The audacity is breathtaking. It requires just $100 billion less of the cost of the war in Iraq to date. Moreover, it is a stunning power grab by the Treasury secretary who, if the bill is passed, will be granted “the most incredible powers ever bestowed on one person over the economic and financial life of the nation.” (The New York Times.)

But there are ways to profit from the madness. Martin Hutchinson has picked three winners.

This from Money Morning:

Treasury bonds are a major loser, since inflation is rising and $700 billion of extra debt must be issued. Go for the Rydex Juno Inverse Government Long Bond Fund (MUTF:RYJCX), a fund designed to move inversely to Treasury bonds. Up to now, it’s been a poor play as T-bond yields have trended steadily downward and prices steadily upward, but it’s about to become a good one.

Gold has to be a winner, so you should consider the SPDR Gold Trust ETF (NYSE:GLD), which may be the most efficient way of getting a pure gold play.

Finally, for the first time in two years, I will venture to recommend a U.S. bank. With $700 billion being poured into the sector, one of the major banks has to be a big beneficiary. But the question is, which one?

Avoid Citigroup (NYSE:C): With so many different ways of losing money worldwide, it’s bound to find another one in this downturn.

Avoid Bank of America (NYSE:BAC): I would be very bullish on BAC after its Merrill Lynch (NSYE:MER) buy – if the morons hadn’t previously bought Countrywide Financial – a black hole of losses.

Wachovia (NYSE:WB): The bank’s leaders were as dumb as bricks when they bought a huge California home mortgage operation right at the top of the market in August 2006 – and they probably made other mistakes also.

Wells Fargo (NYSE:WFC): Possibly, but I don’t like the California emphasis or the fact that it was among the most active in the subprime market.

By a process of elimination, I am left with JPMorgan Chase (NYSE:JPM), which was relatively less active in mortgages and picked up a heavily subsidized investment-banking bargain in Bear Stearns.

It will doubtless get its share of the $700 billion, and not be left with so much rubbish that even the Feds won’t buy. With an earnings multiple of a fairly modest 13, an asset multiple (market capitalization/ stockholders’ equity) of a modest 1.1, a dividend yield of 3.2% and a dividend that appears at least moderately secure, there is comfort on the valuation side too.

Source: Dodge the Pitfalls and Uncover the Profits From the $700 Billion Banking System Bailout

That wiped out the gains from the June infusion of tax rebates and turned the key Personal Consumption Expenditure – which had risen a solid 0.6% in cash terms – into a feeble 0.2% drop in real terms.

It’s obvious that inflation is continuing its inexorable increase. It’s also obvious that the world’s monetary authorities – including the Federal Reserve – are going to have to get serious about this potentially ruinous trend.

For long-term investors, all of this leads to a single conclusion: It’s time to get prepared.

The policymaking Federal Open Market Committee meets today (Tuesday), and is expected to keep the Federal Funds target rate at its current level of 2.0%. Even if the FOMC surprises the market and raises the target to 2.25%, that would still leave short- term interest rates about 3% below the current (actual) level of inflation.

In short, this wasn’t a serious attempt to slay the inflationary dragon.

A real such attempt might, however, have a useful effect on global commodity prices. When you look at a graph of commodity prices over the past year, it becomes very clear that their vertical ascent was ignited at just about the time that Bernanke began cutting interest rates last September.

As the Federal Funds rate was cut from 5.25% to 2%, oil almost doubled in price and overall commodities prices shot up by about 40%. Since interest rates stopped dropping at the end of April, commodities prices have stabilized and indeed oil prices have backtracked from their record high of about $145 per barrel to about $120 per barrel.

Even the start of a monetary-tightening cycle would very likely cause a reversal in commodities markets, with speculators closing off their positions and prices dropping back toward their long-term-trend levels – even if the continued demand growth emanating from the emerging markets prevents them from dropping back all the way.

That, in turn, would be immensely helpful to the global economy; after all, even oil at a $100 a barrel – a level first reached in January, just months ago – still seems like a faint-and-withering dream.

High Inflation and Loose Monetary Policy

Of course, inflationary pressures and a need for tighter money are not exclusive to the United States. Even in Japan, which for a decade has worried about falling – not rising –prices, inflation has reached 2%. That’s above the 1.53% yield on Japan’s long-term government bonds, and is well above the Bank of Japan’s policy rate, which has been stuck at 0.5% for the last 18 months.

China and India both appear to have double-digit inflation – as well as interest rates well below the inflationary level.

China is not yet admitting its true level of inflation, since it wants to present a rosy picture for the Olympics, but the first statistics released after the Olympics conclude may be grim.

As for India, it is fighting inflation not by monetary means (The Reserve Bank’s interest rate is still only 8%, compared to inflation’s 12%), but by subsidizing the price of oil, food, and other basic goods. And those subsidies are causing the country’s budget deficit to spiral out of control – it almost equals 10% of India’s GDP.

In Europe, the European Central Bank (ECB) has made fighting inflation its top priority. At 4.1% in July, compared to the ECB’s policy interest rate of 4.25%, inflation is far above the ECB’s target of 2%. In Britain, the Retail Price Index (the one the government hasn’t fiddled with) is currently up 4.6% over the past year, although the Bank of England has managed to keep interest rates positive in real terms at 5%.

A few countries are fighting inflation vigorously. In Brazil, where retail price inflation is around 6%, the central bank interest rate is 13% – producing mouth-wateringly tight money that will allow the domestic economy to grow even after the commodities boom (from which Brazil generally benefits) has turned down.

However, countries with positive real interest rates, which allow them to fight inflation, are few and far between. At the other extreme, you have monetary basket cases like Dubai, where inflation is 22%, but you can get a home or a commercial real estate mortgage at a fixed rate of 7%. This has naturally led to a gigantic construction boom that could end cataclysmically.

Nevertheless, the global picture is clear. In the United States and worldwide, inflation is reaching levels at which policymakers are forced to pay attention. Their first steps will doubtless be inadequate, since rate-setters remain concerned about recessionary risks, and global interest rates will mostly remain negative in real terms. At some point, however, the gradual tightening of monetary policy will bring an end to the commodity price bubble.

Where to Be When the Fed Gets Serious

When policymakers finally start raising interest rates and the commodity cycle turns downward, stock markets will initially be adversely affected. The shares of oil companies and commodity producers will drop, and other shares will remain affected by the likelihood that higher interest rates will translate into lower profits. But there are two clear investment groups that are poised to benefit:

• First, to profit from rises in dollar interest rates, you might consider the Rydex Juno Fund (RYJCX), the price of which is inversely linked to T-bond prices (the fund shorts Treasury bond futures).

• Second, you should consider investing in countries that have few domestic energy and commodity resources, and that have been particularly hard hit by the price spikes as a result. Those would include Japan and Korea, both highly productive economies that are forced to rely on imports for most of their raw materials. In Japan, the iShares MSCI Japan Index ETF (EWJ) is currently trading at 16 times earnings, and features a yield of 1.6%, giving it a good market spread. In Korea, the iShares MSCI South Korea Index Fund ETF (EWY) trades at a lower Price/Earnings ratio of 12, though with a beefier yield of 1.9%

Source: What to do When the Federal Reserve Finally Gets Serious about Inflation

The minutes of the last policymaking Federal Open Market Committee (FOMC) meeting, released on Wednesday, showed that the Fed’s inflation forecast was raised from a range of 2.1%-2.4% to a range of 3.1%-3.4%.

Add the zooming oil prices we have seen recently into the mix, and the conclusion is inevitable: The nation’s central bank will soon have to reverse course and start raising interest rates – and probably in a hurry, too, if the Fed wants to keep oil prices on this side of the stratosphere.

That’s no small shift: After all, for nearly eight months the central bank has been mounting one of the most aggressive rate-cutting campaigns on record, slashing the benchmark Federal Funds rate from 5.25% down to 2.0%.

The Key Catalysts

Several factors have made it imperative that rates head higher. Let’s take inflation first. The consumer price index (CPI) figures for the last couple of months actually have been encouraging for the market. CPI has been coming in lower than analysts had expected. However, in both March and April, the downward seasonal adjustment was huge, far above the average adjustment for the past 10 years.

Thus, in March, a price increase of 0.9% (equivalent to 11.1% per annum) was revised down by the magic of seasonal adjustment to a mere 0.3%. Similarly, in April, an unadjusted 0.6% figure was seasonally adjusted down to just 0.2%.

It doesn’t require a super suspicious person to find that odd, especially during a period in which everyone’s worried about inflation. If the average March and April seasonal adjustment for 1998-2007 had been applied to the unadjusted figures, the annual rate of inflation for March and April would have been above 7%, instead of the 3.1% officially reported.

In any case, the producer price index (PPI) inflation is running at 6.5%, which suggests the CPI figure could experience an uptick very soon.

Either way, if the Fed thinks inflation will be above 3%, and the monthly figures come in above that number – let alone as high as 6%-7% – it won’t be able to keep the Fed Funds rate at its current 2.0% for long. The FOMC knows quite well that a Fed Funds rate lower than the current inflation rate will only serve to fuel inflationary pressures, and force the inflation rate even higher. If the Fed thought inflation was at 2%, it could justify keeping the Federal Funds rate at 2%; but now that the FOMC has acknowledged that it thinks inflation will be above 3%, it’s difficult to justify such a low Federal Funds target – something around 3%-3.5% seems more plausible, even if the United States is fighting a recession.

If monthly inflation numbers were all the Fed was worried about, we could expect the central bank to gradually ratchet the Fed Funds rate up to about 3% – or perhaps even a little bit higher. This deft initiative might get under way at the FOMC’s June 24-25 meeting, or might start at its Aug. 5 meeting, but either way, short-term rates would reach 3% by the end of this year, unless the banking system suffered another real disaster before then.

However, the oil markets have given the Fed something else to worry about.

Oil prices at $133 per barrel last Wednesday were up 60% from the $83 per barrel level on Sept. 18, 2007, the day the Fed began easing cycle for interest rates [oil prices punched through the $135-per-barrel level on Thursday before sliding back]. Other commodity prices have also gone through the roof during that same period. While U.S. monetary policy isn’t the only thing affecting global oil prices, which are dollar-denominated, it’s pretty clear that the Fed rate cuts and the central bank’s creation of money through bailing out the banking system have made an awful lot of money available for oil speculators.

And while hedge funds and sovereign wealth funds are reaping these massive windfalls, don’t forget the flipside of this equation …

This pricing petro-gusher is costing the United States real money.

The Suicide Squeeze Play

Since the United States currently imports about 9.4 million barrels per day, the $50 price increase since September has cost the United States $470 million a day. That’s $170 billion per annum, more than 1% of gross domestic product (GDP), or 22% of the current U.S. balance of payments deficit.

T. Boone Pickens, the octogenarian Texas oil legend, has emerged with a prediction that the price of oil could reach $150 a barrel by the end of the year. He points out that the world oil supply is currently at a maximum of 85 million barrels per day, while demand is 87 million.

There’s just one problem. There’s no way this supply shortfall of just 2 million barrels per day, or 2.3%, should cause oil prices to soar 60% in eight months – let alone another 15% before year-end as Pickens predicts. Rising prices should reduce demand and (to a lesser extent) increase supply. Economists differ by how much, but no economist I know of thinks the price elasticity of oil is below 10%: And at 10% elasticity, a 2.4% supply shortfall should push the price up 24%, not 60%.

So where does the other 36% come from – not to mention the additional price increases that Pickens is predicting?

It must be “artificial” – that is, created by speculators.

With U.S. interest rates below the inflation rate, betting that oil prices will go up is like shooting fish in a barrel – you can’t miss, provided only that you and your friends are together rich enough to control the market. And with all the extra money that the Fed has created just sloshing around, speculators are nothing, if not rich.

How do you stop speculators? You whack them with a two-by-four, that’s how. You get their attention with a shock move. You bring them pain by increasing their financing cost, you insert in their mind the idea that you might really mean it, and underscore that you might go on attacking them until their speculative run-up in oil prices is ended.