But while the Fed is definitely looking to do what it can to avoid a contraction in the U.S. economy, central bank Chairman Ben S. Bernanke faces a second – equally troubling – challenge. And no matter which route he chooses to take, the solution to one problem will exacerbate the second.

For that reason alone, the Fed has demonstrated some caution with regards to interest-rate reductions.

Seventies Flashback?

During the 1970s, the United States was afflicted with stagflation – crippling inflation coupled with stagnant economic growth and high unemployment. Until stagflation appeared, economists believed it to be an almost-impossible combination. Today, investors of a certain age remember the high fuel costs and long gas lines – along with the headlines about rising unemployment and a stalled U.S. economy that refused to be jump-started.

As U.S. economic troubles mount anew, some experts are using the “S-word” again. But stagflation is a worst-case scenario. The only thing worse than having either a recession or a period of inflation is to have them occur together. But Keith Fitz-Gerald, investment director of both Money Morning and The Money Map Report, believes that “the Fed will do whatever it takes to prevent a recession.”

2008: The Year of the Greenback?

Much has been made in the press about the U.S. dollar’s decline against the euro, yen, and other major currencies. But with the U.S. economy in such a decidedly weak state at the moment, a weak dollar gives the United States a competitive advantage abroad, which in turn is enormously helpful to employment at companies that that make products or offer services for export – and, by extension, is also helpful to the profits of U.S. companies with large international businesses.

At the top end, the weak greenback could even cushion the housing-market downturn, says Money Morning Contributor Editor Martin Hutchinson. “Wealthy European and Asian investors will find bargains in fashionable markets such as California, Nevada and Florida where overbuilding had been most rampant,” he said.

Also, while the dollar is weak, the U.S. trade deficit should continue to decline, making the dollar sounder and reducing the need to attract scarce foreign investors.

There are few factors more beneficial than a weak dollar [to a point] in restoring the U.S. economy to full strength. Ideally, the U.S. balance of payments deficit could be sharply reduced and the housing market stabilized before interest rates have to be raised to fight inflation. When rates are raised – and they will – the dollar will inevitably strengthen.

[Editor’s note: While the falling dollar has roiled many investors, the ones who know why the dollar is falling are pocketing incredible gains. To learn their secrets - as well as profit plays on oil, gold, sovereign wealth funds, emerging markets, agriculture, uranium, biotech and much more - check out Money Morning’s latest book, The Essential Investors Playbook.]

Good Opportunities Exist – Even in a Potential Bear Market

Money Morning’s Fitz-Gerald cautions investors to remember that even though U.S. gross domestic product will advance at a modest pace of only 1% to 2% during 2008, the rest of the global economy will be doing quite well – with economic growth rates in some markets as high as 8% to 9%. With foreign economies growing that briskly, there will be plenty of profitable investment opportunities available in the 12 months to come.

With growth sputtering and a recession still possible here at home, investors should turn their attention to such U.S.-based multinationals as McDonald’s Corp. (MCD) and Yum! Brands Inc. (YUM). Both firms derive substantial portions of their sales from overseas markets, where growth is likely to continue over the next 12 months, regardless of what happens to the U.S. economy.

And while these firms offer significant foreign-market exposure, the fact that they’re U.S. based means such corporations as McDonald’s, Yum! Brands and such others as The Coca-Cola Co. (KO) and PepsiCo Inc. (PEP) offer the transparency of U.S. financial reporting requirements and the relative protection of the U.S. investment-regulatory system.

But if you prefer to invest more directly in foreign growth, then Hutchinson – the Money Morning contributing editor – says to try South Korea’s largest wireless service provider, SK Telecom Co. Ltd. (SKM). SK is well positioned to capitalize on the growing Asian markets. Likewise, the Hsinchu, Taiwan-based Taiwan Semiconductor Mfg. Co. Ltd. (TSM) [commonly referred to as TMSC], the world’s largest dedicated semiconductor foundry, is another Asian tech company that is not currently overvalued and should do well in the New Year, Hutchinson says.

Traditional inflation-sensitive investments such as currencies and commodities are also good plays for 2008, investment gurus as Fitz-Gerald and “adventure-capitalist” Jim Rogers both say.

The PowerShares Agriculture Fund (DBA), operated by German giant Deutsche Bank AG (DB), is intended to reflect the performance of four commodities in the agriculture sector: Soybeans (31.13%), wheat (28.87%), corn (23.43%) and sugar (16.58%). These include some of the key agricultural commodity plays that Rogers advocates.

Another is Van Eck’s recently launched Market Vectors Agribusiness Exchange-Traded Fund (MOO). Like the PowerShares Fund, this reflects the agriculture industry but in a different way. Instead, the ETF’s holdings reflect returns seen from agriculture chemicals (34%), agriproduct operations (33.5%), agriculture equipment (24.3%), livestock operations (5.6%) and ethanol/biodiesel (2.3%).

For investors who have the constitution of a Contrarian investor – as well as some patience and a long time horizon – it may be well worth a look at some of the beaten-down financial-sector stocks that state-run sovereign wealth funds are buying into in a wholesale manner. Although many U.S. investors are preaching caution – if not total avoidance – when it comes to companies involved with the American financial-services sector, these government-run investment pools clearly view such stalwarts as Citigroup Inc. (C), UBS AG (UBS), Merrill Lynch & Co. Inc. (MER), and Morgan Stanley (MS), as bargain-basement investment opportunities.

Fitz-Gerald favors Citigroup.

“Citi is trading for a pittance,” said Fitz-Gerald. “In fact, it’s trading at just barely seven times trailing earnings and eight times [projected] 2008 earnings. Yet, if you add up the growth prospects and current valuations, the company reflects a value that could be as high as $60 or more a share. Value investors will recognize this as important because history shows that the lower P/E ratios are when you make an investment, the better your overall returns tend to be. Generally, large globally diversified companies are considered bargains at a P/E of 12, which makes Citi a screaming deal at 7 or 8.”

Source: The U.S. Economy’s Uncertainty Brings Opportunity for Investors in the Months to Come

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