Is the Die Cast?

This essay assesses the probability that the world economy may be on the brink of spiralling out of control. It concludes that, provided we modify our behaviour and thought process in a departure from historical behaviour patterns, there is still time to salvage the situation.

In 1997 I discovered that a rising wedge pattern - as reflected in the chart below - only has bearish connotations if it occurs as a reaction within a bear trend.

Therefore, before the Dow Jones Industrials broke to a new high in the past week, the rising wedge below (Chart courtesy Decisionpoint.com) also had an importantstrategic implication. If the price broke down, the Dow's prior rise from 12,000 to around 12,600 could be accurately described as being merely a reaction within a Primary Bear Market. If it broke up, an important implication would be that what we are watching is a resumption of the Primary Bull Trend.

It broke up.

In terms of Dow Theory, two conditions need to be met for a Primary Bull Market to be in place:

• There should be underlying value
• The Industrial Market and the Transports should confirm.

Historically, 'value' has been determined by dividend yield. These yields are currently 2.2% on trailing dividends on the DJIA and 1.78% on the S&P 500. Against historical benchmarks of 3% (overvalued) and 6% (undervalued) the Industrial Markets today do not represent value.

By contrast, the charts below (also courtesy Decisionpoint.com) show that all three of the Industrials, Transports and Utilities are confirming - having all broken into new high territory.

One reason these particular charts were chosen is that they tell another and possibly far more important story. Please recognise that they date back to 1930.

The reader is invited to focus on the upper boundary trendlines that have been drawn in red.

Interestingly, the Transports were first to penetrate this boundary in 1981 - likely caused by the spike in the world oil price from $30 to just short of $60 a barrel between 1978 and 1981. This breakout was confirmed in 1983, even though the oil price had fallen. The confirmation was attributable to a decision taken by Ronald Reagan in 1982 (clearly reflecting the views of his 'advisors') to monetise the entire world's economy. At that time, the US economy was on the brink of collapse because the US Government had been raiding the Pension Piggy Bank in order to hide its excesses. Consumers were feeling anxious at that time. There was tension between the superpowers. In turn, Reagan's decision gave rise to a tide of money which caused both the Utilities and the Industrials to break up in around 1986/7.

The so-called 'crash of 1987' brought the industrial prices back to the red trendline, from where they bounced up - again as a result of Central Bank driven liquidity. In hindsight, the wisdom of Ronald Reagan's decision - probably Fed induced - was questionable. It avoided a 1930s style depression at that time but, in the process, gave rise to an era of hedonism never before seen in human history. The current 'Clash of Civilisations' has been one consequence.

The reader's attention is drawn to the recent break-up of the Utilities through the resistance of the upper trendline. This is a consequence of the fact that, since 1986, the Utilities Index has been tracing what is technically known as a 'megaphone formation' of rising tops and falling bottoms.

A megaphone formation is a sign of a market that is spiralling out of control. Again, with the benefit of hindsight, this was probably caused by the extraordinarily short sighted decision to privatise the electricity distribution industry. The Enron crisis reflects the lack of wisdom of that particular decision given that utilities do not operate in 'markets' in the generally accepted sense of the word. Consumers cannot stop buying electricity, gas and water. That effectively gives Private Enterprise owners a blank cheque.

In this context, the break-up of the Utilities Index to a new high, and through the resistance of the upper trendline, is particularly ominous from the perspective of consumer living standards. The flip side of extraordinarily high returns on investment in the Utilities Industry is rapacious pricing to consumers by Private Enterprise organizations which are opportunistically profit oriented. Alternatively, this break-up may also be reflecting the expectation that water prices may rise given the likely impact of Climate Change on availability of potable water supplies. If percentage price rises (as opposed to absolute price rises) are passed on to the consumer, Utility profitability will rise in line with the profitability of the oil companies. For example, in the 2006 year, Exxon earned $39.5 billion profits after tax, representing 34.7% after tax on shareholder's funds. It is one of a select handful of US organizations which have benefited from an oil price rise.

The breakouts of the DJIA, the Transports and the Utilities to new highs - and, in particular, the Utilities penetrating the resistance of its upper trendline dating back to 1930 - begs the question as to how the Fed will react.

If the Fed has a knee jerk reaction, and once again mans the money pumps, the upper trendline on the Dow Jones Industrial Index will also be penetrated on the upside, and the Dow Jones will follow its exponentially rising trendline - exploding upwards as we enter an era of hyperinflation.

In turn, if this exponential trendline becomes the dominant trendline, then the rising wedge on the gold chart below will turn out to be bullish. The gold price will break to new highs and will also explode upwards - finally confirming its Primary Bull Trend.

Thereafter, without the constraints of "management" by the Central Banks, the behaviour of the gold price is likely to be extraordinary. For example, the chart below is calling for a target of around $1,400 an ounce

If, on the other hand, our Political leaders have a rush of integrity to their heads and hearts (unlikely, in my view, but possible) the more honest amongst them will recognise that manning the money pumps will likely end in disaster of unmanageable proportions. Exponential blow-offs typically culminate in systemic collapses.

The flip side of "sensible" behaviour, however, will be to reverse some previous decisions of accommodation - which reversals, in turn, are likely to have political fall out. "Honest" politicians will need the courage to face up to the fact that they will lose the financial support of the various lobby groups.

A 'best case' scenario is to aim for a maintenance of the current status quo for a decade or two as the debt mountains are repaid. This implies aiming for a popping of the hedonist bubble, and taking decisions with the objective of protecting the majority of ordinary citizens by:

• Maintaining Utility Prices (there are solutions here)
• Maintaining oil prices (there are solutions here)
• Maintaining the price of money (interest rates seem capable of management)
• Preventing the US Dollar from falling below 80 (As around 70% of the entire planet's Central Bank reserves are comprised of paper dollars, it is in no one'sinterests to see a dollar index collapse.)
• Maintaining full employment (there are solutions other than waging wars)
• Rescheduling private debt to allow current income to cover debt repayment obligations. (There are solutions here)

But there is still a window of opportunity, as evidenced by the following chart.

Whilst the Dow Jones Industrials - and, indeed, all three key Dow Indices have reached new highs - the broader market is yet to confirm an upward exploding Primary Bull Market. There is still some semblance of sanity prevailing in the markets.

Question: Is the situation manageable, or is the world economy destined to spiral out of control?

Answer: There are solutions to our problems, but they involve drawing the teeth of those currently taking these extraordinarily short sighted - and self interested - decisions, at the expense of broader human society.

Needed more than anything right now are wisdom, maturity, clear thinking and integrity of purpose of society's leaders.

There are solutions!