Interest rates for short-term loans with a maturity of three months or less continue to inch up, despite moves by global central banks to restore liquidity in the markets.

"There’s really only a handful of banks that are offering cash," Ronald Tharun, a money-market trader at a unit of Landesbank Baden-Wuerttemberg, Germany’s biggest state-owned bank, told Bloomberg News. "Everyone is just waiting for the next bank to go down. There is no trust in the market. They’re very afraid."

Central banks including the U.S. Federal Reserve, European Central Bank and Bank of England have poured billions of dollars into the world financial markets in an effort to restore lending confidence.

After over $200 billion in losses and write-downs since the subprime crisis began in 2007 and the recent collapses of The Bear Stearns Cos. Inc. (BSC), even prime borrowers are having trouble finding willing lenders.

Story continues below…

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That $200 billion could easily grow to $460 billion, Andrew Tilton, New York-based senior economist at Goldman Sachs Group Inc. (GS), wrote in a recent report, Bloomberg reported. With a figure that high, investment banks are hoarding capital to cushion against the next round of write-downs and reluctant to lend.

The European Central Bank pumped $336.5 billion (216 billion euros) into the financial markets yesterday (Tuesday), but the marginal rate for borrowing in euros still rose to 4.23%, up from 4.16% just last week.

"There’s still a lot of uncertainty in the market," Jan Misch, money-market trader at Landesbank Baden-Wuerttemberg in Stuttgart told Bloomberg. "Banks are hesitant to lend among each other and nervous due to the closing of the quarter."

Interbank rates are expected to remain elevated until after the quarter-end on Monday.

News and Related Story Links:

• Bloomberg News:
  Money-Market Rates Rise, Defy Central Bank Measures

• The Wall Street Journal:
  Short-Term Credit Markets May Improve After Auction

• International Herald Tribune:
  ECB adds an extra €50 billion for liquidity-starved banks in weekly refinancing operation

Payrolls fell for a second straight month, suggesting that a recession has taken root in the beleaguered U.S. economy and the Federal Reserve will have to take greater steps to increase liquidity and preserve growth despite rising inflationary pressures.

U.S. payrolls suffered their biggest monthly decline in five years in February, as employers shed 63,000 jobs, the Labor Department reported Friday. And 22,000 jobs were lost in January, revised up from the 17,000 originally reported. It was also revealed that only 41,000 jobs were created December, half the 82,000 first reported.

“This confirms the fears that have been lurking in the financial markets in recent weeks,” Richard DeKaser, chief economist at National City Corp. (NCC), told Reuters. “The probability of recession is at more than 50%.”

It’s the first time payrolls have declined for two straight months since May and June of 2003. February’s loss was the largest since March 2003. 

Manufacturing industries slashed 52,000 jobs, retail lost 34,000, and the construction business eliminated 39,000 jobs. Since the housing bubble peaked in September 2006, the construction industry has shed 331,000 jobs.

The only silver lining the labor report had to offer was the addition of 38,000 jobs to government payrolls, and an addition of 30,000 payrolls to education and health services.

Fed Action

Prior to the report’s release, the Federal Reserve announced it would increase the amount of loans it offers to banks this month. The central bank will offer $50 billion in four-week funds to banks at its March 10 and March 24 auctions, up from $30 billion. It will also make $100 billion available through repurchase agreements.

This is the latest action by Fed Chairman Ben S. Bernanke to increase liquidity and help the financial sector overcome mounting losses from lending defaults.

“The amounts outstanding in the Term Auction Facility (TAF) will be increased to $100 billion,” the Fed said in a statement. ”The auctions on March 10 and March 24 each will be increased to $50 billion – an increase of $20 billion from the amounts that were announced for these auctions on February 29.”

In addition to Bernanke’s TAF tinkering, it is largely expected that the Federal Reserve will further reduce interest rates at its next meeting, March 18. The Fed Chair has repeatedly voiced concern about the current prospects for economic growth.

In a pessimistic analysis of the U.S. growth outlook, Bernanke said that the latest data “continues to suggest sluggish economic activity in the near term,” while also asserting that inflation expectations are “reasonably well anchored.”

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Last week, several FOMC members reaffirmed Bernanke’s position, saying the Fed ought to err on the side of doing too much, despite mounting concerns about inflation.

“Because credit contractions can emerge and spread rather quickly the central bank must be prepared to act in an aggressive and timely manner to counteract their effects,” said Cleveland Federal Reserve President Sandra Pianalto. “Inflation expectations appear to be anchored.”

Speaking to the Council on Foreign Relations in New York, Federal Reserve Bank of New York President Timothy Geithner, said: “If turbulent financial conditions and the associated downside risks to growth persist, monetary policy may have to remain accommodative for some time.”

Analysts anticipate a reduction of 50 to 100 basis points in the benchmark lending rate. Futures have priced in a .75-point reduction, which would lower the rate to 2.25%.

However, not everyone is convinced that inflationary pressures remain as “well-anchored” as the Fed asserts. The question of whether the economy is entering into a period of stagflation has also arisen.

“I am disappointed,” Michael Woolfolk, currency strategist at the Bank of New York Mellon (BK) told Reuters. “Bernanke had an opportunity to manage expectations on inflation and failed to take the challenge at his congressional testimony last week. He is rapidly losing the inflation-fighting credentials he won last year.”

The producer price index was the last of three major Labor Department reports on January’s inflation rates, which revealed that producer prices jumped by 1% for the month, more than double the increase analysts expected. The first two indicators, the consumer price index and import prices were equally dismal. Consumer prices rose 0.4% in January, while import prices increased 1.7%.

St. Louis Federal Reserve President William Poole is disappointed as well, after a speech at the University of Illinois, he told reporters Thursday that “insurance against recession is not free.”

“We have to have a balance (between) employment and financial risks with inflation risks,” he said.

The dollar hit a three-year low against the yen Friday, dropping to a value of 101.82 yen, the lowest since January 2005. The greenback also experienced its fourth consecutive weekly decline against the euro, touching $1.543 per euro Friday, its lowest mark ever.

“We’ve seen a huge shift in the market’s thinking,” toward the dollar, Simon Derrick, head of currency strategy at Bank of New York Mellon Corp., told Bloomberg. “The Fed in particular looks as though it’s going to keep cutting and cutting rates. We could very quickly test $1.55.”

News and Related Story Links:

• Reuters:
  Bernanke rapidly loses fans in the forex world

• Bloomberg:
  Geithner Says Rates May Need to Stay Low ‘Some Time’

• Reuters:
  US RATE FUTURES-Hint at 100 bps March Fed cut on Feb jobs

• Bloomberg:
  U.S. Economy: February Payrolls Unexpectedly Decline

• Bloomberg:
  Fed Boosts Lending to Banks as Credit Rout Continues

• Money Morning:
  EU Policymakers Wary of an Overvalued Euro

• Money Morning:
  Stagflation: Even if the Economy Stagnates, Your Investments Don’t Have to do the Same

(The First of Two Parts)

The Fed has kept interest rates too low for the last decade, causing bubbles in tech stocks and housing, and has now begun to lower rates anew.

Other central banks have done the same, notably in China, where the economy and the stock market have overshot all reasonable forecasts.

In the long run, that’s bad news for the world economy, because it translates into higher commodity prices and increasing overall inflation. In the short run, while the money injected by Fed Chairman Ben S. Bernanke from his Sept. 18 rate reduction (with perhaps another one to follow on Oct. 31) is working its magic on the economy and on the stock market, it’s also hugely wonderful news for Gold Bugs.

We’re going to show you how to profit from this current situation. But, first, some historical context is necessary.
Gold at $2,000 an Ounce?

Back in 1980, gold soared briefly to $850 per ounce; that’s equal to $2,000 per ounce in today’s money. At gold’s current price of around $770 an ounce, it’s highly likely gold has considerably further to rise. While the rise from $260 to $770 has been quiet and orderly, in line with the worldwide re-rating of commodities caused by Indian and Chinese demand, a further rise from this point will probably look more like the price increase of a speculative bubble.

Since the gold market and the market for gold mining companies are both small compared to the amount of money that may potentially head in that direction, the final speculative peak may be huge, with the price of gold soaring almost vertically – advancing several hundred dollars an ounce in a mere matter of weeks, only to collapse as the bubble bursts.

It’s a familiar pattern – just think back to what happened to Internet shares back in the "dot-bomb" era of 2000-2001 – although this one will pay out in a very short period of time, mere weeks, as I stated.

This is a dangerous market move to play, but is potentially highly lucrative if you’re both careful and very disciplined. For investors who want to surf this wave, remember: always have your trailing stops in good order on an electronic trading system, so if the market collapses while you’re in a meeting, in the men’s room, or out on a day trip with the family you can still exit with a profit!

The simplest way to play gold is the StreetTracks Gold Shares Exchange Traded Fund (GLD), which invests in gold directly. However for those Money Morning readers who think this is boring, and want a little more spice to their lives, I will run down and review each of the world’s 12 major gold mining companies, and will pick out the couple pick out the few best values.

(Part Two: Gold Plays to Make, will appear on Thursday’s Edition of Money Morning.)

U.S. Federal Reserve Governor Randall Kroszner yesterday (Monday) assured investors that the central bank would take the necessary steps to protect the economy and to foster growth.

"The Federal Reserve will continue to monitor developments in financial markets and act as needed to support the effective functioning of these markets and to foster sustainable economic growth and price stability," Kroszner said.

The central bank official’s remarks came during a speech at the Institute of International Bankers and followed a shaky market opening, as well as a 336-point plunge in the Dow Jones Industrial Average on Friday.

Economists are divided as to whether or not the Federal Reserve will cut its key interest rate at next week’s two-day policymaking meeting.  Chairman Ben S. Bernanke led the charge for a half-point reduction last month as the credit turmoil drove investors to despair. It was the first reduction in the benchmark Federal Funds Rate in more than four years.

After dropping close to a hundred points in early morning trading the Dow rallied to close in positive territory.

Every year I talk with thousands of investors around the world and invariably the Number One question I’m getting lately is: "What’s up with the dollar?"

That’s completely understandable.

But it’s actually what’s "down" with the dollar that matters when it comes to setting the stage for your own global greenback rally.

The reason is that the ultra-cheap greenback makes buying U.S. assets and investments super cheap for those around the world who are flush with Yuan, Euros, Yen, Dinar – or any other currency against which the dollar has dropped.

We’ve seen this phenomenon before.

In the late 1980s, the hyper-inflated Japanese stock-and-real-estate markets enabled Japan to go on an unprecedented global shopping spree – taking advantage of the cheap-dollar Easterners. I know this personally, for I was a consultant working with Japanese companies that were laying out these revved-up dollars for both financial assets and real property.

Here are three reasons why we’ll see a repeat performance:

• With the dollar declining as it has, it’s unavoidable. It’s a trend you can basically bank on seeing again. The benefit is that it will provide important clues about where the "smart money" from overseas is going to invest.
• Second, a cheaper dollar actually provides a powerful incentive for global market makers to establish new financial linkages between previously unconnected markets and instruments. The net result will be an increased fluidity between the world’s exchanges. And that can only broaden your investment choices by ultimately opening up presently inaccessible markets. Some recent examples of this sort of transaction include the Dubai stock exchange, which just acquired a 19.9% share in the Nasdaq, and Qatar’s state investment agency, which recently purchased 20% of the London Stock Exchange, and nearly 9.9% of the Stockholm-based OMX.
• Third, a cheaper dollar actually enhances America’s exports by making them less expensive for the rest of the world. Ultimately, this has a positive effect on our employment base and helps stabilize our own consumer spending. But the real magic is that increased U.S. exports help mitigate the rapidly burgeoning U.S. trade deficit, which is inevitably a lightning rod for critics of the U.S. economy.

I realize that most of this is probably too theoretical for such an early morning read, so let me turn to some more practical thoughts – like how to profit from the falling dollar.

That’s actually the easy part.

Cheap Dollar Deals

There are literally thousands of companies fueling the global boom right now. But the key is to spotlight the leaders – the firms that are generating big-dollar deals abroad.

My favorite tactic, and one that I’ve written extensively about in the past, is to invest in globally diversified U.S. companies and ADRs traded on American exchanges that derive a majority of their sales overseas. Examples include such companies as AFLAC Inc. (AFL), Exxon Mobil Corp. (XOM), PepsiCo Inc. (PEP), and Yum Brands Inc., (YUM) – most of which derive up to 70% of their sales from overseas.

These sales, I might add, grow in value every time the dollar declines further [** See footnote at story's end].

Plus, these companies pay dividends, which are always a nice benefit.

Other choices worth considering include major American exporters in such industries as electrical equipment and defense contracting. No. 1 U.S. exporter Boeing Co. (BA), Honeywell International Inc. (HON), Lockheed Martin Corp. (LMT), and Raytheon Co. (RTN), spring to mind.

If exchange-traded funds (ETFs) are more your style, you may want to consider the SPDR Global Titans (DGT) and the PowerShares International Dividend Achievers Portfolio (PID). Both have benefited handsomely from the extra juice a falling dollar has provided, and are likely to continue to benefit in this way in the months to come.

Of course, you could also play the currencies, and more directly, too. My favorite choice in that arena is the PowerShares DB G10 Currency Harvest (DBV), which is up 11.64% so far this year.

In closing, let me state emphatically for the record – and for all the strong dollar advocates who are no doubt foaming at the mouth over my comments-that I don’t like a weak dollar any more than you do.

In fact, I can’t stand it because every time I travel overseas (and that’s frequently), I feel like I get mugged when I pull out my wallet. And I especially don’t like seeing my cost of living increasing the way it has recently.

But when it comes to investing, what I like is really immaterial.

What matters is this: There are choices that I can make that will offset the huge cost-of-living increases I’m seeing here at home by earning bigger profits abroad.

And that’s the bottom line.

News and Related Story Links:

• Money Morning Investment Analysis:
  How to Profit From an Earnings Surprise From China’s Rise.

• Money Morning Investment Analysis:
  Here’s Why MGM is a High-Profit Play on China.

• Money Morning Investment Analysis:
  How to Profit From the Dubai-China Connection.

• Money Morning Investment Analysis:
  Pepsi "Goes Red" in China.

• Money Morning News Analysis:
  Dubai Plans to Boost Asia Investment by 150% Within Two Years.

• Money Morning News Analysis:
  The China Connection: Why Dubai is Really Interested In MGM.

• Money Morning News:
  Dubai’s Investment Arm Grabs Stake in MGM.

• TBO.com:
  Regulators Should Not Fear the Dubai-Nasdaq Deal.

[** This situation is known as a "translation gain." You see, sales are made in a currency that's rising in value against the dollar - perhaps the euro. When the quarter closes, that money has to be repatriated back to the U.S. headquarters, as do all revenue and profits. But since the dollar has fallen in value, that foreign currency will now buy more dollars than it would have at the start of the quarter. Thus, the company's profit base is magnified by the dollar's decline.]

As a professional trader, I’m never far from my trading screens. But I find that I’ve been watching them even more intently than usual over the past few days.

When I take a step back and attempt to assess just why I seem to be so concerned, I’m left with this answer: Were it not for the Fed, I believe this “record-setting rally” would have run out of gas some time ago.

Consider yesterday (Tuesday) as a case-in-point. Stocks were rather listless until the Fed’s minutes were released. That sent stocks up sharply, and both the Dow Jones Industrial and Standard & Poor’s 500 market averages closed at record highs. [For our news report on the Fed minutes report, and on the market’s reaction, please click here.]

Let’s rewind the tape back to Sept. 18, when a Federal Reserve interest rate cut played a similar role.  The belief the rate cut was coming kept a flagging rally alive. And when that bigger-than-expected rate cut became a reality, stocks were up and way and rallying again.

Against this setting, the general perception today is remarkably similar, and the fact that stocks hit all-time highs seems to imply that it’s clear sailing into the fall. But nothing is a given in this business. This market simply seems exhausted to me, and I can’t shake the feeling based on 20 years’ experience that the proverbial “other shoe” may be out there and getting ready to drop. We’ve already had a housing slump, a subprime mortgage crisis and even a global credit crunch. And still the market keeps climbing.

That worries me. And here’s why.

Trading over the last few weeks has been largely based on two assumptions:

• The U.S. dollar will continue to weaken, and the U.S. Federal Reserve will abandon all attempts at supporting or rescuing the greenback.
• And corporate earnings both here and abroad will be largely positive.

Neither is guaranteed.

Earnings so far seem to be under control: There haven’t been any of the ‘whisper numbers’ that so often lead to investor disappointment, and then to a steeply dropping share price. Nor have we seen any earnings warnings. But either situation could change at any time.

I do have a couple of earnings-related observations, however. The third quarter already seems to be emulating the second in that truly global companies are using better-than-expected earnings abroad to more than offset lackluster profits here at home. And all of us here have noticed that wage costs and raw materials costs are rising in China, a situation that could lead to badly crimped profit margins if costs keep rising, or revenue growth slows.

But overall, earnings have been so far, so good.

So that leaves us with the Fed.

Since late August, the dollar has enjoyed a comeback of sorts: Granted it’s not roaring out of the basement by any means, but it does appear to be building a strong base, particularly when measured against the latest trading data.

What’s more, the employment situation – which really had appeared to be weakening here in the United States – actually did turn out to be better than expected based on the most recent readings.
Admittedly one report doth not a trend make. But let’s face it, Friday’s reasonably strong jobs report served to substantially undermine the fervent believers in the “Fed is going to cut rates again” crowd. When the masses realize the Fed may not cut rates again soon, a market reversal could result.

Moreover, no less than three Fed governors seemingly spoke their minds about the dollar vis-à-vis exchange rates in recent days. This is highly unusual, because they almost never talk about exchange rates. And it suggests to me that there are some behind-the-scenes machinations taking place inside Team Bernanke, where one of two things is happening. Either:

• The Fed governors who spoke out really don’t agree with Bernanke’s strategies or decisions, and are trying to publicly distance themselves from him in the event the dollar flops.
• Or these Fed governors seemingly spoke out-of-school and out-of-turn as a kind of ‘trial balloon,’ to get an early reading on the impact of a potential exchange-rate-boosting, interest-rate hike.

Perhaps – for me – that’s where the market appears tired.

Without the repeated injections of Fed-brand jet fuel, this Bernanke-piloted market would have trouble staying airborne. And if there’s a jet-fuel boycott (in the form of an interest-rate increase), then Air Bernanke will be grounded on the runway.

If you’re concerned, as I am, here are a few potential action items to consider:

• First, set protective stops on any of the holdings you’re most concerned about, particularly holdings where you have large profits at risk.
• Second, rebalance your portfolio to include the diversified overseas companies I call the ‘global titans.’
• And, third, steer clear of mortgage-related holdings: The much-heralded “recovery” is, at best, premature, especially ahead of credit-crunch-related earnings reports.

Fed policymakers – concerned the credit crunch and housing slump could take a heavy toll on economic growth – voted unanimously to cut interest rates by half a percentage point at their Sept. 18 meeting. Fed policymakers unanimously agreed to slash interest rates by one-half percentage point to 4.75 percent, calling it "the most prudent course of action," according to minutes of that meeting released yesterday (Tuesday).

The minutes also said that “given the unusual nature of the current financial shock, participants regarded the outlook for economic activity as characterized by particularly high uncertainty, with the risks to growth skewed to the downside.”

The release of the minutes of the policymaking Federal Open Market Committee (FOMC) buoyed hopes of another interest-rate reduction, and sent stock into record territory yesterday.

The Dow Jones Industrial Average soared 120.80 points, or 0.86%, to close at a  record 14,164.53 – eradicating the prior record close of 14,087.55 reached Oct. 1. The Dow set a new trading high, as well, reaching 14,166.97.

The Standard & Poor’s 500 Index rose 12.57 points, or 0.81%, to close at a record 1,565.15. It eclipsed the prior record close of 1,557.59, reached last Friday, and also achieved a new trading high of 1,565.26.

The Nasdaq Composite Index climbed 16.54 points, or 0.59%, to close at 2,803.91. This marks the first time the tech-laden Nasdaq has closed above 2,800 since January 2001.

A federal employment report back in September originally stated that the U.S. economy shed 4,000 jobs in August – the first such decline in four years. That sent stocks into a careening nosedive, based on fears the U.S. market was headed for a near-certain recession. But then, last week, revised figures showed that the economy actually added 89,000 jobs in August.

Job-creation continued to climb in September, when payrolls rose by 110,000 jobs.

That news eased fears the economy would slide into a recession and cast doubt on whether the Fed policymakers would cut rates again, at their next scheduled meeting, set for Oct. 30-31.
But back during the Sept. 18 FOMC meeting – without the benefit of the revised jobs figures – there was a tremendous concern that a weaker economy could worsen the credit crunch and, in turn, “reinforce the economic slowdown.”  While it was expected that the markets would stabilize over time, “participants judged that credit markets were likely to restrain economic growth in the period ahead,” the minutes went on to say.

If the Fed did not take action policymakers “saw risk that tightening credit conditions and an intensifying housing correction would lead to significant broader weakness,” not just in terms of economic growth but employment, as well.
 
News and Related Story Links:

• Money Morning Investment Analysis:
  Super-Sized Rate Cut Spurs Super-Steep Rally; Dow Soars Nearly 336 Points.

• The Associated Press:
  Fed Minutes: Rate Cut in Sept. "Prudent".

• Money Morning News Analysis:
  Surprisingly Dismal Jobs Report Unleashes Its Fury on the Federal Reserve and Wall St.

The unexpected resignation of Japanese Prime Minister Shinzo Abe on Sept. 12 spooked the Tokyo stock market. But as the dust clears, it’s obvious that investors shouldn’t worry.

The new prime minister, Yasuo Fukuda, isn’t about to change an economic policy that is currently working quite well. That’s especially true when that policy is very much in line with his longstanding personal beliefs. And because Fukuda is likely to further the economic policies of his predecessor, Japan will continue to represent an island of stability in a global economy that’s still riding the subprime waves.

For shrewd investors, that scenario spells opportunity. And we can suggest several ways to play it. Let me explain …

What Really Matters in Japan

There’s really only one issue that Japan investors should be tracking: Public spending. Until 2001, Japan had expanded the public sector like madmen trying to spend their way out of their decade-long recession. That not only didn’t work; it left Japan with a debt load equal to 170% of Gross Domestic Product, and a public spending deficit equal to about 8% of GDP.

In 2001, Junichiro Koizumi took over. In addition to a real fondness for Elvis Presley, he had a high respect for free-market capitalism and an aversion to expanding the public sector. He brought the annual deficit down, and real growth resumed.

Abe, who took over in September 2006, continued Koizumi’s policy and produced an excellent budget last December, which promised a surplus by 2011. The problem was that Abe wasn’t all that great at running a government. He lost several ministers to scandal, one to suicide, and the ruling LDP party did poorly in the midterm elections in July. And at a mere 52, he may have been too young for tradition-laden Japanese tastes.

The new guy, Yasuo Fukuda is 71, a "proper" age for a Japanese prime minister. He was said to be a moderate – meaning no visits to the Yasukuni shrine and better relations with China. Although his age might suggest that he favors public spending, I don’t think that will be the case. Here’s why…

Like Father, Like Son…

You see, Yasuo Fukuda is the son of Takeo Fukuda – Japan’s prime minister from 1976 to 1978. He was also considered to be the father of the 1980s Japanese boom. He was an opponent of the corrupt big spender Kakuei Tanaka (1972-74) who gave Japan lots of infrastructure, 34% inflation, and the Lockheed bribery scandal. Conversely, Takeo Fukuda cut the budget deficit, reduced inflation, and laid the foundation for the long 1980s boom.

Significantly, Daddy Fukuda also gave Koizumi his start. Koizumi got his first political job as Fukuda’s secretary in 1970, and the two became close – close enough that Daddy Fukuda was best man at Koizumi’s wedding. Yasuo Fukuda himself was in Koizumi’s cabinet for three years and is a good friend of Koizumi. Thus his father’s political tradition and his family’s closeness to Koizumi strongly suggest Yasuo Fukuda is not about to reject Koizumi’s tight budget policies. Just because he’s 71 doesn’t mean he’s stupid!

The opposition is calling for an early general election, but since the LDP has a two-thirds majority it doesn’t need to call one until 2009. Fukuda may decide to call an election next spring but, presumably, only if he thinks he’ll win it. Japanese public spending and debt should stay controlled.

Issue #2 Under Control

The other big issue in Japan is interest rates. Short-term rates have been close to zero for far too long and need to be around 2% or so, in line with the economy’s growth potential. Japanese savers are getting ripped off, and it’s about time that changed. And with lots of Japanese nearing retirement age, the country’s savings are huge.

Bank of Japan Governor Toshihiko Fukui has been trying to push short-term interest rates up, but hasn’t been allowed to raise them since they went to 0.5% in February. Abe was worried that a rise would be politically unpopular. If Fukui raises them, probably to 0.75%, at the next Monetary Policy Committee meeting October 11, you’ll know two things:

• Fukuda realizes higher short-term rates are a good thing.
• And he believes the subprime mortgage crisis is irrelevant to the Japanese economy, which remains in pretty good shape.

The stock market may well dip as rates rise, but that will be a short-term reaction. In the long run higher rates mean a stronger economy, a stronger yen, and probably more foreign and domestic money coming into the Japanese market.

Outside the world of Japanese politics, the market’s recent drop was largely caused by the subprime mortgage crisis, to which Japan has almost no exposure, probably the lowest of any major economy. Since Wall Street, the epicenter of the problem, hasn’t dropped much, it seems unfair that innocent Japan has fallen more.

The one genuine reason for the drop is that the yen has been strong recently, moving from 120 to 114 against the dollar, and likely to strengthen further, particularly if Fukui raises interest rates. As the dollar is weak overall you probably don’t want to buy companies exporting to the U.S., since their profit margins will be squeezed. Three suggestions therefore:

• streetTracks SmallCap Japan ETF (NYSE:JSC.) which invests in smaller Japanese companies, which are mostly domestic and can benefit from continued growth in the Japanese economy without being buffeted by international problems.
• Kirin (OTC:KNBWY:PK), Japan’s largest brewery. It’s traded on the dreaded "Pink Sheets" in New York, but has a market cap of $12.5 billion in Tokyo. Kirin’s over 20 times earnings, so a bit pricey, but it has focused its growth on East Asia and Oceania, which looks the way to go.
• Third, Japan’s largest investment bank Nomura Holdings (NYSE:NMR), whose share price has suffered recently because Western investors don’t like the industry – or its modest holdings of subprime U.S. mortgages. Nomura is however dominant in the domestic market and reasonably priced at 15 times earnings.

News and Related Story Links:

• Wikipedia:
  Shinzo Abe.

• BBC News Asia-Pacific:
  Profile: Shinzo Abe.

• MarketWatch:
  International ETFs Take New Ground.

• FT.com:
  Tokyo Market Hits High Mark.

From Staff Reports

Australia’s ongoing economic boom – fueled by the continued growth in the Asia-Pacific Region – has left Aussie families less leery of debt, and more vulnerable to an economic shock or recession, Reserve Bank Deputy Governor Ric Battellino stated at a convention in Melbourne yesterday.

At a convention organized by the ‘Melbourne Centre for Financial Studies,’ Battellino said that Australian households were running a "highly mismatched balance sheet," consisting of property and shares on the asset side of the personal ledger, and a load of debt on the liability side. It’s the kind of highly leveraged mix that professional investors use to magnify returns on the upside – but which magnifies and acclerates losses on the downside.

"This balance sheet structure is very effective at generating wealth in good economic times," Battellino told the audience, according to a report by Australia’s Age.com newspaper. "But households need to recognise that it leaves them exposed to economic or financial shocks that cause asset values to fall and/or interest rates to rise."

But there’s also some good news. Unlike in the U.S. economy, where high debt levels are used to help fuel consumption, the rise in debt in Australia is being taken up by mostly higher-income households, and was used to buy such assets as homes, stocks, and investment properties. That means the debt is backed by assets, which can help diffuse any damage during a downturn, Battellino quite correctly observed.

"It would be a mistake, therefore, to conclude that a rising ratio of debt to income is necessarily a sign of financial stress," Battellino said.

But debt loads are worrisome when they climb. And in a sobering commentary, Battellino said there was absolutely "no precedent" in Australian history for the constant – and essentially vertical – growth in debt over the past four decades. In the mid-1960s, credit was only equal to about 25% of Australia’s gross domestic product. Today, that exceeds 150%.

News and Related Story Links:

• The Age.com News:
  High Debt Leaves Households Exposed: RBA.

• Speech by Australian Reserve Bank Deputy Governor Ric Battellino:
  ‘Some Observations on Financial Trends,’ Address to Finsia-Melbourne Centre for Financial Studies, 12th Banking and Finance Conference, Melbourne, Australia, Sept. 25, 2007.

• Money Morning News:
  Aussie Bank Chief Favors ‘Big Four’ Merger to Avoid Asia-Market Irrelevance.

When Federal Reserve policymakers announced the half-a-point cut in interest rates last Tuesday, I was almost at a loss for words.

As all of you know, I had projected reduction of 25 basis points, and by the time Tuesday’s meeting of the central bank’s Federal Open Market Committee (FOMC) rolled around, the market supported my view. Going into that FOMC meeting, the outlook was decidedly negative: The U.S. economy was slowing, and the lousy housing market was leading the downturn, and the global fixed-income markets are undergoing a painful restructuring. So far, everything was playing out according to our expectations.

But then the Fed surprised us with a mammoth injection of “monetary steroids.”

The central bank, seeking the Fed Holy Grail – a ‘soft landing’ – for the economy 9except for the housing sector), watched in recent months as the subprime-mortgage-induced housing problems spilled over into the fixed-income markets. Suddenly, what had started out as a domestic housing slump had turned into a global credit contagion.

While the ‘science’ of central banking includes many degrees of ‘art,’ the Fed found /itself in the difficult position of having to choose between two strategies, neither of the optimal. It could:

• It could cut interest rates – on the basis of one bad employment report and the possible widening of a global credit crunch – in anticipation of a possible economic slowdown.
• It could ‘stand pat’ and hold the line on interest rates – in the face of renewed inflationary expectations – as evidenced in the higher prices of gold, oil, wheat, and other commodities, as well as the low value of the U.S. dollar. But with the markets already having factored in a rate cut, the “stand pat” option was really no option at all. The reason: The moment the Fed said it was holding the line on short-term rates, the stock market would literally fall out of bed.

That meant that the central bank’s choice was a Hobson’s choice – for it was really no choice at all.

So the Fed opted to “protect” economic growth – and, in the process, mitigate the downturn in housing and the problems facing such highly leveraged players as financial institutions or hedge funds by dropping interest rates. It caught the entire market by surprise. This was much more than the market and I expected, and generated a rush out of cash and bonds. Why?

Very simple: A fear of re-acceleration in inflation. With a weak U.S. dollar and very strong global growth, the cuts add more fuel to the fire. And this will have a very beneficial effect on U.S. growth six to nine months down the line. While core inflation has recently been in a downward trend, the rise in the U.S. dollar-denominated commodities (oil, gold, other minerals and agricultural commodities) – together with the low value of the U.S. dollar – poses a major inflationary risk.

So, what’s your best defense in this situation?

• Go on the offense by taking advantage of the expected continued increase in commodities prices by purchasing commodities producers, such as major global mining companies.
• Buy into the more-promising emerging markets – such as Brazil – since they will be big exporters of these commodities. Also, many of these markets will benefit from major consumer booms as the economies evolve and develop.

The Fed acted boldly, and the markets responded likewise. We remain opportunistically bullish, with a preference for international and U.S. companies that will benefit from international growth.

Stay tuned for more action, probably as soon as next week.