If I were Zhou Xichuan, the governor of the People’s Bank of China and chairman of the government’s Monetary Policy Committee, or Toshihiko Fukui, governor of the Bank of Japan, I would have been stunned by US Federal Reserve Chairman Ben Bernanke’s 50 basis point cuts in the Fed funds and discount rates this week. Coming at a time when rate increases were needed to combat the sinking dollar and surging gold, oil and other commodity prices, it may go down as the most irresponsible move in Fed history.

The countries holding the most U.S. debt at the end of the first quarter of 2007 were Japan, which held $612.3 billion at the end of the first quarter of 2007, and the People's Republic of China, which holds the second most U.S. debt, ending the first quarter of 2007 with more than $1.2 trillion in total foreign reserves, of which about $420.2 billion are U.S. Treasury securities. To Japan and China particularly, whose mountains of dollar reserves will be debased by lower US rates, this action amounts to the monetary equivalent of “let them eat cake.” My prediction is that rather than doing so, they will just throw it back in our faces, and refuse to continue funding our deficits.

Wall Street bulls have heaped praise on the Fed, at times calling the rate cuts courageous and brilliant. From their response, you would have thought that Bernanke’s solution was akin to Einstein’s breakthroughs on relativity. In the first place, what is so brilliant about cutting rates? My five year old could do it and would gladly accept payment for his service in popsicles.

Furthermore, a 50 bp cut was not an act of bravery but one of cowardice. The brave thing to do would have been to raise rates and allow market forces to purge the economy of the imbalances built up during the Greenspan bubbles. It would have taken some real courage to level with the American public and let them know that the country’s profligacy has consequences, rather than pretending it can ride to the rescue with a wave of its magic wand and a crank of the printing press.

If Bernanke really had any guts he would have assured the creditors that they will be repaid with real purchasing power, and that the Fed was willing to put some teeth in the alleged “strong dollar policy” which kept countries like China and Japan amassing their mountains of US debt. His capitulation proves that this phony policy was pure propaganda all along, merely designed to fool foreign creditors into holding US paper.

Those who believe the Fed should reduce interest rates to ward off a recession or stabilize home prices simply do not understand the situation. More credit is not the solution: it is part of the problem. The US economy is on the brink of disaster because irresponsible Fed policy encouraged Americans to borrow and spend too much and created an unprecedented national real estate bubble. The last thing the Fed should do is entice Americans to borrow more money they cannot repay, buy more imported products they cannot afford, and attempt to blow more air into the deflating real estate bubble.

Bernanke’s attempt to circumvent the free market forces that are bringing on a long overdo recession (which is necessary to purge our economy of unsustainable imbalances) will lead to an even greater disaster. Make no mistake about it; had the Fed done nothing, or raised rates as I would have preferred, the economy would have clearly tipped toward a severe recession. However, by “coming to the rescue” with rate cuts, the Fed assures that the country is gong to experience something far worse, and the rest of the world, particularly Asia, is going to face considerable economic pain beyond just the devaluation of their reserves.

Again, the coming recession is not the problem but the solution. Painful as it will be, a recession is the only way to cure the US’s sick economy and they will need to grin and bear it. When it ends, the US will be a lot poorer, but at least it would be clawing its way out of this gigantic hole. Cutting rates now only assures that the country will dig itself into an even deeper hole. In the end, it will be that much harder for the US to get out, and it will be that much worse off when they finally do.

Although they may slow the process down for a few quarters, the rate cuts will neither prevent the recession nor keep house prices from collapsing. But they will cost dearly. The dollar’s fall, which had been held somewhat in check by the possibility of a hawkish Fed, has accelerated in earnest now that the curtain has been pulled back.

Unlike previous bouts of Fed easing, this time any additional liquidity will not artificially pump up the economy or the housing market, but merely accelerate the rise in consumer prices and eventually push up long-term interest rates as well. If Americans are having problems making mortgage payments now, think of how much more difficult the task will become when food and energy prices double. If you think mortgage rates are high now, wait to you see how much higher they rise after a few rate cuts. After all, with the dollar in free-fall, why would foreign savers really want to buy mortgage-backed securities, or lend any more money at single digit interest rates?

For some reason everyone seems to think the Fed can bail out homeowners and mortgage lenders without anyone picking up the tab. There is no such thing as free lunch, especially if served by the Fed. If Congress does not raise taxes to fund a legitimate, although ill-advised bailout, then the Fed can not perform the same task for nothing. As the additional dollars the Fed creates reduce the value of all other dollars already in circulation, the cost for the “bailout” is simply borne by all holders of US dollars. Why should they stick around to take on more?

The irony of the situation is that on September 11th, while in Germany, Bernanke delivered a speech in which he admitted that we need to increase our savings and declared that the inevitable adjustment to our current account deficit would have both real and financial consequences. Bernanke’s actions, which reward borrowers and punish savers, merely exacerbate those imbalances, ensuring even greater consequences when the inevitable adjustment finally occurs.

Of course, the most comical spectacle of all was Alan Greenspan’s attempt to steal the spotlight. During his media blitz to promote his new book, he simultaneously disclaimed any responsibility for the problems the US is now facing while forecasting that both inflation and interest rates would eventually rise to double digit levels. He even admitted on “60 Minutes” that he personally had already diversified his own assets out of the US dollar. Expect China, Japan and the world’s other creditors to read that statement. I guess it’s fairly easy to read the writing on the wall when you are the one with the spray paint. Greenspan sowed the wind. Unfortunately the entire nation is about to reap the whirlwind.

Peter D. Schiff (schiff@europac.net) is president of Euro Pacific Capital, Inc of Darien, Connecticut