Why Bernanke Was Wrong

Jan. 22, 2008, may go down as the scariest day in the market in decades. On that day, we learned for certain what many of ushadlongbeensuspecting. The current Federal Reserve under Chairman Ben "Helicopter" Bernanke:

  • Answers to Wall Street banks and Jim "Mad Money" Cramer.
  • Is spurred to action by stock market gyrations.
  • Acts directly contrary to its primary duty of fighting inflation.
  • Wants to "help" by trying to reinflate the bursting housing bubble.

On that fateful day, in a much-requested move -- though still technically a surprise -- the Fed lowered interest rates by 75 basis points. In response:

  • Gold closed up $7.90.
  • The Lehman TIPS Fund (NYSE: TIP  ) closed up $0.82.
  • The dollar tumbled against nearly all major currencies.
  • The 2-year/10-year Treasury yield spread widened by 14 basis points.
  • The Dow and the S&P 500 fell more than 1% and the Nasdaq shed more than 2%.

All of which are signs of higher inflation and other nastiness to come.

The General is fighting the last war
The news wasn't all bad, though, if you happened to be the very specific target of the latest round of overindulgent monetary intervention. Bailout-happy Citigroup (NYSE: C  ) fell only $0.04, Bank of America (NYSE: BAC  ) rose 4% in spite of nasty earnings, and collateralized debt obligation (a.k.a. CDO) perpetrator Morgan Stanley (NYSE: MS  ) shot up better than 7.5%. It seems it's a good idea to be part of the only industry on the radar of an increasingly myopic Fed.

Unfortunately, however, the talking heads that pull Bernanke's marionette strings are already claiming that the intervention may have been "too little, too late." They're wrong. The intervention was in fact far too much and in the wrong direction. Lost in all of the banking panic is that the real economy is turning in impressive results.

The same day the Fed issued its panicked rate cut, transportation giant CSX (NYSE: CSX  ) issued a strong earnings release. Additionally, that very same day, health and personal care titan Johnson & Johnson (NYSE: JNJ  ) reported solid earnings and forecasted growth for 2008. The message is clear: Aside from people who borrowed too much to buy homes they couldn't afford and banks that devised too-clever derivative securities to try to pass on the risks, the overall economy is not so horribly off-track.

As a result, the bond market, stock market, currency market, and gold market all did exactly what you would expect, given this backwards Fed policy: They forecast higher inflation and adjusted accordingly.

It's only going to get worse
The participants in the global capital markets realize this far better than the Fed does. The Fed is essentially trying to "push a string" with its panicked rate cuts -- trying to stimulate demand that isn't really sagging outside of housing. For heaven's sake, even the housing bubble behind this banking crisis hasn't completely deflated. Homes have simply become less insanely expensive. Nationwide, houses still cost more than they did in 2004 (link opens a PDF). Unless you're a real estate agent, a house flipper, or a subprime mortgage originator, that's not a crisis -- that's a correction.

In years gone by, aggressive rate cuts helped stimulate the American economy by encouraging domestic investment and spending. That worked wonders when manufacturing and consumption were heavily centered in the United States. These days, however, the rules of the global game have changed. A policy that may have worked years ago will fail in today's globalized economy. As a result of continued Fed missteps, capital is clearly fleeing the U.S. for more lucrative opportunities abroad.

Take advantage of reality
There are now middle-class consumers popping up all over the world. That provides demand that's independent of the U.S. The bailouts for Citigroup and Morgan Stanley came largely from foreign capital. That means there's real money in the rest of the world. And as important, the world's biggest steel maker isn't based in Pittsburgh anymore. Instead, Luxembourg-based Arcelor Mittal (NYSE: MT  ) holds that title.

Capital. Industry. Consumers. Put them all together, and you have a recipe for a global economy -- one that's set to gain from the missteps of the Fed. That's why, at Motley Fool Global Gains, we believe that every American investor must have exposure to foreign economies.

If you're looking to profit (and diversify) from what otherwise will be a painful period for Americans, join us today.

At the time of publication, Fool contributor Chuck Saletta owned shares of Bank of America and Johnson & Johnson, both of which are Motley Fool Income Investor recommendations. The Fool's disclosure policy has never abandoned its duties.


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