One of the major stories being discussed is America’s huge debt. We have been spending more than we have been making for quite a while. Much of our debt is owed to our trading partners. They loan to us so that we can buy from them. After years of this, our debt is colossal; plus, like any other debtor, we end up paying a lot in interest.
Trying to fight a war with borrowed money doesn’t help either. In the “good old days”, besides taxing its citizens to pay for a war, the government would borrow from its citizens with “savings bonds”. The interest paid would be spent buying goods and services from our own economy. No more. The interest we pay now goes to stimulate economies of the lending countries (our trade competitors/partners).
We have often said that this latest spate of borrowing to provide stimulus during the last recession will really test our government. The Federal Reserve pumped in liquidity and lowered interest rates. This is called “monetary” stimulus. Congress spent much on pet programs as “fiscal stimulus”. The tricky part is to remove those stimuli when the economy starts to recover. Well, by any measure, the economy has started to recover. But cancellation of those stimulus programs can be painful to those who benefit from the programs. Politicians don’t like to do unpopular things. They lose votes. Being less political, the Fed will likely do what it can. They just have to be right.
Congress must end those programs and more. Entitlements must be taken on. The great American public will probably not understand. They must be educated and then led down the path of fiscal responsibility. We are talking about leadership here. The politicians are going to have to lead, not follow opinion polls.There are a few things that need to be done that are fairly obvious, such as increasing the age before one can draw social security. This means testing social security for higher taxes is likely; reigning in costs of Medicare and Medicaid and charging recipients more is inevitable. There will be many other measures taken as well.
What if the politicians don’t come? Very simply, our creditors will stop lending to us. Or, if they do continue lending, it will be at higher interest rates to compensate for their increased risk. About what risk are they concerned? Our creditors know there is one way we can rid ourselves of much of our debt burden: print more money and inflate our way out of the debt. But that would come at a huge cost. The dollar may lose its status as the world’s reserve currency. Then we would be just one of the crowd. Interest rates would soar. The value of the dollar would dive. Retirees on fixed incomes would hurt big time.In my opinion, there is one major benefit to losing our status as the world’s reserve currency: we will be forced to grow up and be fiscally responsible. This is a good thing.
Inflation and a weakening dollar will be painful for our creditor trading partners too, because our ability to buy from them will be impeded. This is not as critical to them as it once was because Americans are no longer the only consumers to whom they can sell. The developing countries are spawning their own middle class. They are eager to consume!
So what are the investment implications? First, invest. The retirees who will be hurt worst will be those in cash and who depend on social security or annuities. Have a diversified portfolio of stocks and bonds, foreign and domestic. That means being globally diversified. Don’t bet your financial future strictly on the U.S. We at Huff, Stuart and Carlton have been favoring mutual funds that can invest globally. As the dollar weakens, foreign currencies tend to strengthen. Foreign investments benefit. Bond funds we use include international bonds, inflation protected bonds and short and ultra short term bond funds, all of which should perform well in an inflationary environment. We also use natural resource and real estate funds as inflation hedges.
This has been something of a “downer” article. I would like to end it on a positive note. The U.S. still has a lot going for it. The dollar is still the world’s reserve currency. We are far-and-away the world’s largest economy. The U.S. is a great place to start and grow a business. Our language is that of global business. English-as-a-second-language is probably the most popular course in the world. Our colleges are world class and attract many foreign students. (I wish I could say the same about grades 1 – 12.) Our laws are fair and property rights are respected. Our standard of living remains the envy of the world.
We just have to act responsibly.