Janet Tavakoli says CDSs traders demand payment in GOLD

03-08-2010 • huffingtonpost.com/

These obligations now settle in euros, but the end game is to settle them in gold. This is so ripe for speculative manipulation that you might as well cover the U.S. map with a bull's-eye. Credit default swaps are not insurance. If you buy fire insurance on your home, you must own the house. If you buy credit protection on the United States, however, you do not need to own U.S. Treasury bonds. If your protection gains value after you buy it -- not because the U.S. defaults, but because of market mood changes -- you can resell that protection and make a profit. Lower credit risk means a lower price for protection. Zero implies zero risk. The higher the basis points, the higher the implied risk. When U.S. credit default swaps were first introduced, the price of protection was around two basis points. According to Bloomberg, the price for five-year protection was around 38 basis points on Friday. But the price in the over-the-counter market -- where this stuff actually trades -- was almost double or around 75 basis points. Since most traders in U.S. credit default swaps don't think the U.S. will default any time soon, why are they trading U.S. credit default swaps? They are speculating on price movements the way a day trader buys and sells stocks to speculate on stock price movements. Volume in U.S. credit default swaps is relatively small, but it can explode rapidly, just as volume expanded rapidly for credit default swaps on mortgage debt in 2006 and 2007. Speculators Want U.S. CDS Payoffs in Gold Remember AIG? When prices moved against AIG on its credit default swap contracts, AIG owed cash (collateral) to its trading partners. AIG paid billions of dollars and owed billions more when U.S. taxpayers bailed it out in September 2008.