The year 2012 is shaping up to be the year when five

 around the world's sources of oil and savings. Eastern and Middle Eastern powers are pulled together and pushed away from Western power and influence.

After decades of accumulation of risk to the steady-state political economy formed in the decades after WWII and reformed after the Cold War, in 2012 we see the potential for step function change that puts it all, or nearly all, up for grabs. On an a multi-millennial historical time line, it may happen in blink of an eye.

Call it the Year of the Jump Ball. Like a jump ball, the win goes to the quick and the strong. Who will it be and what does it mean for us as investors?

America's Five Critical Risk Factors

The US made five manageable and recoverable public policy errors in the early 1970s and 1980s. Then, as each administration failed to confront them, these once manageable and recoverable errors grew and metastasized into America's Five Critical Risk Factors. One or more of these factors may culminate in crisis in 2012 with consequences that are as difficult to predict as the timing.

The potential consequences can be traced back to the original source of each of the five risks.

Risk Factor Cause #1: Unilaterally abandoning the international gold standard to force the world onto the US Treasury dollar standard in 1971

Economist Robert Triffin and French president Charles de Gaulle warned of the consequences of currency reserve accumulation by US trade partners and of the US "going into debt for free" if global monetary system based on the currency and debt of a single sovereign nation -- the US -- persisted. The imbalances predicted by the Triffin Dilemma and the threats they pose to the international monetary system (IMS) and the global economy became apparent decades later, in the 1990s, yet Prisoner's Dilemma economics motivated all major parties in the system to perpetuate it. The cost of reform will fall largely on the monetary system's main beneficiary, the United States. Major parties to the system are in no position to press the US for reform at US expense because they depend on the US for either export demand -- dependence on the "over-consumption" growth model that Triffin warned about -- and thus domestic economic security, or military security, or both. Paradoxically, the economies of US its trade partners have over time become dependent on the global imbalances that Triffin predicted. (read more...).

 
Next we survey a panorama of potential outcomes of Five Critical Risk Factors for 2012. The results will be difficult to distinguish from randomness. In Part II we nonetheless identify scenarios that are more likely than others.

2012 Forecast: A strife of FIRE Economy interests masquerading as a contest of principles

With January arrives a smorgasbord of annual forecasts on the economy and markets penned by every pro with money under management. Each portrays economic developments as precipitous for the asset class they manage: inflation and currency depreciation for the hard assets guys, deflation and QE for the bond guys, currency volatility for the long-short currency guys, and the perennial promise by the long equity guys on a return to robust growth and multi-year bull market. Never mind that the bull market in equities has failed to materialize after more than a decade of similar calls.

Denial springs eternal.

Among the prognosticators, hedge funds and family practices tend to most truly report the figures they spy in the crystal ball without passing them through an asset class based bias filter. Although these managers have greater editorial flexibility than their mono-asset class management brethren they are still bound by the mindset of the clients they have attracted with a storyline of ideologically oriented analysis, an editorial style of financial analysis that came into fashion in the wake of the American Financial Crisis (AFC) that caught so many believers in Wall Street's game flat footed.

The AFC caught most funds flat-footed. Who to blame for missing an event that loomed large enough to inspire us to call in December 2007 for a 40% decline in the stock indexes in 2008? How to deflect the ire of clients for neglecting to point them to gold and lowly Treasury bonds, two seemingly antithetical assets that live on opposite ends of the ideological spectrum, one a short government position and the other long, while perfectly balancing the bi-polar political economy dominated by FIRE interests and failed monetary policy?

Funds embellished client letters thereafter with heavy doses of contempt for panoply of miscreants, from the Fed to the ratings agencies to bankers as a group, one and all accused of causing the Who-Could-Have-Known? cheap oil and cheap credit bust debacle (More $ Subscription)...