, the participation of financial wings of major corporations, and the involvement of commercial and investment banks. [21] All of this signals an increasing predominance of the financial sector of the economy over the productive sector. It also points towards greater susceptibility to economic instability, as the "default by a major institution, a shift in the prices of derivatives in financial markets sufficient to undermine the viability of a major institution, or the inability to net out obligations and receipts" could all trigger a system-wide crisis. [22] With less productive capital overall in the era of financialization, greater exposures to risk likewise threaten the longevity of the productive sector itself, which is now thoroughly integrated into the financial sphere. Taking on greater risks through trading in derivatives raises the likelihood that the investor will profit or lose money. Large losses can result in bankruptcy, engulfing the various individuals, banks, and institutions that lent money to them and exacerbating systemic risk. [23] In this sense, we may begin to better understand the paradoxical connectedness between the 'real' economy and financial markets.

Different Types of Derivatives

Most derivatives traded today take the form of forwards, futures, options, and swaps. The oldest and most intuitive type of derivative is a forward. Briefly, a forward is a contract between two parties codifying the obligation to buy or sell a particular quantity of an item at a fixed price or rate and a definite future point in time. Foreign exchange forwards, for example, obligate both parties to exchange agreed upon amounts of foreign currencies at a specified rate at a future date. These rates are generally traded 'at par' or 'at market,' meaning the value of the contract at the time it is traded is zero and no money need be traded at the contract's initiation. This means that the market value of the contract is zero, but parties can decide to post collateral as a means of insuring the terms of the contract.[24] Because they are specialized according to specific needs, forwards are relatively limited derivatives contracts, and may involve high search costs to find parties with opposite needs (i.e., exposures to risk). [25] Forwards' binding of parties to exchange may also lead to inconveniences for one or both parties after the contract is actually entered into. If one party defaults, significant legal fees may be required to secure the forward price, and this risk prompts both parties to monitor one another's respective viability.[26] Contract terms are often standardized in order to avoid some of these potential issues. Forward contracts that are standardized, publicly traded, and cleared through a clearing house are referred to as futures. As opposed to forwards, futures are traded on organized exchanges and are largely substitutable for one another, which allows for greater trading volume and contributes to higher market liquidity. This new liquidity may improve the price discovery process, or how reflective market prices are of key information.[27]

As opposed to forwards and futures, option contracts allow the buyer or holder (also called the long options position) to buy or sell the underlying asset in the future. More specifically, buyers are purchasing the right to buy or sell the asset at a particular price (known as the strike price) either at a particular date (known as a European option) or at any time between the option's initiation until its expiration date (known as an American option), and can be traded on individual stocks, stock indexes, and even through futures contracts themselves. [28] Options to buy and sell are known as calls and puts, respectively. Buying and selling on options is somewhat trickier than with forwards and futures; if the spot market price of a stock exceeds the strike price during the window in which the option could be exercised, then the holder may buy at a lower strike price by exercising the option. In this case, the option's value would be the higher market price. If the market price remained below the strike price during the period in which the call option could be exercised, however, then the option would expire worthless. [29] An option's price is often a reflection of market interest rates, the time to its maturity, the historical price volatility of the underlying asset, and the proximity of the underlying asset to its strike price. [30] As with other types of derivatives such as foreign exchange forwards, options can concern financial rather than real commodities. For example, interest rate options provide insurance against increases and deceases (caps and floors) and hikes and drops (collars) in interest rates. Cap options create a ceiling to protect against hikes in interest rates, while floor options create a minimum rate to protect against a potential fall in rates. [31] Options are predicated on the tension between selling short and going long. If someone who does not own the underlying asset sells it through a derivative contract in anticipation of buying it back at a lower price or in the open market at whatever price prevails, they are selling it 'short'. Short-selling produces tremendous exposure to risk. As Henwood notes, "short-selling exposes the practitioner to enormous risks: when you buy something-go long, in the jargon-your loss is limited to what you paid for it; when you go short, however, your losses are potentially without limit." [32] Brokers hypothetically are expected to evaluate clients' credit rating in order to justify short-selling, but this practice is not highly regulated.

More recently, derivatives markets have turned towards the proliferation of swap contracts, which differ somewhat from forwards, futures, and options. A swap contract is perhaps most reflective of the contemporary usage of derivatives, constituting an agreement between counterparties to 'swap' two different kinds of payments, each calculated by applying an interest rate, exchange rate, index, or the price of an underlying commodity or asset to a notional principal.[33] Swaps usually do not require the transfer or exchange of the principal. Uniquely, payments based on swaps are done at regular intervals throughout the duration of the contract. In other words, whereas exchange-traded derivatives involve actual claims on an underlying assets, swaps do not; instead, the swap is between two sets of cash flows, which are usually destabilized by positions in other securities such as bonds or stock dividends.[34] Swaps can take several forms. A 'vanilla' interest rate swap, for example, involves one series of payments based on a fixed interest rate and another based on a floating interest rate. A foreign exchange swap entails an opening payment to purchase a foreign currency at a specified exchange rate, and a closing payment selling the currency at a specified exchange rate. A foreign currency swap consists of one set of payments derived from either a long or short position in a stock or index, and another set derived from an interest rate or other equity position,

amounting to a combination of a spot and forward transaction. [35] Currency and interest rate swaps have become especially important in recent decades. The former allows investors to hedge principle and interest payments in one currency against a preferred currency, while the latter allows borrowers to arbitrate between component markets of the international bond market. In this respect, swaps have played an instrumental role in controlling for short-term risk and thus making international bond markets particularly attractive for global investment. [36]

While each type of derivative contract is uniquely structured, they all share important commonalities. Derivative contracts can be settled either through the physical delivery of the underlying asset or through cash settlement with adjustments of margins on financial differences. Cash settlements allow for agents uninvolved in either production or the use of the underlying assets to speculate. Today cash settlement is more common, as most derivatives no longer involve the transfer of a title or a principle; instead, they create price exposure by conjoining their value and a notional amount or principal of the item form which the contract derives.[37] Taking a price position in the market while only putting up a small amount of capital used allows the investor to leverage, making it cheaper to hedge and speculate. Here derivatives are able to cover hedgers' risks on the spot market covering losses or compensating gains. [38] In speculative transactions with derivatives, however, an agents' position does not correspond to the spot market, and is thus exposed to greater risks in price variation.[39] A similar dynamic applies to arbitrage transactions, which occur simultaneously on the spot market and in the derivatives market. Arbitrage transactions, however, involve parties attempting to profit by exploiting price differentials, thus creating the opportunity for gains without risks. [40] All of this shows us that derivatives are used by a wide range of actors (investors, corporations, banks, etc.) to protect themselves against forms of risk. International agencies and banks use derivatives to hedge their loan portfolio positions, and transnational corporations use them to reduce their exposure to risk, with many creating financial divisions to actively speculate in derivatives markets. [41] Investment banks may also trade in derivatives for corporate clients, with the aim of boosting their liquidity by hedging positions in an inter-bank market.

An Abridged History of Derivatives

Some accounts of derivatives date their origins to biblical times in the form of agricultural consignment transactions. While derivatives trading can also be traced to 12th century Venice (exchanges on agriculture), late 16th century Amsterdam (forwards and options on commodities and securities), and 18th century Japan (futures on warehouse receipts and rice), modern derivatives trading began officially in 1849 when a group of grain merchants created the Chicago Board of Trade (CBOT).[42] The Chicago Board of Trade was originally designed to coordinate "geographically dispersed agricultural markets." [43] Through its legal framework for standardizing the classification of grain trading, it became the central hub in the United States for pricing grains. The CBOT's centrality during this period was facilitated by the development of new networks of railways and telegraphs in the US, which consequently enabled the CBOT to become first institution with a highly liquid futures market for grain contracts.[44] In so doing, the CBOT set the stage for a new kind of financial system in the late twentieth century, with the first formal set of rules governing futures contracts in forged in 1865. [45] Many farmers initially objected to the CBOT because they believed their products were priced too far away from the point of production. Such prices soon became essential for farmers, processors, and traders, however. As Muellerleile explains, "as grain commerce became more integrated with circuits of credit and capital, and more dependent upon risk-management tools such as futures contracts, the flow of price information became a prerequisite for cash crop farming."[46] This integration into growingly expansive flows of capital allowed the consistency of the price mechanism to become a measurement of the strength of the grain industry, which the US Congress declared in the national interest in 1922.[47]

With the onset of the Great Depression, however, the government adopted a more stringent role towards financial speculation (though the agricultural sector was excluded from this approach). The financial legislation put in place by the New Deal would form the bedrock for these new regulatory efforts, most particularly the Banking Act of 1933, which comprised of Regulation Q (the imposition of ceilings on savings deposits and interest rates that could be paid on time), the Glass-Steagall Act, and the creation of a national deposit insurance system facilitated by the Federal Deposit Insurance Corporation.[48] By the 1970s, however, the Chicago exchanges began to apply their methods for pricing agricultural futures to urban financial instruments. State institutions began to more heavily regulate speculation, marking its first serious effort to do so since 1936. [49] The Chicago Mercantile Exchange created the International Money Market in 1972, which allowed for trading in currency futures and paved the way for more abstract contracts. [50] This development in part signified the dissolution of the boundary between agricultural futures and finance, aided by the expansion of the Chicago Mercantile Exchange's (the second largest exchange in Chicago) entrance into new products. [51] Chicago exchanges influenced the passage of the 1974 Commodities Exchange Act that expanded the definition of a commodity from several agricultural products (in the 1936 Commodities Exchange Act) to all goods, articles, services, rights, and interests that can be dealt in futures contracts. [52] At the same time, Congress granted the Chicago Futures Trading Commission (CFTC) sole jurisdiction over futures trading, disallowing any other federal agency or state government entity or law from interfering with the development of futures markets.[53] The CFTC and its related state financial agencies saw it as their duty to promote the spread and hedging of risk, including by the range of non-financial corporations that had traded in derivatives to shield themselves from fluctuating commodity prices, interest rates, and floating exchange rates with the demise of the Bretton Woods Agreement in 1971. [54] These developments were also aided by technological and conceptual innovations during the 1960s, as more economists began to claim that the US stock market was fully efficient in responding to all publicly available information and could be modeled with reasonable accuracy. [55] The popularization of the Black-Scholes pricing formula, for example, changed the character of speculation from advising on option prices to calculating mispriced options or assets, empowering traders to invest on market mispricings with large amounts of borrowed money. [56] Today hedge funds carry out these activities, pooling wealthy clients' investment contributions to arbitrate and trade in derivatives. [57] By the late 1970s in the midst of a crisis of stagnant economic growth and inflation, the Treasury decided it could stabilize currency by raising interest rates to encourage foreign holdings in US Treasury bonds and allowing for the exchange of derivatives on US debt brought to bond markets by the New York Federal Reserve.[58] This move provided the foundation for an unprecedented internationalization of derivatives markets.

Derivatives and Financialization

Derivatives trading has expanded to global proportions since the 1980s. The industry's growth may be attributed most centrally to the development over-the-counter trading for financial derivatives, which corporations utilize to protect themselves from volatility in interest and exchange rates, and which speculators use in their efforts to predict trends in financial markets.[59] The proliferation of financial derivatives during this period is a less frequently discussed but critical component of broader patterns of neoliberal financialization beginning with the gradual dissolution of the Fordist-Keynesian accumulation regime beginning in the late 1960s and taking off in the early 1970s. Keynesianism had provided a unique way of managing risks through stimulating consumer demand with demand-side policy. Its decline gave way to a flexibilization of price relations and the growing importance of market processes in managing financial matters, leading to an influx in derivatives trading. [60] With the deregulation of capital flows, Nixon's move to decouple the US dollar from the gold standard, and the 1973 OPEC oil shocks, price volatility increased in the early 1970s and paved the way for the internationalization of trade investment, exposing firms to greater degrees of risk. With the end of the fixed exchange rate system of Bretton Woods, Panitch and Gindin explain, "the derivatives revolution was crucial to the stabilization of currency markets…and was also immediately linked to the internationalization of the US bond market, which was occurring at the same time as the development of the separate Eurodollar market." [61] More simply, the growth of financial derivatives markets was a requisite for avoiding capital devaluation in a period of economic tumult. The growth of the multinational firm during this period demonstrates the attempts made to mitigate the new volatility endemic to a globalizing derivatives market. [62]As the US bond market opened up, foreign investors began maintain greater holdings in US Treasury securities, above 21 percent by the 1980s. Paradoxically, this uncertainty, "amid the volatility of commodity prices and rising short-term interest rates, actually enhanced the attractiveness of Treasury bills for international investors, who recognized the depth and liquidity of the US bond market despite all the hand-wringing about declining US economic power and strength."[63] Here we can begin to trace a theme of global integration into the financial derivatives market, underpinned by the US dollar-trading on international bonds implicates investors in the volatile movements of currency and interest rates. With investors able to swap various floating and fixed exchange rate obligations in order to better fit their perception of the market direction, the changes in currency levels and interest rates that had traditionally slowed markets down (investment in bonds denominated in suboptimal currencies were deemed too big a risk) began to play a different role in the global economy. [64]

Like the Fordist-Keynesian accumulation regime before it, financialization is a stage of capitalism fraught with contradictions. The term 'financialization' itself is heavily debated, with disagreements over its periodicity, its coherence with or distinctiveness from neoliberalism, and its most essential characteristics. For our purposes here, Kippner's definition is useful. For her, financialization refers to "a broad-based transformation in which financial activities (rather than services generally) have become increasingly dominant in the US economy over the last several decades."[65] The 'financial' here "references the provision (or transfer) of capital in expectation of future interest, dividends, or capital gains," as opposed to productive capital that arises from the production and trade of commodities.[66] This shift towards finance, beginning in the 1970s and expanding in the 1980s and 1990s, provided the state with a means for displacing the rigidities of the Fordist-Keynesian accumulation regime. This displacement occurred first and foremost in the deregulation of domestic financial markets throughout the 1970s, which gradually reduced restraints on the flow of credit. [67] Concurrent spikes in interest rates (most notably Federal Reserve Chair Paul Volcker's 1981 hike, more notoriously known as the "Volcker Shock") in order to restrain the economy in the absence of regulation on the supply of credit also emerged as a response to deregulation. These higher interest rates attracted remarkably high levels of foreign capital into the US economy, thus allowing for a drastic expansion of domestic financial markets and helping to tie the global economy to the floating US dollar. As strict monetary policy became the preferred tactic for stabilizing US currency during this time (resulting in rising unemployment), the Federal Reserve turned to a greater extent to the market, expanding credit at the same time as it increased interest rate volatility. [68] Above all, however, it was the deregulatory moves of the 1980s-removing controls that had restricted interest rates payable on savings deposits-that shaped the course of financialization. [69]

Financialization with Derivatives

Deregulation increased the price of credit while extending it to a broader constituency.[70] The incorporation of US multinational commercial banks into derivatives trading-in addition to Wall Street-based investment banks-should not be overlooked here. (Whereas investment banks create liquidity by dictating the terms of trading of securities, commercial banks do so by transforming deposits into longer-term assets.) [71] With the first significant derivative bond swap in the early 1980s between IBM and the World Bank, banks such as J.P. Morgan used overseas operations in London to bypass the regulations previously put in place by the Glass-Steagall Act and take advantage of growing derivatives markets. After executing the first credit default swap in the early 1990s, derivative contracts accounted for over half of Morgan's trading revenue. [72] Because derivatives are able to conjoin a variety of forms of capital and convert fixed and floating rate loans and currencies, Panitch and Gindin note, these markets were "able to meet the hedging needs not only of financial institutions (which exchanged 40 percent of all swaps among themselves), but also of the many corporations seeking protection from the rapidly evolving vulnerabilities associated with global trade and investment." [73] By the time the Clinton administration took power in 1993, Streeck explains, financial deregulation had "made it possible to plug the gaps resulting from deficit reduction, by means of a rapid extension of loan facilities for private households at a time when falling or stagnant wages and transfer incomes, combined with rising costs of 'responsible self-provision', might otherwise have jeopardized support for the policy of economic liberalization." [74] This shift may be understood as a kind of 'privatized Keynesianism,' [75] in which the public debt taken on by the state during the Fordist-Keynesian accumulation regime is transferred onto consumers in the form of individualized debt relations in tandem with a dissolving social safety net. This extension of credit to compensate for slipping wages and benefits effectively redistributes capital upwards.[76] With the state shifting debt-driven consumption from public financing to private, credit-based consumption, government debt comes instead from low receipts, or limits to taxation, while corporate interests are empowered to make increasing demands on the state. [77]

Arguably the central paradox of financialization is that while financial institutions, markets, and assets "can secure the return of value in particular instances," they "cannot guarantee the systematic augmentation and return of value in the aggregate." [78] As opposed to a wage labor relation, in which a fixed amount of capital is guaranteed to a capitalist according to the rate of surplus-value extracted from a worker and marks a contribution to the overall amount of real capital in circulation, financial markets operate in the sphere of circulation and can only either redistribute capital or create fictitious value. Financial markets begin to malfunction when the expansion of monetary value across an economy can no longer be guaranteed by participants in financial transactions. Here we can better understand a central contradiction of derivatives: they exist to offset or control this risk but ultimately increase it. Despite this paradox, it is not difficult to understand why derivatives have grown over the past nearly-four decades. They provide investors, corporate treasury departments, and bank risk management departments with the advantage of being able to hedge risk as a measure of insurance against adverse fluctuations in the market. [79] Moreover, they can provide signals to larger financial markets, which could ostensibly reduce uncertainty and unequal access to information. Derivatives also allow investors to more cheaply diversify their portfolios, as managers are able to expose themselves to derivatives according to a larger number of shares. Furthermore, derivatives operate on leverage and are thus cheap to trade in.[80] A liberal economic perspective might claim that derivatives are incapable of affecting the price of underlying assets in conditions of perfect market competition, and that they simply provide greater economic stability by spreading risk between different agents in the market; in reality, however, asymmetric access to information and imperfections in the instruments themselves open markets up to greater degrees of systemic risk. [81] In bypassing the sphere of production, surplus-value in production is replaced by essentially zero-sum casino bets, manufacturing risk through a social logic of mutual indebtedness.[82]

What's New About Derivatives?

As the field of financialized economic activity incorporates greater numbers of people through the financialization of risk, capital circulation becomes decoupled from the labor process. [83] Whereas the labor process relies on the extraction of surplus-value in the sphere of production, financialization means that the appreciation of fictitious capital becomes autonomous relative to productive appreciation, as tradable financial instruments are valued according to expected income flows and discounted by an interest rate. [84] On the other hand, however, this process should be understood as a means of integrating the workforce into financial channels and is thus actually semi-dependent on productive capital. Carneiro et al. assert that the advent of derivatives constitutes a new form of accumulation entirely, which they call the 'fourth dimension'.[85] While historically this fourth dimension of capital has developed in tandem with capital in its monetary form, it also "progressively constitutes an autonomous force in the process of capital appreciation when deep and liquid markets freely negotiate stocks of wealth." [86] In other words, this fourth dimension is linked to the changing role of derivatives in the 1970s, along with fundamental changes in the international financial and monetary systems allowing for more rapid accumulation over greater distances.[87]

At this point it is necessary to clarify two related yet distinct issues. One is the process of financialization, the other the growth of derivatives trading. Carneiro et al. assert that derivatives markets constitute a unique form of accumulation because capital appreciation occurs independent of initial investment. This is markedly different from credit-based capital appreciation. Since the 1970s financial relations have dominated economic policy-making, pushed more individuals into debt, and formed a new mode of accumulation characterized by falling profit rates and real wages, persistent unemployment, and mediocre growth in productive sectors. Yet within financialization, derivatives signify an even greater abstraction of capital from the process of accumulation. [88] Carneiro et al. explain this as "a difference in the nature of the gain from the operation," jettisoning the "need for money as a means of appreciation, or its advance in the beginning of the process." [89] This means that though "money is still an end to the process of valorization," it "loses its relevance as a vehicle of valorization, as well as the credit system." [90] This form of accumulation is intrinsically speculative-gains from derivatives transactions come simply from a bet on a price movement by an asset that is not owned by the speculator. Despite this fundamentally unique character of derivatives, however, it would be unfair to claim that derivatives are actually entirely independent of the production process. When changes in risk perception generate price-adjustments in the market in the form of the inversion of bets and settlements of contracts, "social relations of property and credit are again essential to ensure liquidity and solvency of agents involved in these markets, revealing the real social relations of power, property, and money that appeared previously only in a veiled manner."[91] The remainder of this report will detail the relation between the spheres of production and circulation vis-à-vis derivative-based accumulation.

Derivatives, Time-Space Compression, and Spatio-Temporal Fixes

Though the derivatives market is the most liquid in the world, it is also highly vulnerable to systemic crisis. Of particular concern is that derivatives may be based on practically any asset, including worker debt. As Lapavitsas explains, "these derivatives could be thought of as synthetic bonds," or "securities promising to pay the holder a return (interest) out of a variety of payments made by the workers which are pooled and then divided."[92] Workers' payments on, for example, housing and consumer debts, would entail a payoff for the holder of a given derivative security who has a claim on that personal debt. Despite their separation from the sphere of production, derivatives are in the final instance contingent on it. Labor thus becomes an extension of financial services themselves, vulnerable to risks entailed by the circulation and realization of capital, which it simultaneously empowers through deferred wages and relies upon in order to access necessities such as education and retirement costs. [93] Those that make up the productive sector are both incorporated into and dependent upon these circuits of realization.

Understanding derivatives' functionality helps us evaluate the specificities of contemporary capitalism's tendency towards crisis. As derivatives markets are predicated on the mitigation of risk, it is crucial here to consider how derivatives fit with established theories of capitalist crisis. One of the most notorious theories on this count is David Harvey's 'spatial fix.' Harvey explains that competition between capitalists leads to an uneven accumulation of capital, which threatens the reproduction of both capitalist and working classes. To recall from earlier, this threat takes the form of an excess of capital relative to available opportunities for profitable reinvestment (also known as overaccumulation). Overaccumulation manifests through a surplus of commodities, money-capital, and/or labor power. [94] There are two solutions to this problem. The first involves the devaluation of capital through inflation, gluts of commodities on the market and falling prices, productive capacity culminating in bankruptcy, and falling real wages and standards of living. This solution is not optimal for capitalists. The second solution, however, involves lending surplus capital abroad to create productive powers in new regions. This latter option is the crux of the 'spatial fix'. Crises are temporarily resolved because rates of profit in these new regions incentivize a flow of capital and raise the rate of profit in the system as a whole. The problem here is that higher profits entail an increase in the tendency towards overaccumulation; moreover, this now takes place on an expanding geographical scale. As Harvey writes, "the only escape lies in a continuous acceleration in the creation of fresh productive powers. From this we can derive an impulsion within capitalism to create the world market, to intensify the volume of exchange, to produce new needs and new kinds of products." [95] While capital is ultimately limited through productive capacity (only so many goods can be produced and circulated), derivatives-as instruments whose value is only derived from the asset underlying them-may represent a way of circumventing real barriers to accumulation.

According to Harvey, an irresolvable tension emerges between the devaluation of domestic capital due to international competition (apropos the development of new export-driven regions), and the internal devaluation of capital in these regions (as constrained development also limits international competition and blocks opportunities for profitable export). Productive forces in new regions constitute a competitive threat to the country that introduced the spatial fix, whereas limited development in new productive centers hinders international competition and reduces profitable opportunities for capital export, thus leading to an internal devaluation of capital with immobile overaccumulated capital. [96] Geographical expansion allows overaccumulated capital to be invested into labor surpluses and for the development of primitive accumulation processes in these exterior regions as an alternative to devaluation. Though the spatial fix applies mostly to overaccumulation resulting from competition in the sphere of production, overaccumulation itself is not limited to this dimension of capitalist relations. Beginning in the 1970s, for example, overaccumulated manufacturing capital in cities-in tandem with the influx of capital due to higher petroleum prices-garnered an excess of speculative capital that could not be used to boost industrial production. [97] This speaks to a crucial tension between speculative and productive capital, as this juncture required the freeing of speculative capital from the production process by creating a separation between new derivative instruments and their underlying assets. It is thus argued here, then, that derivatives markets constitute their own paradoxical form of a spatial fix, especially as the underlying assets become currency-related.

Crucial to the spatial fix embodied by derivatives markets is the time-space compression endemic to capitalist accumulation and financialization more dramatically. During the 1970s this dynamic took the form of organizational shifts in production that undid the managerial tendencies of Fordism, generating a more fluid and decentralized mode of production.[98] At the same time, technological innovation during this period allowed for a faster and more geographically distantiated financial sector. With an expanded reach, however, comes an increased tendency towards volatility; the shortened length of time capital takes to move across space facilitates more short-term gratification, but compromises states' ability to engage in long-term planning. This limitation means that financial institutions must either adapt quickly to rapid market shifts, or find ways to control volatility themselves.[99] The rapid and expansive movement of capital under financialization represents a paradox for Harvey, as "the less important the spatial barriers, the greater the sensitivity of capital to the variations of place within space, and the greater the incentive for places to be differentiated in ways attractive to capital," all of which leads to increasingly uneven development "within a highly unified global space economy of capital flows."[100] Though Harvey's "globalized space economy" still primarily refers to the sphere of production, the flexibilization of the financialized accumulation regime entails a fundamental shift in how value is represented as money: "the de-linking of the financial system from active production and from any material monetary base calls into question the reliability of the basic mechanism whereby value is supposed to be represented." [101] In other words, the productive sphere loses power relative to the financial.

Here it is necessary to question more precisely how the migration of capital from the sphere of production to the sphere of circulation may constitute a spatial fix. Bob Jessop, a critic of Harvey, argues that for however important the spatial fix, Harvey's focus on "the production of localized geographical landscapes of long-term infrastructural investments that facilitate the turnover time of industrial capital and the circulation of commercial and financial capital" [102] cannot adequately account for the movements and contours of capital under financialization. By examining spatial fixes solely in terms of the contradiction between the unstable movement of productive capital in the form of profits for reinvestment and the fixity of concrete assets with particular times and places, Jessop explains, Harvey elides a discussion of "the different forms of spatio-temporal fix in relation to the different stages or forms of capital accumulation, nor their articulation to institutionalized class compromise or modes of regulation." [103] While production entails a profit motive (the creation of surplus-value through relations of exploitation), the profits resulting from circulation derive not from any value it creates, but rather from its capacity to redistribute surplus-value. Jessop writes of the importance of 'time-space distantiation'-not just compression-in a globalizing world economy, or the expansion of political-economic relations across time and space such that they may be coordinated over greater distances and scales of activity. [104] For him, the twin dynamics of compression and distantiation indicate that "the power of hypermobile forms of finance capital depends on their unique capacity to compress their own decision-making time…whilst continuing to extend and consolidate their global reach." [105] This tension is present within any individual or interconnected circuit of capital, depending as they do on the relationship between "a physical marketplace and a conceptual marketspace." [106] Despite the altered character of these spatial barriers to accumulation, however, physical territory remains essential to the circulation of capital, as it is contingent on static ensembles in which the means of production and organization necessitate the extraction of surplus-value. [107]

Derivatives markets exhibit a unique spatio-temporal in relation to contemporary capitalist accumulation. As Bryan and Rafferty write, "derivatives, through options and futures, establish pricing relationships that 'bind' the future to the present." [108] Like Harvey's spatial fix centered on productive capital, derivatives markets may be viewed as a spatial fix in and of themselves in their attempt to hedge risk and stave off devaluation as more individuals and institutions become exposed to financial risk. Corporations trade in derivatives markets in order to handle their exposure to risks in a sea of variable rates and prices. Ensuring the value of money is key, and the spatial displacement constituted by derivatives (into cyberspace or digital space, as it were). It purports to facilitate this process in several respects. First, derivatives constitute a unique form of money by providing a universal measure for asset value across space, despite their dependence on nationally-based unequal levels of contestability. [109] In other words, derivatives are ultimately based on US norms of risk value and conceptions of secure financial claims. Second, derivatives markets aim to allow for the limiting of exchange- and interest-rate risks for corporations and for comparing various risk management strategies across time and space, though this may increase systemic volatility even these new strategies do not immediately drain productive capacity. [110] Finally, banks or other financial institutions might engage in securitization and over-the-counter trading in order to mitigate the uncertainties of profiting from credit money. As Soederberg explains, over-the-counter trading on securitized derivatives, particularly credit default swaps, "facilitates temporal and spatial displacements that allow banks to shift loans off the balance sheet by selling them to outside institutional investors, such as pension and mutual funds." [111] By spreading risk and shifting risks on to others, these institutions are able to at least temporarily protect themselves.

Here we encounter some problems, however. In particular, the dominance of credit makes it especially difficult to ensure the quality of money. This is especially true when it is less profitable to expand value production than to provide credit and profit through interest rates. [112] This is what Jessop means when he writes of "a fundamental contradiction between the economy considered as a pure space of flows and the economy as a territorially and/or socially embedded system of extra-economic as well as economic resources and competencies." [113] When capital is able to quickly exploit resources in one area without contributing to their reproduction and then move elsewhere to replicate this kind of circulation, it is compromising the sphere of production and thus the strength of the dollar. The sphere of circulation is particularly vulnerable when debt enmeshed in the web of speculation becomes irredeemable or the gap between the value of credit and that of real money becomes too wide. [114] However, the increasing use of securitization and derivatives markets as a risk management strategy has made regulating banks for capital adequacy unable to guarantee seriously limiting risk exposure. This is why in 2008 the key US financial institutions (the Fed and Treasury, as well as the Bank for International Settlements) all shifted to the same models for assessing risk as the largest banks, in the hope of accessing regulators' "fire codes."[115] Competitive pressures between big banks in derivatives and securities markets can lead to an indifference to these regulative warnings, thus further widening the gap between fictitious and real value. [116] When this occurs, the glut of fictitious values (in the form of privately created credit money) contributes to inflation and devalues currency. This problem was most severe in the crisis of 2008, when the American International Group (AIG)-a financial institution that provided insurance for other financial institutions on the creditworthiness of their derivative holdings-was ultimately unable to honor its insurance contracts and protect against loss.[117] Banks extending mortgages to borrowers turned to commercial banks in order to fund the loan, which would then sell the loan to government-sponsored enterprises such as Fannie Mae. These institutions consolidate a range of mortgages and sell the resultant mortgage-backed security (MBS) to an investment bank, which repackages the MBS according to its needs and issues other derivatives such as collateralized debt obligations (CDOs) to be bought by other lenders, banks, or hedge funds.

The link to the sphere of production is again crucial here. As Wolfson explains, "at the base of this complicated pyramid of derivatives might be a subprime borrower whose lenders did not explain an adjustable-rate loan, or another borrower whose ability to meet mortgage payments depended on a continued escalation of home prices. As the subprime borrowers' rates reset, and especially as housing price speculation collapsed, the whole house of cards came crashing down." [118] Derivatives do not require ownership of the underlying asset, so it is possible to speculate-via credit default swaps with an insurer-on the chance of default on a security without owning it. This property of derivatives means that the volume of insured securities can increase quickly and significantly, such that a relatively small quantity of securities can be insured at a much higher amount.[119] Since consumer credit can circulate only as a claim over a share of future profit, or surplus-value and depends on the stability of creditors to pay their loans, asset-backed securitzation has developed in order to ultimately ensure the quality of real money for speculative interests. [120] The time-space compression that occurs through derivatives trading "entails new actors, new strategies and the continual inversion of time and the expansion of virtual space to continue to fund claims on the fictitious value of credit."[121] It is clear, then, that derivatives are ultimately reliant upon productive capital. And while price fluctuations might trigger financial crises, the fear of devaluation due to an overaccumulation of capital is still at the crux. Because of the global scale of derivatives, it is not just the American state that must ensure the stability of the dollar, but any marginal economy, as a means of guarding against a downturn in their own currency value.[122]

Conclusion: Towards a Typology of Spatial Fixes

This paper has attempted to explain derivatives' instrumental properties, their historical development, and their distinct role in both mitigating and exacerbating crises. The basic premise argued that derivatives markets act as a kind of spatial fix in and of themselves, one that maintains several properties of Harvey's spatial fix of productive capital but that also differs in important ways. In summing up, then, this paper will provide a brief typology of spatial fixes in order to provide some clarity to the question of how these spatial fixes differ analytically.

We can think here of three kinds of spatial fixes. First is Harvey's spatial fix, which pertains to productive capital only. Second are financialized spatio-temporal fixes. These fixes are unique in their supplying of fictitious capital. Last are derivative spatio-temporal fixes which, like financialized spatio-temporal fixes, ultimately are dependent upon the sphere of production (in the sense of its effect on interest rates and exchange rates), but operate abstractly in digital OTC markets and move at an unprecedentedly rapid speed. While maintaining many of the properties of financialized spatio-temporal fixes, derivative spatio-temporal fixes constitute their own category because of their separation from an underlying asset. What unites these three forms of spatial fixes is that they are used in order to solve the problem of overaccumulation, yet ultimately contribute to greater systemic risk. What differentiate them are their respective degrees of separation from the sphere of production and, equally important, how they modify the circulation of capital according to spatial parameters. Each type of spatial fix also affects those linked to them in unique ways. For example, a spatial fix of productive capital mitigates a crisis of overaccumulation by opening up productive markets in new regions, or expanding the means of production. This affects capital by increasing the rate of profit in the system as a whole by incentivizing the flow of capital to these regions and trading on the world market, which ultimately tends again towards overaccumulation. A financialized spatio-temporal fix, in contrast, works by extending fictitious capital to individuals and institutions in exchange for later interest payments. Finance capital may be deployed in tandem with productive capital in order to build industry, procure assets, or pay for goods and services. At the same time, fictitious capital is by nature unproductive and thus its extension can be characterized as a mode of debt-driven accumulation. We can understand this process as a spatio-temporal rather than simply a temporal one because finance concurrently reshapes the landscape for productive capital while maintaining speculative interest due to stable currency. Of course, when expectations are too optimistic and a speculative bubble pops, debts are not repayable and financial institutions experience severe losses. [123]

Derivative spatio-temporal fixes are unique in their ability to commodify risk itself, thus "transform[ing] the temporal horizon of circulation-centered capitalism." [124] Derivatives constitute a fundamental shift in the operations of speculative capital and the internationalization of risk. [125] Whereas financial spatio-temporal fixes constitute a debt-driven accumulation tactic, derivative spatio-temporal fixes commodify the inherent relationship structured by that debt, and may be used for hedging, speculation, and leveraging across infinite space. This movement entails particular political consequences that are unlikely to recede on their own. As risks to capital are speculated on rather than altered and the globalization of risk is further insulated from political pressures, [126] crises such as that of 2008 will continue. Understanding the proliferation of these fixes to capitalist crisis is crucial if we are to consider viable alternatives.


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[1] David Harvey, "The Spatial Fix - Hegel, Von Thunen, and Marx," Antipode, Volume 13, Issue 3 (1981): 7.

[2] Costas Lapavitsas, Profiting Without Producing: How Finance Exploits Us All (New York: Verso, 2013), 4.

[3] Scott Aquanno, "US Power and the International Bond Market: Financial Flows and the Construction of Risk Value," in American Empire and the Political Economy of Global Finance , ed. Leo Panitch and Martijn Konings (New York: Palgrave Macmillan, 2009), 121.

[4] Randall Dodd, "Derivatives Markets: Sources of Vulnerability in US Financial Markets," Financial Policy Forum, Derivative Study Center (May 2004), 1.

[5] Ibid, 643.

[6] Dick Bryan and Michael Rafferty, Capitalism with Derivatives: A Political Economy of Financial Derivatives, Capital, and Class (New York: Palgrave Macmillan, 2006), 13.

[7] Sarah Breger Bush, "Risk Markets and the Landscape of Social Change: Notes on Derivatives, Insurance, and Global Neoliberalism," International Journal of Political Economy, Volume 45 (2016), 127.

[8] Bryan and Rafferty, Capitalism with Derivatives, 2.

[9] Lapavitsas, Profiting Without Producing, 6.

[10] Ricardo de Medeiros Carneiro, Pedro Rossi, Guilherme Santos Mello, and Marcos Vinicius Chiliatto-Leite, "The Fourth Dimension: Derivatives and Financial Dominance," Review of Radical Political Economics, Volume 47 (2015), 642.

[11] Lapavitsas, 5.

[12] Ibid, 9.

[13] Carneiro et al., "The Fourth Dimension: Derivatives and Financial Dominance," 644.

[14] Randy Martin, "What Differences do Derivatives Make? From the Technical to the Political Conjuncture," Culture Unbound, Volume 6 (2014), 193.

[15] LiPuma and Lee, 87.

[16] Bryan and Rafferty, 63.

[17] Adam Tickell, "Dangerous Derivatives: Controlling and Creating Risks in International Money," Geoforum, Volume 31 (2000), 90.

[18] Tickell, "Dangerous Derivatives," 90.

[19] Lapavitsas, 8.

[20] Ibid.

[21] LiPuma and Lee, 91-92.

[22] Tickell, 90.

[23] Dodd, 6.

[24] Dodd, 20.

[25] Bryan and Rafferty, 42.

[26] Ibid.

[27] Dodd, 20.

[28] Doug Henwood, Wall Street: How It Works and for Whom (New York: Verso, 1997), 29.

[29] Dodd, 21.

[30] Henwood, Wall Street, 30.

[31] Dodd, 22.

[32] Henwood, 29.

[33] Dodd, 23.

[34] Henwood, 34.

[35] Dodd, 23.

[36] Aquanno, "US Power and the International Bond Market," 131.

[37] Ibid, 19.

[38] Carneiro et al., 643.

[39] Ibid.

[40] Ibid, 644.

[41] LiPuma and Lee, 43.

[42] Tickell, 88.

[43] Chris Muellerleile, "Speculative Boundaries: Chicago and the Regulatory History of US Financial Derivative Markets" Environment and Planning A, Volume 47 (2015), 2.

[44] Ibid, 4.

[45] Tickell, 88.

[46] Muellerleile, 5.

[47] Ibid.

[48] Greta Krippner, Capitalizing on Crisis: The Political Origins of the Rise of Finance (Cambridge: Harvard University Press, 2012), 60.

[49] Muellerleile, 8.

[50] Tickell, 88.

[51] Muellerleile, 9.

[52] Ibid, 12.

[53] Ibid, 13.

[54] Leo Panitch and Sam Gindin, The Making of Global Capitalism: The Political Economy of American Empire (New York: Verso, 2013), 150.

[55] Donald Mackenzie and Yuval Millo, "Constructing a Market, Performing Theory: The Historical Sociology of a Financial Derivatives Exchange," American Journal of Sociology, Volume 19, Number 1 (July 2003), 114.

[56] Ibid, 44.

[57] Bryan and Rafferty, 4.

[58] Panitch and Gindin, The Making of Global Capitalism, 150.

[59] Bryan and Rafferty, 7.

[60] Ibid, 8.

[61] Panitch and Gindin, 150.

[62] Ibid, 50-51.

[63] Ibid, 151.

[64] Aquanno, 131.

[65] Krippner, Capitalizing on Crisis, 2.

[66] Ibid, 4.

[67] Ibid, 52.

[68] Ibid.

[69] Ibid.

[70] Ibid, 58-59.

[71] Lapavitsas, 134.

[72] Panitch and Gindin, 176.

[73] Ibid.

[74] Wolfgang Streeck, Buying Time: The Delayed Crisis of Democratic Capitalism (New York: Verso, 2014), 51.

[75] Colin Crouch, "Privatized Keynesianism: An Unacknowledged Policy Regime," The British Journal of Politics and International Relations , Volume 11, Issue 3 (August 2009), 382.

[76] Martin, 195.

[77] Streeck, Buying Time, 66.

[78] Lapavitsas, 108.

[79] Tickell, 89.

[80] Ibid.

[81] Ibid.

[82] Martin, 191.

[83] Ibid, 199.

[84] Carneiro et al., 647.

[85] Ibid, 648.

[86] Ibid.

[87] Ibid.

[88] Lapavitsas, 3.

[89] Carneiro et al., 649.

[90] Ibid.

[91] Ibid, 650.

[92] Lapavitsas, 167.

[93] Martin, 196.

[94] Harvey, "The Spatial Fix," 7.

[95] Ibid.

[96] Ibid, 8.

[97] LiPuma and Lee, 98.

[98] David Harvey, The Condition of Postmodernity: An Enquiry into the Origins of Cultural Change (Oxford: Wiley-Blackwell, 1991): 284.

[99] Ibid, 287.

[100] Ibid, 295-96.

[101] Ibid, 296.

[102] Bob Jessop, "The Crisis of the National Spatio-Temporal Fix and the Tendential Ecological Dominance of Globalizing Capitalism," International Journal of Urban and Regional Research, Volume 24.2 (June 2000), 337.

[103] Ibid, 340.

[104] Ibid.

[105] Ibid.

[106] Ibid, 346.

[107] Ibid.

[108] Bryan and Rafferty, 12.

[109] Aquanno, 130.

[110] Panitch and Gindin, 188.

[111] Susanne Soederberg, Debtfare States and the Poverty Industry: Money, Discipline and the Surplus Population (New York: Routledge, 2014), 91.

[112] Ibid, 54.

[113] Jessop, 347.

[114] Soederberg, Debtfare States and the Poverty Industry, 54.

[115] Panitch and Gindin, 266.

[116] Ibid.

[117] Marty Wolfson, "Derivatives and Deregulation," in Real World Banking and Finance, 6th Edition, ed. Doug Orr, Marty Wolfson, Chris Sturr (Boston: Dollars and Sense, 2010), 152.

[118] Ibid.

[119] Ibid, 153.

[120] Soederberg, 43.

[121] Ibid, 91.

[122] LiPuma and Lee, 52.

[123] Wolfson, 151.

[124] LiPuma and Lee, 127.

[125] Ibid, 37.

[126] Bush, 134.