Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

2012: The Other Prediction

Posted by butalidnl on 18 October 2011

On 21 December 2012, the “world as we know it will end.” The Maya seem to have made a similar prediction, but they were referring to physical things happening e.g. a polar reversal, or a rapid change in sea level, or something like that. (Remember the movie ‘2012’?). My prediction, on the other hand, refers to the world financial system. More specifically, I predict that on 21 December 2012, the postwar Bretton Woods financial system – which has the US dollar as the world’s reserve currency – will collapse.

The dollar-based world financial system is set to collapse. This we saw during the 2008 world financial crisis.  The main reason that it didn’t collapse then was that the whole world’s economy would have crashed, as in deep depression worldwide. Thus, all countries chipped in to prevent the system from collapsing.  In the years since then, many countries have de-coupled from the US economy to the extent that if the US economy were to collapse, they will get ‘only’ a recession, instead of a depression. Other countries will be less willing, the next time around, to go into deep into debt to save the US; and causing them to suffer from secondary crises e.g. Eurozone sovereign debt crisis.

The US dollar is the cornerstone of the world’s economy, and it is under pressure. This is because of the dire state of the US economy, with its very high sovereign debt, negative trade and exchange balances, high unemployment, falling housing prices, etc. The US economy has been kept running mainly because of extremely low interest rates for US Treasuries, which have to go up sooner or later.

Why 21 December 2012? Well, why not?, why not on that date? But I have more going for this date than any other, as I will now explain. There are enough reasons to think that A CRASH WOULD HAPPEN on or around this date.

Triple Witching
21 December will be the ‘triple witching’ date for world markets in 2012. Every third friday of a month, option contracts (as well as warrants and futures) for stocks, bonds, currencies, and commodities expire. That is the month’s ‘witching’ date. Every three months (March, June, September and December), quarter options also expire. And on the 3rd friday of December (which is 21 December in 2012), the year options, quarter options and month options all expire at the same time.

Trading on a witching day is a lot more volatile than in ordinary days, since holders of contracts need to settle their accounts at the end of the trading day. Depending on how widely options had been bought and sold for a category, the fluctuations in the price of the underlying asset can vary by several percentage points. With triple witching, it could vary enormously.

Lame Duck, Debt Ceiling
The US will be having elections in early November 2012, but the winners will be installed only in late January 2013.  There will be almost 3 months when the outgoing congressmen and senators (and perhaps even president) will still be in office. This is known as the ‘lame duck’ period.

If, for example, the tea party congressmen and senators lose big in November, they will try to maximize the 3 month lame duck period to pass all kinds of laws they like. They will also block everything they don’t want with even more energy. It so happens that there is an important piece of legislation that is practically scheduled to be passed during the lame duck period, and this is a law that would (again) increase the debt ceiling for the US government. The recently approved higher debt ceiling is expected to be reached around December 2012, meaning that the debt ceiling would need to be raised at that time. The Democrats had demanded this, so that the decision won’t be influenced by the election’s dynamics.

Thus, the US debt ceiling legislation will have to be passed by the lame duck congress in December 2012. The fight over this promises to be even more intense than the last time, which was then quite destructive (as a result, the US Treasuries’ credit rating was downgraded).

Window Dressing
During the course of the year, traders buy shares of small-cap companies, emerging market stocks and bonds, etc, and before the year ends they sell most  of these and buy prime stocks, mostly from the Dow Jones Index. This is called ‘window dressing’. Traders everywhere do something similar, because they want to report holding ‘stable’ stocks at the end of the year. The only difference is that in each country, they would have some local stocks which are a ‘must hold’.

Now, imagine what traders will do when presented with the prospect of buying Dow Jones stocks, which are almost sure to lose value come 1 January. What will they do in terms of ‘window dressing’? Well, the prudent trader would buy up Euro, Yen and Swiss Franc denominated stocks (e.g. Nestle, Toyota, Shell, or Siemens)  and bonds; in the process selling a corresponding amount of US stocks and bonds. This may be prudent for the individual trader seeking to protect the capital of their investor-clients, but if they all do this at the same time it will mean a massive sell-off of dollars.

Christmas and New Year
21 December 2012 will be the last full trading day before Christmas. On Monday, 24 December, markets will only be open for a half day, at most.

But Christmas 2012 will be a bit different from most others. For one thing, it will be end of a year of depressing economic performance, particularly with regards to employment.  By mid-December, there will be initial figures for Christmas sales and Christmas hiring; and both are sure to be disappointing (i.e. significantly lower than 2011).

To make matter worse, foreign Central Banks usually decide to reduce the percentage of dollars in their currency reserves at the beginning of the year (i.e. on 1 January). They’ve been doing this for the last few years already, reducing the percentage of dollars held in reserve by one or two percent every time. It usually leads to a slight deterioration in the value of the dollar in January, and then the effect usually dwindles. But at the end of 2012, with so many things going on, the prospect of yet another factor causing the dollar value to dip could really worry traders. They may take from the experience of 2006, when the dollar lost value starting early December in anticipation of the January dip.

External Factors
So far, I have mentioned America-specific (and date specific) reasons for the US economic collapse on 21 December 2012. Now, let’s look at the external factors.

The Euro will be stable. It may be hard to imagine now, but by the middle of 2012, the so-called Euro crisis will be over.  The Eurozone countries would have settled the Greek problem with a programmed partial default, and have saved the banks from bankruptcy. They would have strengthened the EFSF, and made sufficient funding arrangements to help countries in trouble.  They would have even amended the relevant treaties to strengthen the Eurozone’s financial health. Financial market speculators will avoid betting against the Euro, knowing that it has enough ammunition to defend itself.

With the Euro stable, it will only take a few months before US investors would realize that they stand to earn more if they invested in Euro-denominated assets. The dollar is sure to lose value as a result. A stable Euro will make the dollar a lot less attractive as a place to put money. Why invest in dollar denominated assets when the dollar will devalue 10% to 15% per year? Dollar devaluation will be a self-perpetuating process.

High Oil Price. When winter comes, the price of oil usually goes up, as demand for heating oil rises. During the whole of 2012, the oil price would have inched itself higher and higher, reaching from $130 to $150/barrel (if not even higher) by December 2012. The price of oil has an inverse correlation with the value of the dollar.

Political Events. Foreign countries know that America’s political ‘wiggle room’ during the lame duck period is limited. If a country wanted to declare war with its neighbor, or if people plan to rise in revolution against a state that is supported by the US, the lame duck period would also be a great time to do it.

China Sanctions? I expect that the Democrats will seize control of both Houses of Congress in the November 2012 elections. With this, the Democrats would push for legislation accusing China of currency manipulation, and compelling the government to impose extra taxes on chinese imports. The Chinese would be extremely worried about this, and may start reacting as early as December 2012.

All in all, there is every reason to expect a very significant fall in the value of the US dollar and a huge stock market decline on 21 December 2012.  The US financial system is so shaky that it won’t be limited to a mere ‘dip’, but will become a crash that will signal the end of the US dollar’s financial dominance.

All this is assuming that nothing apocalyptic of the type the Maya predict will happen.

You have been warned.

2 Responses to “2012: The Other Prediction”

  1. Hmmm. Your predictions are definitely thought provoking. They seem much more “normal” than other 2012 predictions, let me tell ya! Here is a perspective that is not so much a prediction as it is an alternative belief. You can get a free preview of the short book here:
    Hopefully it proves to be as entertaining as your blog was! Thanks for the entertainment.

  2. Palawan dreamer said

    Future predictions on economic and political outcomes one or more years out are fun to give but tend to be way off the mark. I think this will be similarly true of your December 2012 scenario – that it won’t pan out. Obviously, since your gloomy posting in October quite a bit in the US economy has shifted more toward positive and growing momentum to make your depressing scenario much less likely. Thus even with the dicey situation in Europe dragging on and on, the possibility of a rough slowdown in China, higher oil prices a la Middle-East tensions/Iran, plus the incalcitrance of policy makers in Wash. DC. regarding debt issues threatening future long term growth (substantive moves re debt issues before 2013 are almost impossible)
    the US economy will weather the storms (grow moderately) and manage to keep the dollars value fairly stable or within a reasonable range or not too far from where it was in October 2011.
    Barring some huge natural catastrophe (like a massive California quake/flood/tsunami in Los Angeles or Silicon Valley/San Francisco) or heavy handed military strike against Iran by Israel – 2012 should be a year of recovery for the US.
    Longer term – what happens in the US and globally in 2013 and beyond is very much a crapshoot or guessing game.

    I think your prediction has already proven to be wrong because you greatly underestimate the power of the American spirit and the ability of people to adapt to difficult situations – at least in the short term. Late 2012 for your scenario to play out is too early. It’s the longer term – a couple of years or more down the road where things could really unravel. A nuclearized Iran and/or the speed of dislocation/job loss brought on by the information age and mechanization is very alarming – not to mention the mounting and possible unmanageable national debt situations.These will come to a head all too soon.

    Btw, I think your scenario with regard to Obama being reelected in a down US is flawed – if the US economic situation were to decline or stay the same throughout the year leading up to November – Obama would lose the White House – it’s basically that simple.

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