It doesn?t seem like a week goes by without some major piece of the US financial system falling off or some radical new step by the US financial authorities to forestall an incipient crisis. In this week?s column, I would like to assess what the latest moves by the US Federal Reserve mean for Indian investors. But before I do that, I want to reiterate the recommendation I gave you on May 26, and have repeated a few times since. Stay away from global equities. I know it?s emotionally difficult for equity investors, so I shall repeat it. Stay away. Hold your nerve. Wait. Those who have followed this advice have profited. The day you should go back into global stocks is approaching, but it is not this day. Recent events in the US reinforce that message.

Two weeks ago, the Fed was rescuing ?Fannie Mae? and ?Freddie Mac?, the quasi government agencies that finance around half of the $12 trillion housing stock. Last week, the Federal Reserve announced that it was extending its emergency lending programmes to Wall Street firms until January 30, 2009, auctioning longer term cash to commercial banks and expanding its programme of swapping tainted securities held by securities firms for government bonds. This announcement is a clear indication that the Fed does not see an early end to the liquidity crunch. It is also a validation of the idea that modern banking in the US and Europe now means that central banks are no longer just lenders of last resort, they have also become ?buyers of last resort??buying up the diseased assets of sickly institutions.

The more cynical amongst you will say the Fed is only taking out extra insurance today to ensure that there is no liquidity debacle in the run-up to the November presidential election. Perhaps, but that plays to my market conclusion. The Fed?s liquidity actions this week have shown their anti-inflation strategy rests on a wing and a prayer. But the gods will not be impressed. The inflation rate, at 5% in June 2008 is significantly above the short-term interest rate of 2%, implying negative real interest rates. There is little surplus capacity in the economy to bear down on demand inflation. In this context, the Federal Reserve?s actions to expand liquidity further tells us loud and clear that the Fed is too distracted by the problems in the financial sector to pay any heed to inflation. Which will mean inflation will rise further until it is their primary concern. I would not be surprised to see a 6% handle on the US inflation rate before the year is out?the highest rate in three decades.

Optimists say that the global slowdown will put a lid on inflation, but they are being too optimistic. Inflation is being driven by an excess of demand over supply?monetarists will argue this in money terms. Global supply is running up against bottlenecks as evidenced by the rise in inflation in those previous sources of disinflation, China and commodity markets. Following a record five years of over 5% growth, the growth of global demand may be slowing, but it is still growing above a level that is inflationary. Even when levels of demand fall back in line with levels of supply, the US inflation rate will have an extra-kicker from the 50% devaluation of the dollar since 2002.

More inflation than currently anticipated is generally better news for equities than bonds, especially given that yields on US, 10-year government paper have now sunk below 4%. I reckon 10-year US yields will end up closer to 6.5% in 12 months? time. The problem for all other markets, though, is that if you can earn 6.5% on risk-free 10-year US dollars, all other risky instruments?from US corporate bonds to Indian equities?will have to be devalued to compete in the global market for capital. Equities may outperform government bonds, especially where they represent an investment in real assets, but it is not a bullish equity background and, perhaps more importantly, equity markets have yet to discount stubborn inflation and the policy dilemmas this delivers. Once the markets do so, equities will be a steal.

In a world in which it is hard to find absolute value, it is worth considering relative value. US monetary policy is inflationary, but it is not so everywhere. Indian monetary policy has been tightened. European monetary policy appears on hold, but from a tighter position than in the US. I favour the bond and currency markets of those countries likely to be tougher on inflation than the US. Remember that currency markets are an extension of the bond market not the equity market. It would appear the US officials have not finished debasing the dollar and so, the recent pull back in the value of the euro, gold and oil will prove temporary. Good luck.

The author is chairman of London-based Intelligence Capital, governor of the London School of Economics and Emeritus Professor of Gresham College in the UK