Last week the U.S. Federal Reserve moved one step closer to acknowledging reality.

Unfortunately, it didn’t let that admission move it from a policy course firmly guided by fantasy – meaning the central bank opted to stand pat on interest rates, despite the clear escalation of inflationary pressures.

In the policy statement that accompanied that decision last week, Fed Chairman Ben S. Bernanke and the other members of the interest-rate-setting Federal Open Market Committee (FOMC) took an important step in noting that inflationary concerns had taken hold in the country at large.

But as it asserted that it expects inflation to moderate this year and next, the Fed gave no indication that these heightened expectations are gaining traction within the FOMC itself. As a result – with Richard Fisher, president of the Federal Reserve Bank of Dallas, casting the sole dissenting vote – the FOMC signaled no likelihood that it was actually prepared to do something to fight a problem that it doesn’t really seem to believe exists in the first place.

In fact, by indicating that it expects inflation to moderate, the Fed is effectively saying that the elevated expectations are unwarranted. In other words, Bernanke claims that despite the fact that so many people are carrying umbrellas, he still believes it will be a sunny day. The takeaway from the statement is that no rate hike is forthcoming.

The markets saw this position for what it really is – a capitulation to inflation and to a weakening dollar. No surprise then that gold responded with the biggest-single-day gain in more than 20 years!

Those Missed Opportunities…

With the ensuing carnage on Wall Street, many Thursday-morning quarterbacks claimed the Fed missed an opportunity to reverse the dollar’s slide by either talking tougher or perhaps actually raising rates by a quarter percentage point. If the Fed really believed it could “jawbone” the dollar higher, or that a small rate hike would do the trick, policymakers would have given it a try.  I believe they chose a dovish route because of a greater fear of having a hawkish stance casually disregarded.   Imagine what would happen if the Fed raised rates and the dollar kept falling?  It would be like one of those horror movies where someone holds a crucifix up before an advancing vampire, only to have the Count sweep it aside without so much as a cringe.

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Some observers claim that now is the time for a coordinated central bank intervention to reverse the dollar’s decline.  Those who place their faith in such a plan overlook the fact that Asian and Middle East central banks have been unsuccessfully intervening on the dollar’s behalf for years.  Nations that maintain dollar pegs must constantly intervene in the foreign exchange markets by buying dollars to keep their own currencies from rising in value.  Over the past few years the scope of this intervention has been unprecedented, with foreign central banks accumulating trillions of excess dollar reserves.  Yet despite these misguided, Herculean efforts, the dollar has fallen drastically.

Help From Across the Pond?

Intervention advocates must believe that if the European Central Bank (ECB) and a few other central banks joined the fray, that a better outcome would be achieved.  However, any additional efforts to artificially prop up the ailing dollar will be equally ineffective.

Even if ECB intervention could slow the dollar’s descent, what possible reason would the Fed’s European counterpart have for doing so?  The ECB is already concerned about inflation and is preparing to raise rates as a result.  Intervention to support the dollar would only worsen Europe’s inflation problem and run counter to these efforts. To buy dollars, the ECB must increase its own money supply.  That is exactly what is happening in countries like China and Saudi Arabia, which is why inflation in those nations is already much higher than it is in Europe.

Further, since the ECB is asking Europeans to endure higher interest rates to fight inflation in their own backyard, why should Europe’s citizens have to make additional sacrifices to help Americans fight inflation in the U.S. market?  Indeed, that would be an especially tough sell given that the U.S. central bank has held this economy’s benchmark interest rate at the ridiculously low level of 2%, and has effectively excused Americans from the conflict.

Since we can’t count on any help from our friends, the only option would be for the U.S. Treasury to intervene unilaterally.  However, the U.S. government should think twice about bringing a knife to a gunfight.  The Treasury only has about $75 billion in foreign currency reserves with which to intervene.  That “war chest” would make about as much difference as adding a raindrop to the Atlantic Ocean.

To put that U.S. currency-reserves figure in some perspective, consider that Poland has $77 billion, Turkey has $78 billion, and Libya has $79 billion. On the other end of the spectrum, China has $1.7 trillion (not counting Hong Kong’s own $150 billion), Japan has $1 trillion, and Russia has $550 billion. India and Taiwan each have about $300 billion. Singapore, a nation with fewer than 5 million people, has $175 billion. 

In fact, the United States holds just about 1% of the world’s $7.6 trillion of foreign currency reserves, and our total position amounts to just 2.5% of the total daily volume of foreign exchange trading.  Talk about Bambi vs. Godzilla!

Here’s the bottom line: If the U.S. dollar is going to fall, the U.S. Treasury is completely powerless to do anything to stop it.

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a regular contributor to Money Morning, and most recently wrote about plans to grant the Fed additional powers. For a more-detailed analysis of the nation's financial problems, and the inherent dangers that these problems pose for both the U.S. economy and for dollar-denominated investments, click here to download Euro Pacific's new financial-research report, "The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities." The report is free of charge.]

News and Related Story Links:

• Euro Pacific Capital Inc. Special Research Report:
  The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities

• Money Morning:
  Fed Holds Rates Steady in Face of Upside Inflation Risk.

• Money Morning News Analysis:
  
  E.U. Stocks Slide as ECB Gears Up to Fight Inflation with Higher Rates.

Central banks around the globe could launch an initiative to buoy the dollar, as the greenback’s continued slide seems to warrant foreign intervention.

“We’re on intervention watch,” Stephen Jen, head of foreign exchange research at Morgan Stanley (MS), said in an interview with Bloomberg News. “While I don’t think we have reached the threshold yet, the argument in favor of it is gradually becoming more compelling.”

The dollar has been in a freefall ever since the U.S. Federal Reserve began cutting rates in mid-September. Since then, the dollar has plummeted 15% against the euro and 14% against the yen. Last Thursday, the dollar fell below the 100 yen level for the first time since October 1995, which is the last time an international intervention effort was undertaken.

While a weak dollar has helped bolster a slumping U.S. economy by boosting exports, it is taking a heavy toll on the economies of Japan and the European Union by making foreign exports more expensive. 

“We’re concerned about excessive exchange-rate moves in the present circumstances,” European Central Bank President Jean-Claude Trichet said last week.

His statement echoed the concerns raised by several EU finance ministers and Luxembourg Prime Minister, Jean-Claude Juncker, just a week prior.

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“I am starting to become increasingly concerned and vigilant,” Juncker said at a meeting of European finance ministers. “Existing exchange rates do not give an adequate reflection of the fundamental data.”

Unfortunately the ECB doesn’t have much room to act in the way of rate cuts. Eurozone inflation climbed to 3.3% in February, and remains the bank’s primary concern. Now well beyond the region’s established guideline of just under 2%, inflation has forced the ECB to keep its rate at a six-year high of 4%, while the U.S. Federal Reserves ratchets its rates back even further in a desperate bid to get the economy back on track.

The Fed has slashed its rate by 2.25% in the past six months, taking the benchmark Federal Funds rate down to 3% from 5.25%. It’s a near certainty that Fed Chairman Ben S. Bernanke will reduce the rate again at tomorrow’s Federal Open Market Committee meeting. Futures on the Chicago Board of Trade show a 90% chance that the Fed will cut the federal funds rate by another 0.75% tomorrow (Tuesday).

And some economists see an even-more aggressive move.

Citigroup Inc.’s (C) U.S. economists on Friday said that they anticipate Federal Reserve policymakers will lower the benchmark Fed Funds rate by a full percentage point, taking it down to 2% from its current 3%, and said “and more cannot be ruled out,” CNNMoney.com reported.

Economists led by Robert DiClemente said “aggressive action is needed to stabilize the financial setting.” The economists said Friday’s near-collapse of Bear Stearns Cos. Inc. (BSC) “underscores the current fragility of the system.”

However, if the Fed does come through with another cut, the dollar could quickly be on its way to $1.60 per euro.

“The dollar’s fall will worry other markets, which are so fragile right now,” Jim O’Neil, chief economist at Goldman Sachs Group Inc. (GS), told Bloomberg. “Intervention will definitely be on the minds of policymakers.”

Finance ministers from the Group of Seven nations are set to meet in Washington, D.C., on April 11. That’s when O’Neil expects to see action.

“A change in the G-7 statement is highly likely in April,” O’Neil said. “Whether they can last until then without doing anything is another question.”

Value of the Dollar Vs. the Euro Over the Past Year

Money Morning Executive Editor William Patalon III contributed to this report.

News and Related Story Links:

• Bloomberg:Dollar Rebounds From Record Versus Euro on Intervention Concern
• Associated Press:Euro Zone Inflation Rises 3.3 Pct
• Money Morning:EU Policymakers Wary of an Overvalued Euro
• Money Morning: Dear Ben: To Save the U.S. Economy, Here Are the Moves You Need to Make Now.
• CNNMoney.com: Citigroup Sees Fed Lowering Funds Rate By 1 Point Next Week.

[Editors Note: The Second of Two Parts. To Read Part I of this story, please click here].

If you were a gold investor back in the good old days of 1895, life was pretty easy. You’d spend the day in a huge leather armchair at your London club, sipping fine brandy. Periodically, a servant would telegraph buy-and-sell orders to your broker as you played the "Kaffir" gold-share-boom of that year.

You would avoid political risk by investing only in gold mines located in British colonies. And you wouldn’t worry about the price of gold, either – it was 3 pounds 17 shillings and 10 pence an ounce – and had been since Britain went back on the Gold Standard in 1819.

Back then, you had but two worries. First, did the mine contain any gold (engineers’ reports were crucially important)? Second, was the mine developer such an out-and-out crook that none of the profits would reach you?

It was a very simple business model. The price of gold was the price of gold, the mining cost was the mining cost, and if the difference between the two was positive, profits would flow into your pocket.

Today, of course, it’s quite a bit different. Modern finance has intervened with long-term futures and options contracts.

As a result, we still know the market price of gold, but we don’t know the price at which gold mining companies are selling their gold!

For example, gold miner AngloGold Ashanti Ltd. (AU) has recently "sold forward" three years of its gold mine output for a set price of $600 an ounce, regardless that the market price is now ranging upwards of  $750.

This process is known as "hedging." And I understand why gold miners do this. The executives want to make sure their jobs, and the jobs of its miners, are secure – even during a gold-market downturn.

However, investors don’t care much about preserving the jobs of gold miners, let alone those of mining company executives. We want to know what we’re getting in the form of earnings and dividends – and we want to benefit from a rise in gold prices.

The bottom line is that to invest in gold mines today, one must read a lot of boring and incomprehensible accounting footnotes – and must hope that the mining company isn’t in a jurisdiction where they don’t need to disclose the facts those footnotes usually contain. We’re also fortunate that hedging – very fashionable a few years ago – has decreased in use as gold prices have soared.

And gold prices are projected to keep rising. So let’s take a look at the world’s largest gold mining outfits that U.S. investors can easily buy into, either directly, or through American Depository Receipts (ADRs).

Of course, for the highly risk-averse investor who still wants to invest in gold, the simplest strategy is to buy an exchange-traded fund, or ETF. The StreetTracks Gold Shares Trust ETF (GLD) invests in gold directly and is a good bet.

But for Money Morning readers looking for higher potential returns, here’s a look at the major players, along with my five "best bet" recommendations:

• Barrick Gold Corp. (ABX) is a Canadian company with mostly North American production. It has some operations in South America and Africa, and mines copper and zinc, as well as gold. It has a $36 billion market cap, so there’s plenty of liquidity. The shares are trading at a trailing P/E of 34 (on the last 12 months’ earnings), but a forward P/E (on next 12 months’ profits) of 20. The company has eliminated its forward hedging program. By gold mining standards, this company is substantial in both size and scope, is reasonably valued, and features very little political risk.

• Agnico-Eagle Mines Ltd. (AEM) operates a gold mine in Northeastern Quebec, so there’s no political risk – unless Quebec separatism worries you. $7 billion market capitalization. Trailing P/E 46, forward P/E 44. You can pay too much for a nice location.

• AngloGold Ashanti Ltd (AU) is a South African company with operations in Argentina, Australia, Brazil, South Africa and West Africa. It has a market cap of $12 billion, a trailing P/E of 34, and a forward P/E of only 17. The good news: I like the diversification. And with its medium political risk, it’s reasonably priced based on next year’s projected earnings. The bad news: It has sold forward three years worth of production at a contract price of $600 an ounce. These contracts already have a value of minus $2 billion, and that negative value will increase as the price of gold rises. Stupid people, but bear in mind that this company’s earnings will jump if they ever manage to get rid of the hedges.

• Yamana Gold Inc. (AUY) is a Canadian company with operations in Brazil, Argentina, Chile, Honduras and Nicaragua. It is spending the equivalent of $3.8 billion in cash and stock to take over Meridien Gold Inc. (MDG), which has operations in Chile, Mexico and the United States. Yamana’s market cap is $5 billion, and its shares trade at a trailing P/E of 64, but a forward P/E of only 13. There’s a middling political risk, and a bit of an added business risk, due to the Meridien takeover. Investors can look forward to production doubling to 2.2 million ounces per year by 2012, primarily in Brazil and Argentina. I like this one, too, though the added risk of the Meridien acquisition should be kept in mind.

• Gold Fields Ltd. (GFI) is a South African company with mining operations in South Africa, Ghana, Australia and Venezuela (of which they just sold control to a local company). The company has a market cap of $12 billion, a trailing P/E 31, and a forward P/E 20. Upper-medium political risk, depending on what you think of South Africa. My view is that South Africa is acceptable currently, but there’s a good chance of Jacob Zuma winning the Presidency in April 2009, and he’s a nasty anti-Western leftist with a criminal record. On the other hand, that’s 18 months away, and the gold surge will probably have played out by then. GFI doesn’t hedge the gold price, which is a plus.

• RandGold Resources Ltd. (GOLD) is an offshore British company that mines in Africa (but not South Africa). The political risk is medium-high. With a market cap of $2.4 billion, a trailing P/E of 62 and a forward P/E of 31, this stock is expensive, especially given the elevated political risk.

• Harmony Gold Mining Co. Ltd. (HMY) is a South African company, with gold, copper and uranium mines, and operations in South Africa, Australia and Papua New Guinea. There’s only a medium-level political risk here. The company has a market cap of $3.8 billion, and the shares feature a trailing P/E of 79 and a forward P/E of only 17. The company does not appear to hedge, but that’s not a statement I can make with certainty. This miner has made some losses in recent quarters (theoretically, very tough to do at current gold prices). Given the losses, I’d have to regard this one as overpriced.

• IAMGOLD Corp. (IAG) is a Canadian company that mines primarily in Canada, Surinam, Ghana and Mali. Despite some of those exotic-sounding locales, the political risk is low-to-medium. The company has a market cap of about $2.4 billion. Though the shares trade at a forward P/E of about 22, the company has a trailing loss. Given that loss, the shares should be considered expensive.

• Kinross Gold Corp. (KGC) is a Canadian gold-and-silver miner, with primary operations company in Canada, the United States, Brazil, Chile and Russia. Kinross issued shares to buy a large Brazilian/Russian company in February. The market cap is big at $10 billion, the political risk is low to medium and the company doesn’t appear to hedge. However, with a trailing P/E of 35 and a forward P/E of 24, the shares appear a bit on the expensive side.
• Lihir Gold Ltd. (LIHR), a Papua New Guinea-based company, operates in PNG and explores in Australia. Given that some PNG miners have had some problems, there’s a mid-level political risk here. And with a market cap of $7 billion, a trailing loss, and a forward P/E of 29, this stock looks overpriced, too.
• Newmont Mining (NEM) is one of the better-known miners, based in the United States and operating in the U.S., Australia, Peru, Indonesia, Ghana, Canada, Bolivia, New Zealand, and Mexico markets. The political risk is low. It has a market cap of $21 billion, a trailing loss and a forward P/E of 26. Newmont used to hedge, selling gold at $384 an ounce, but closed out its positions, took the loss (from the contracts as well as losses related to a fatal accident at its Midas mine in Nevada) and now operates un-hedged. Not a bad value, but Barrack looks better.

Royal Gold Inc. (RGLD) is a U.S.-based company, with operations in Nevada, Mexico and Argentina. The political risk is low. But with a market capitalization of $930 million, a trailing P/E of 41, and a forward P/E 35, this stock looks expensive.

Having taken this tour of the global gold-mining industry, and having evaluated the key players, the best values appear to be:

#1: Barrick (ABX).
 
#2: Yamana (AUY).

#3: AngloGold (AU) (an attractive play if you don’t mind its excessive hedging and South African political risk).

#4: Newmont (NEM).

#5:  Kinross (KGC) would be my final choice.

And, of course, don’t forget the bonus: the Gold Shares ETF (GLD).

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The Canadian dollar – also known as “The Loonie” – moved above $1 last week, an extraordinary turnabout for a currency that was languishing down around $0.62 in January 2002. Americans are used to acting somewhat condescending toward their northern neighbor, but in this period of high commodity prices, the relative economic strength of the two countries is shifting. And it’s Canada you should be investing in.

Much of the Canadian economy is indeed of a “branch-plant” nature – offshoots of U.S, companies that manufacture in Canada because of the slightly lower labor costs – although those low labor costs are accompanied by substantially higher welfare costs. Then there’s the government; the Canadian Liberal Party, which has governed for most of the last century, is both slightly anti-American and mildly socialist. Famously, Canada has a national healthcare system, the likes of which Michael Moore would love to copy.

Overall, the Canadian government spends more than the U.S. government – about 40% of Gross Domestic Product for Canada, compared to 36% for the United States, including both countries’ provincial, state and local governments – but the difference isn’t extreme. And Canadian government spending would be considered wildly free-market in the EU, where of its 25 countries, only Ireland and Slovakia have lower spending. Canada has 1.6% per annum productivity growth over the last 10 years; that’s lower than its U.S. rival, and is far below Asia, but would actually rank quite well in Europe. Overall, the Canadian economy grew at 2.8% in 2006, a bit below the U.S. rate. The Economist expects it to grow at 2.5% in 2007 and 2.7% in 2008, both slightly above the U.S. rate. However, unlike its southern neighbor, Canada runs a balance of payments surplus.

Doesn’t sound terribly exciting, though, does it? And, indeed, for most manufacturing companies, it isn’t. They enjoyed big cost advantages for decades with the loonie being so low against the dollar, and those cost advantages have disappeared – for certain against U.S. rivals, although the loonie has been more or less flat against the euro.

There’s less high-tech in Canada than in the U.S. market, and what is there isn’t all that exciting. JDS Uniphase (JDSU) made a splash in 2000, and was briefly worth well over $100 billion, with the share price peaking at $135. But that telecom equipment company is now selling at a more sober price of $14 – which still isn’t as good as it sounds, since the company did a 1 for 8 reverse split last October; meaning just one of today’s $14 shares would have traded for the princely sum of $1,080 back in the bull-market days of 2000.

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Unless you’ve discovered the “flux capacitor,” and have found a way to make time run backwards, that’s not the investment performance we’re seeking!

However Canada’s true strength does not lie in manufacturing, or even really in agriculture – too bloody cold in winter! In today’s world, where interest rates are low and commodity prices are high, Canada’s in a very strong position indeed, and for two reasons:

• It has oil reserves – somewhat larger than the Middle East – in the form of the Athabasca tar sands.
• And it’s the world’s largest producer of uranium, with 25% of the world market. For purposes of comparison, Australia is second, with about 23%.

Let’s take uranium first. Uranium prices, which were stagnant for decades, have zoomed up recently, from $20 a pound in December 2004 to a peak of $120 a pound in June 2007, though they have dropped back in the last few months and are currently around $85. With global warming the world’s most fashionable concern, the best solution appears to be to build more nuclear reactors, and those will require uranium to operate – thus the price run-up.

While Australia’s reserves of uranium are double Canada’s, Canada still has 9% of the world’s known uranium reserves, meaning it will be a major producer for decades to come.

The world’s largest uranium mine is the McArthur River mine, operated by Cameco (NYSE:CCJ), Canada’s largest producer, while Areva, the second largest producer, owned by the French Areva Group (OTC: ARVCF.PK) has two new mines opening shortly, and may surpass Cameco, once they are on stream.

Unfortunately, Cameco and Areva are trading at historic, nosebleed-level price-earnings (P/E) ratios of 42 and 50 times earnings. And Areva is only traded in New York on the dreaded “pink sheets,” so may be illiquid. Nevertheless, you may want a modest flutter here – earnings growth in both companies currently appears stellar.

In oil, the Athabasca tar sands are estimated to have reserves of 1.7 trillion barrels, about four times the current proven reserves of Saudi Arabia. More important, Canada is a lot closer and friendlier than the Middle East, or even Venezuela, which has the other big tar sands reserves at Orinoco. Oil production from Athabasca is currently profitable at about $30 per barrel, which in times of low oil prices is not competitive with Middle East production costs of about $2 per barrel. However, oil prices have been soaring for several years, and at current oil prices of $82 per barrel, Athabasca is hugely profitable. If you think about that, market prices of $82 a barrel, minus breakeven costs of $30 a barrel (Market Price of $82 – Breakeven of $30 = Gross Margin of $50-plus a barrel gross margin) is a gross margin you can make money on. And there should be an extra kicker to come in Athabasca earnings, as oil prices have only recently risen from the $60 level.

Canada’s oil resources aren’t as expensive for investors as uranium. The best pure Athabasca play is Suncor (NYSE:SU), which is a positive bargain at 20 times earnings. Most of the oil majors are currently in Athabasca; Royal Dutch Shell (NYSE:RDS-B), in particular, has a big participation. However, it’s still only a modest part of their overall operations and earnings – but at 9 times earnings the shares may be worth a look.

The Canadians call their dollar the loonie, after the loon bird that has graced their $1 coin since 1987. Americans have taken to using the term as something of an insult. They shouldn’t; the loonie is a strong, friendly bird and there’s money to be made from it.

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The Canadian dollar rose to parity against the U.S. dollar for the first time since 1976 yesterday (Thursday), supported by surging oil prices and broad weakness in the greenback, the Financial Times reported.

RBC Capital Markets analyst Adam Cole expects the Canadian dollar to continue its upward trajectory. The reason: “Canada produces the commodities the world wants – it is still the number one commodity play among major currencies.” Cole said.

What’s more, Cole said, the Bank of Canada is welcoming the currency’s strength. Prevented from boosting interest rates by the global credit crunch, the rise of the Canadian dollar has helped that nation’s central bank in its battle against inflationary pressures.

Late in New York yesterday, the Canadian dollar surged 1.4% C$1.0012 against the American greenback.

In other trading, the U.S. dollar also dropped against the European euro – to a record low through the $1.40 level – as the dollar continued its skid on the heels of the U.S. Federal Reserve’s decision to cut interest rates by half a percentage point on Tuesday. Traders told the FT that the euro’s rise through the psychologically important $1.40 level – a “pain barrier” for eurozone exporters – triggered a surge in stop-loss buying, shooting the euro even higher. The euro rose 0.8% to $1.4071 against the dollar.

The dollar fell 0.4% to $2.0093 against the British pound Sterling, skidded 1.5% against the yen to Y114.44, and fell 1% to SFr1.1717 against the Swiss franc, the FT said.

News and Related Story Links:

• The Financial Times: Dollar hits lows against major currencies.

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The European euro hit a record value of $1.39 this past week, and the Japanese yen strengthened again to 114 to the dollar, well above the 120 it’s traded at most of the year. The British pound Sterling is at $2.03, back to levels it hadn’t seen since 1980 or so.

For U.S. investors who are not planning a winter vacation in ever-more-expensive Europe, this may not appear to matter much.

However, it’s a trend that’s likely to continue, and it’s worth adjusting your portfolio to take advantage of it.

The Doleful Dollar

The dollar is likely to remain relatively weak for two reasons:

• First, the United States is still running a $700 billion balance-of-payments deficit with the rest of the world. Asian central banks have been financing this by purchasing Treasury bonds. Indeed, U.S debt comprises a nice chunk of China’s $1.33 trillion in foreign reserves. As we now know German regional banks have also been financing the shortfall by purchasing subprime mortgage debt. (It’s particularly good for the balance of payments when foreigners buy subprime mortgage debt, air-filled dot-coms, or the Brooklyn Bridge because the profit that domestic shysters make from selling worthless assets to foreigners counts as income). Nevertheless, both these trends are showing signs of ending. This means the United States has to export more, which means that the dollar has to drop against the euro, sterling, yen, renminbi and currency of anyone else who might be persuaded to buy U.S. products if they’re cheap enough.

• And, second, it looks like U.S. Federal Reserve Chairman Ben S. Bernanke will be cutting interest rates. Since the Bank of England, the European Central Bank (ECB), and the Bank of Japan (BOJ) all are closer to raising interest rates instead of cutting them, a Fed rate cut should make the dollar weak. That short-term factor explains the dollar’s current weakness; if Bernanke doesn’t cut rates next Tuesday, it may bounce back. (Unfortunately, if Fed policymakers opt to not cut interest rates, the U.S. stock market will probably fall out of bed).

Assuming you think this trend will continue, what should you be buying?

Currency and Fixed-Income Plays

One possibility is foreign currency itself, preferably in the form of deposits or short-term assets denominated in foreign currencies. However, remember that interest rates seem to be going up, so bonds should be approached with caution (when interest rates increase, those bonds that you bought will drop in market value from what you paid for them).

If your bank will allow you to make foreign currency deposits, that may be the simplest solution. You should avoid sterling, as Britain has many of the same problems (over-bubbly real estate market, too much financial services), though their problems haven’t advanced as far as our have – yet.

In terms of individual currencies, the euro and yen are probably the two best bets.

If you want to buy foreign currency bonds, you might consider a foreign currency bond fund (of which there aren’t very many available in the United States), such as the no-load T. Rowe Price International Bond Fund (RPIBX), which invests in high quality non-dollar-denominated bonds.

Two warnings:

• First, don’t buy bond funds investing in foreign junk bonds (because then you become like the sleepy and less-than-sharp German banks that invested in subprime mortgages – you don’t know what you’re getting).

• Second, don’t buy an emerging-markets bond fund, because emerging-markets bond portfolios, unlike stock portfolios, tend to be dominated by the countries with the most debt, which are consequently in most danger of defaulting.

There’s a second possibility. Don’t buy bonds. Buy stocks.

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Buy a Stake in the Leaders

The second possibility is to buy shares of U.S. companies with a lot of foreign business. These will benefit from a weak dollar in two ways:

• First, if they do business as local companies overseas, their assets and income in foreign countries will be worth more when translated back into dollars so that the company can consolidate its financial statements and report its performance to its U.S. shareholders.

• Second, if they export from the United States, their income will go up relative to their costs – a wonderful position to be in. There are lots of these companies. But the two of the best examples would be Coca Cola Co. (KO), which does business all over the world, and Boeing (BA), which is the United States’ largest exporter. Both stocks are currently trading at price-earnings ratios of over 20 – placing them on the pricey side – but the earnings going forward should be strong.

• Third, you can buy foreign company shares (avoiding companies exporting heavily to the United States, who suffer from a weak dollar just as Boeing benefits from it). Here you might as well benefit from rapid Asian growth. One possibility would be the streetTracks SmallCap Japan ETF (JSC) which invests in Japanese smaller (and, therefore, mostly domestic) companies. Another is SK Telecom (SKM), Korea’s largest cell-phone company, which has international operations in China, Vietnam and the United States, although the U.S. market is only a small part of its operations.

Probably a mix of strategies would work best. You shouldn’t turn your portfolio upside down to bet on a weak dollar, but you might as well make sure that some of your money is invested to benefit from it.

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Companies in Europe face a situation in which they need to refinance nearly $140 billion worth of commercial by the end of next week, according to Deutsche Bank AG, Germany’s biggest bank. This will increase corporate borrowing costs.

According to Bloomberg News, Deutsche Bank Credit Strategist Jim Reid wrote in a research note to investors yesterday (Wednesday) that “this could be a pivotal seven to 10 days. This will inevitably lead to wider corporate spreads, especially in high yield.”

Borrowers are paying the most in six years on commercial paper – essentially corporate IOUs that mature in 270 days or less. The market for so-called “conduits” created by banks that use short-term debt to buy long-term assets – worth an estimated $1.2 trillion – is “seizing up” because of the global credit crisis, according to Bloomberg. Conduits are the entities that have prompted banks in Europe to require bailouts due to their investments in the ailing subprime-mortgage crisis.

Yields on 30-day U.S. commercial paper have rocketed to more than 6.3% this week from roughly 5.5% on Aug. 9. The benchmark London Interbank Offered Rate (LIBOR) for one month, based in euros, is at 4.45%, and closed at a six-year high of 4.5% last week, Bloomberg said.

Deutsche Bank’s Reid wrote that nearly $60 billion of the commercial paper due this week and next is owed by the conduit units. The debt is backed by bonds, such as asset-backed securities, not to mention automobile loans, company receivables, and even mortgages. The remaining $80 billion of the $140 billion total is unsecured debt.

Gertjan Vlieghe, director of European interest-rate strategies with Deutsche Bank’s London office, said that “it seems that even the commercial paper that is being refinanced is being rolled into shorter maturities [with the result that] with each week that goes by, the stock of [commercial paper] that needs refinancing is getting bigger.”

According to Merrill Lynch, corporate bond spreads are widening significantly. The reason: Banks are focusing on keeping their own conduits funded than in doing the same for other banks. That’s why Merrill Lynch’s indexes show that the spread on high-risk bonds in Europe (versus government debt of similar duration) has reached 426 basis points now from 358 basis points at the outset of August.

When interest costs rise, corporate profits can get squeezed – unless companies can find cost savings elsewhere. That can lead to such cost-reducing moves as layoffs.

News and Related Story Links:

• Bloomberg News:
  Debt Market in Pivotal Test as $140 Billion Matures.

Asian shares were pounded Friday in the wake of continued turmoil in the global credit markets. But then they soared today (Monday) in a powerful rebound, fueled by the U.S. central bank’s interest-rate action on Friday.

In Japan, shares suffered their worst single-day decline in seven years – with heavy selling in such exporters as Canon Inc. and Honda Motor Co. leading the way – as the yen rallied against other key global currencies.

The Nikkei 225 Index today jumped 458.80 points, or 2.25%, to close at 15,732.48. On Friday, the Nikkei notched its biggest fall in seven years, falling 874.81 points, or 5.4%, to close at 15,273.68 – a 52-week low. Japan’s broader Topix index declined by an even-steeper 5.6%, closing at 1,480.39.

There’s been a long spell of weakness in the value of the Japanese currency because of the so-called “yen carry trade,” a transaction in which investors borrow low-yielding yen to buy higher-yielding currencies. Currency experts say that the yen’s rebound coincides with a rebound in the yen’s value. On Friday, for instance, the dollar fell 0.8% to 112.77 yen to the dollar. The euro fell 0.9% to 151.31 yen to the euro.

Hirokazu Yuihama, a regional strategist at Daiwa Institute of Research in Hong Kong, told MarketWatch that “nobody expected such a fast appreciation. That caused a huge sell-off in export-related stocks such as autos and high-tech.”

Money Morning continues to see Japan as one of the better markets to invest in [For more information, see our special investment report, "The Three Best Investments In Asia Today"].

International investment banker, Deutsche Bank AG, sent out a short note to its trading clients said the performance in Japan was “dire.” The reason: Japanese stocks have lagged other Asian indexes so far this year, and because U.S. shares recovered overnight.

According to MarketWatch, Deutsche Bank told clients that “as the carry unwind sees the dollar-yen approach the key 110 level, swap desks are being forced to sell dollar-yen into a falling market to hedge existing structures, which could only mean further yen strength to come.” The heavy selling in Japan touched off a sell-off in Hong Kong, where the Hang Seng Index fell to a low of 19,386.72 – though it subsequently reversed course and headed north, finally ending at 20,387.13, a decline of 1.4%. “A lot of institutional investors are offloading their positions," Peter Pak, vice president at BOCI Research in Hong Kong, told MarketWatch. Traders, in general, “are still quite nervous and may stay on the sidelines. We expect the turnover (in Hong Kong) to drop sharply.”

On other Asia exchanges, South Korea’s Kospi Index gained 5.7% today, after plunging 3.2% Friday. Australia’s S&P/ASX 200 Index today enjoyed its biggest one-day gain in a decade, soaring 261.6 points, or 4.6%, to close at 5,932.6, after dropping 0.7% Friday. China’s Shanghai Composite Index rose 5.3% today, after dropping 2.3% on Friday. New Zealand’s NSX 59 rose 2.3% today, after dropping 1.6% Friday. And Taiwan’s Weighted Index rose 5.3% today, after a dropping 1.4% Friday.

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China’s ambassador to the United States has taken steps to assure Congressional leaders that China has no plans to dump its U.S. dollar reserves as a way of retaliating against the United States for its attempts to strong-arm China into revaluing the Chinese Yuan currency, according to published reports.

“I’d like to assure you that the top leaders and officials of China have stated that China’s dollar-denominated foreign reserves will not be affected, and China does not have the plan to drastically adjust the structure of its foreign reserve,” Chinese ambassador Zhou Wenzhong told U.S. Sen. Charles Grassley of Iowa, ranking member on the Senate Finance Committee.

“On Aug. 12, China’s central bank, the People’s Bank of China (PBOC) reaffirmed this stand,” Zhou also wrote.

Reserves reached $1.33 trillion at the year’s midpoint, an increase of nearly 26% from the $1.06 trillion in reserves China had at the end of December, just six months before. And the growth has been accelerating: That six-month gain was greater than the $247 billion increase for all of last year, the English-language China daily’s online edition reported.

Analysts had previously said that foreign reserves were expanding by $200 billion every six months, a growth rate that’s now been officially eclipsed.

China’s soaring trade surplus has been the biggest source of the growth in foreign reserves, acting as a spigot spilling every major currency into that country’s coffers.

Just this week, the U.S. government reported that this country’s trade deficit with China jumped 5.7% in June to reach $21.2 billion, the biggest total since January. At the present rate, the United States will easily surpass the 2006 total of $233 billion – and even that was the biggest imbalance ever recorded with a single country. In the first half of this year alone, government reports state that the U.S. trade deficit with China is more than 15% ahead of last year.

The overall trade deficit is also expanding at an alarming rate, according to many economists.

The deficit with China is growing even in the face of a series of major product problems that range from tires to toys, and include high-profile problem with pet food. Also this week, toy-industry giant Mattel Inc. said it was implementing a recall involving millions of toys – including some of its famed die-cast toy cars that may have lead paint problems. Mattel recalled 1.5 million China-made toys, ostensibly because of similar paint issues.

But Chinese Ambassador Zhou says he wants to work to “further strengthen (the) constructive relationship of cooperation” between China and the United States. In a statement carried on the PBOC’s website earlier this week, the central bank noted that the U.S. greenback has an “important status” in the international monetary system and in global trading, business and finance, and underscored that it remains an “important component” in China’s reserves – of which more than $420 billion is in U.S. dollars.

Prior to its summer break, the U.S. Senate approved two bills that could lead to tariffs on imports from China – unless China allows the Yuan to appreciate against the U.S. dollar, and in a big way. Within days, China appeared to hint they could dump dollars into the financial system. This could be incredibly damaging – if not disastrous for the United States, and for the capital markets in general. But most experts say it’s not likely this would happen. At least not yet. The Yuan had appreciated against the dollar by about 9.5% over a two-year period since it was allowed to start to float. But it’s drifted backward, and now is up only about 8.8%.

China on Monday scrapped a regulation that forced companies to convert a portion of their foreign currency holdings into the Chinese Yuan, the AsiaTimesOnline reported this week.

Prior to the rule change, companies could retain foreign reserves equal to 80% of their revenue for the previous year, plus 50% of their revenue. Anything above that total had to be sold to the state under mandatory foreign exchange settlement regulations.

According to a statement by China’s State Administration of Foreign Exchange, the change will help companies better utilize their foreign-currency caches. It’s also supposed to contribute to a “more balanced” international payments situation.

Zhuang Jian, a senior economist at the Asian Development Bank (ADB) in China, told the AsiaTimesOnline that the rule change would slow the growth of China’s foreign reserves, which continue to soar.

Reserves reached $1.33 trillion at the year’s midpoint, an increase of nearly 26% from the $1.06 trillion in reserves China had at the end of December, which was just six months before. And the growth has been accelerating: That six-month gain was greater than the $247 billion increase for all of last year, the English-language China daily’s online edition reported.

Analysts had previously said that foreign reserves were expanding by $200 billion every six months, a growth rate that’s now been officially eclipsed.

China’s soaring trade surplus has been the biggest source of the growth in foreign reserves, acting as a spigot spilling every major currency into that country’s coffers.

Just yesterday (Tuesday), the U.S. government reported that this country’s trade deficit with China jumped 5.7% in June to reach $21.2 billion, the biggest total since January. At the present rate, the United States will easily surpass the 2006 total of $233 billion – and even that was the biggest imbalance ever recorded with a single country. In the first half of this year alone, government reports state that the U.S. trade deficit with China is more than 15% ahead of last year.

The overall trade deficit is also expanding at an alarming rate, according to many economists.

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The deficit with China is growing even in the face of a series of major product problems that range from tires to toys, and include high-profile problems with pet food. Just this week, toy giant Mattel Inc. (NYSE: MAT) announced yesterday (Tuesday) that it was recalling 9 million toys, including some die cast cars made in China that may have lead paint problems. The latest recall came less than two weeks after Mattel recalled 1.5 million Chinese-made toys, also because of concerns about lead paint. About 80% of the world’s toys are made in China, making this a huge blow to the industry.

The current account deficit, the currency exchange rates and China’s growing reserves have been a real sore point with officials in both China and the United States. Even so, U.S. elected officials have failed to develop an adequate strategy to negotiate with China. And China’s moves have been largely half-hearted, most experts believe.

China’s growing reserves have induced it to create a state-run private equity fund to buy into ventures in other markets.

The new company-currency rules will help cut China’s foreign exchange reserves, but only in the medium to long term, Yan Qifa, an analyst with the Export-Import Bank of China, told the China Daily newspaper. The reason: In the short run, with the Yuan continuing to rise in value against the dollar, companies will want to hold the Chinese currency, and not one that’s dropping in value, Yan said.

Therefore, the companies will continue converting their foreign reserves, causing China’s currency coffers to grow even more, analyst Yan said.

Interestingly, the new rules may also make it easier for some China-based firms to invest in markets abroad, But ADB’s Zhuang said the country should strengthen capital outflows. He said that the abrupt, short-term outflow of large amounts of capital may affect a country’s financial stability, as shown in the so-called “Asian Contagion” of 1997-98.

China has gradually eased restrictions on companies retaining foreign exchanges. From 2002, companies were allowed to retain 20% of their foreign exchange revenues. The proportion was raised to 50% in 2004 and to 80% in 2005, the newspaper reported.

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