Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

The Day the Markets Crashed

Posted by butalidnl on 27 January 2012

(To fully understand this story, refer to 2012:The Other Prediction , where I explained why the US dollar would crash on 21 December 2012)

It was the morning of Friday, 21 December 2012, and the bell at the New York Stock Exchange was about to ring. Gloom and a sense of foreboding hung over the trading floor. Outside, there were hundreds of ‘Occupy Wall Street’ protesters rallying against the abuses of the 1%.

It was not only ‘triple witching’ day (the day when all kinds of option contracts expire), but also only three full days before the trading year ends; and many traders were still holding more US stocks than they wanted. The Dow Jones stocks that they still held no longer seem to be safe anymore, and they had to have ‘safe’ stocks in their portfolio by year-end. Thus, many traders were set to sell off the rest of their Dow Jones stock holdings that day.

2012 had been a disastrous year. Till February, the Dow Jones was above 12000 points, but by March the tide had turned and prices drifted downward the rest of the year. Nothing could cheer people enough to take prices higher. The reelection of Obama and the Democratic sweep of Congress had not helped. On the contrary, Wall Street was depressed after the elections. There are now bills pending in Congress that will force an increase of taxes on Chinese goods come the New Year. And this will surely cause a Chinese reaction and a trade war at the worst possible time. And to make things worse, oil prices had drifted upwards all year – Brent was now at $150/barrel (and WTI at $130).

Today, the Dow Jones was just above 10,000 points. For the first time in history, foreign traders have dumped their US stocks in their year-end ‘window dressing’ operations. Apparently, they no longer considered Dow Jones stocks as ‘good’ stocks to hold.

After the Bell
Right after the opening bell, share prices plummeted. Within the first hour, stock trading had to stop for 15 minutes because the Dow fell more than 10% below the average of the previous quarter (the trading curb, at approximately a 1000 points drop), triggering the automatic stop.  After trading resumed, the Dow reached 9000 points, and a whole series of stop-loss orders to sell stocks hit the exchange.  In contrast to previous crashes, investors were no longer rushing into Treasuries. They were in fact dumping US Treasuries almost as fast as they were dumping stocks. This meant that the effective interest rates on US debt rose from 3% to 5% in a couple of hours.

The US dollar suffered accordingly. It was at $1.60: 1 Euro by 1 pm. At 2 pm, there was concerted action by a number of Central Banks (most of them were limited in their response because their home markets were already closed by this time), which buoyed the dollar to $1.55: 1 Euro. It was the middle of the night in Asia, and the Fed was mainly alone in intervening to save the dollar.

The market dipped even lower by the close of trading, as a whole swath of put options were exercised (which involved the sale of a lot of stocks and currency); the Dow closed at ‘only’ 8500 points (it had gone below 8000 points during the day), and with the exchange rate at $1.60: 1 Euro. It was terrible, but everyone was sure that concerted Central Bank action scheduled for Monday will calm the markets.

It was not to be. Middle Eastern markets were opened on the 22nd and 23rd (Saturday and Sunday), and stocks and the US dollar continued their slide, reaching $1.70:1 Euro at the end of Sunday trading. In the morning of Monday, the Bank of Japan  intervened heavily to support the dollar; but by midday, it stopped. At the same time, the Peoples Bank of China started dumping dollars. This was followed by Russia, and then a host of Third World countries.

The ECB, the Bank of England, the US Fed and the Central Banks of Canada and Switzerland furiously bought dollars all day. Together they bought more than a trillion dollars on that day alone. It did not help. Middle Eastern, other Third World sovereign funds and many Third World Central Banks dumped their US$ bonds and stocks all day. The Euro remained at $1.70:1 Euro all day.

It was a gloomy Christmas in most US households, who saw their 401k balances evaporating, and who realized that the prices of goods will go up a lot in January.  On the 26th, ordinary Americans dumped their holdings in Dow Jones stocks, and bought Japanese and European mutual funds. Oil (WTI crude) hit $200/barrel, and gasoline rose to $6/gallon.  The US government announced that it was monitoring to see that no gas station will sell gasoline above that level. The government warned against price gouging by retailers, and issued an order that prices were to remain at the present levels for the meantime, unless explicit permission was given to raise an item. But this set off a stampede of people buying what they can while the prices were relatively cheap. By the end of the year, grocery stores reported that their stocks of food had been all sold out; panicky people were stocking up.

By the first trading days of the new year, the US dollar had gone to $1.90: 1 Euro, and it was steadily deteriorating. Interest rates on US treasuries hit 7%, and kept climbing. By 15 January, the US government formally called on the IMF for help. The US government could no longer finance its debt, with the interest rate on Treasuries at 9% and climbing. The IMF put together a rescue package of about 1 trillion SDRs. But this would only be given if the US reduces its deficit from $1.3 trillion yearly to only $100 billion in 2012. Obama then forwarded a budget proposal which specified: a 50% cut of defense spending, a tax on luxury houses, cars and yachts, a national Value Added Tax of 15% (and abolition of state sales taxes), etc.

The IMF declared that it was making the SDR the new international reserve currency, and that it would exchange dollars held by Central Banks at $2: 1 SDR. This provided a floor for the value of the US dollar, and stabilized the currency markets. For cash, people used the Euro or the Yen.  After the IMF action, the US dollar was removed as the reference currency for oil (which changed from dollars/barrel to Euros/hectoliter), gold (to Euros/gram) and other commodities.

(this is a depressing story, but it will actually end up well. In another blog, Two Years After the Fall    I show what would happen two years after the crash.)

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