With Derivatives At An All-Time High, US Economy Can Handle $100 Oil, Falling $ and Subprime Crisis?
I blogged before about why "The Energy Efficient Economy Can Handle $100 Oil," and Greg Mankiw linked to that CD post on his blog asking "Where have all the oil shocks gone?" As Mankiw summarized, "The economy is far more energy-efficient today than it was in the past, in part because economic activity is based more on services and less on manufacturing. As a result, energy prices matter less today."
Another reason that the U.S. economy today can handle record oil prices, a falling dollar, and increasing credit risks, without going into recession? Price, currency, and credit risks have been hedged effectively using derivative contracts (futures, options, swaps, etc.), insulating the U.S. economy more than ever before from oil shocks, currency risk and the subprime mortgage crisis.
As the top chart above shows, the volume of futures contracts at the Chicago Mercantile Exchange is at an all-time historical high, and have increased by a factor of 6X between 2000 (231 million contracts) and 2006 (1.403 billion).
Likewise, the value of derivative contracts (according to the OCC) held by U.S. commercial banks in 2007 ($152 trillion) is almost 11X 2007 U.S. GDP ($14T), compared to a ratio of 2:1 in 1994 (see bottom chart above) for Derivative Contracts:GDP.
Bottom Line: With derivative trading at an all-time historical high, which allows for low-cost effective hedging of price risk, currency risk, interest rate risk and credit risk, the U.S. economy of 2007 has been able to easily accommodate oil shocks, a falling dollar, and the subprime mortgage crisis, without the risk of recession.