The deficit: How to protect yourself
BY BRETT ARENDS, THE WALL STREET JOURNAL — 02/02/10
What do these budget deficits mean for you and your finances?
The federal government is expected to borrow $1.6 trillion this year, or about $15,000 for every household in the country.
Over the next 10 years it’s expected to borrow a total of $8.5 trillion. And the government was already deeply in debt to begin with.
Deficits are certainly not always bad for the economy. And it makes sense for Uncle Sam to borrow heavily in a crisis, like now. But these figures are enormous. And they are expected to stay big well down the road. The Obama administration forecasts deficits of $1 trillion in 2020.
Here’s a look at the risks the deficits pose for personal wealth–and what can be done to guard against them:
Be very wary of long-term bonds. Whether we pay for these deficits by issuing bonds or by printing money, we run the risk of inflation in due course. Longer term bonds are most at risk. Yet the prices right now are not compensating you for the risks. Ten year Treasurys yield 3.65 percent; 30-year Treasurys, 4.57 percent.
Remarkably, the Treasury market has not yet panicked about the deficits: Yields have barely risen this week. Embedded in the market is a long-term inflation forecast of about 2.5 percent. I call that a dangerous complacency. (I usually recommend inflation-protected government bonds, but right now they are looking a little pricey).
The danger may be nearer than many realize. Our deficits are financed by savers in emerging markets, especially in China. But many emerging markets are now seeing rising inflation. If that continues they will have to raise interest rates at home. We will have to do the same here if we want to keep attracting their money.
Make sure you are globally diversified and not entirely dependent on the U.S. economy and the dollar.
There is a danger of a dollar slump. Those most convinced it will happen should look at having some gold exposure, but it’s volatile and that’s not the only way to reduce your dependence on the greenback. It makes sense to keep plenty of money in overseas stocks and bonds. Many U.S. blue-chip stocks–from Kraft (KFT to Apple (AAPL to Exxon (XOM –are really global as well.
Make the most of your tax shelters. Give as much as you can to your 401(k) or equivalent, your IRAs, 529 college savings plans for the children and maybe even low-cost variable annuities, if appropriate for you. Sooner or later taxes have to go up to narrow the budget gap–especially as the interest on the debt skyrockets.
Those who think we can escape this just by cutting spending should consider that two-thirds of the federal budget goes towards Social Security, Medicare and Medicaid, defense and debt interest. They won’t be cut.
Secure a cheap fixed-rate 30 year mortgage on your home while you can. These rates are closely linked to the interest rate on 10 year Treasury bonds. You would expect them to rise a long way if bond yields do.
Take a hard look at the risks in your portfolio. The issue with share prices right now isn’t that they are egregiously expensive. They’re not. It’s that they aren’t cheap–and we live in risky times. Too few investors are getting compensated for the risks they are taking.
Depending on your circumstances, this may be a time to think about cashing in some of your riskier chips–especially if you are sitting on big gains from the last year.
Am I being too gloomy? Maybe. But in light of the gridlock in Washington and the deep divisions in the country at large, I’m skeptical about our ability to solve this problem.
It makes sense to be prepared.