5 Savage Truths About the Debt War

07/25/2011 9:24 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

Even if Congress wins the battle to avoid default by raising the debt ceiling, the war of inflation rages on, much larger and much closer to home, writes MoneyShow.com personal finance expert Terry Savage.

D-day is drawing nearer, with that once memorable abbreviation now turned into “Default Day"—August 2. The battle lines have been drawn, and it seems that compromise has been rejected.

The Savage Truth is that no matter which side wins, Americans are destined to lose—unless we can grow our way out of our debt.

One way or another, sooner or later, we will have to deal with our debt. That includes the debt we have accumulated already, and the debt that is surely about to grow exponentially as we strive to make good on all our well-intentioned promises to our own citizens, and to those who have lent us money.

Default—not paying interest or not paying off our maturing debt—is unthinkable. And it won’t happen on August 2. Some stopgap solution will be enacted at the last minute to pay the interest and roll maturing debt.

Still, America will lose credibility—and your personal finances will be impacted. Our choices are few. If we don’t enact policies to encourage economic growth, the only way to deal with the debt is to write it off slowly (as Europe is doing) or “devalue” it by creating more currency to lessen the burden of repayment.

That process is called inflation. And it will impact every American—rich or poor.

The Inflation Numbers
Even a little bit of inflation can be devastating to those who have savings and investments, and to those who depend on the government for benefits.

At just 3% inflation, which is our average historic rate, the value of your money will be cut in half in 25 years. So if you have been saving money for retirement this year at age 65, and planned that $3,000 a month would cover your lifestyle, you’ll need twice that monthly amount to break even if you live to age 90.

It’s doubtful that your Social Security check will keep up with inflation, as the government tries to hide the true numbers. After all, how will the Treasury has to come up with enough money to cover the cost-of-living increases?

And even if you’re not dependent on a government check, the value of your savings —your buying power—will be diminished by inflation.

Inflation has a way of creeping up. At 3%, inflation seems tolerable—even welcome.
But at 6% inflation, the value of your money is cut in half in 12 years. At 12% inflation, your spending power is cut in half in six years!

Think it can’t happen in America? In 1980, the United States briefly had a CPI inflation rate of nearly 13%! It took Fed Chairman Paul Volcker and a prime rate of 21% to tame inflation, and the expectations of future inflation.

That caused a devastating recession, with unemployment at 12%. But that was 30 years ago, and few today remember the pain.

NEXT: Your Personal Finances

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Your Personal Finances
Of course, inflation is not a sure thing. Higher interest rates could happen now, before future inflation is apparent, and despite Fed attempts to keep rates low to encourage growth.

Once the rest of the world fears a default, they will demand higher interest rates to buy our national debt—Treasury bills, notes, and bonds. Those higher interest rates on government securities will quickly impact rates on mortgages and credit-card debt and car loans. And that could send us back into recession.

So what should you be doing with your personal finances? I will repeat the advice I have been giving you in recent months, and over the years.

First and last—do nothing out of panic. And keep these basics in mind:

  • Money in bank CDs will remain safe, because we have learned that the government will not let the banking system go down. They will print money as a last resort, and guarantee the money they print. That will work—until it doesn’t. That point is way down the road, not next week. Hopefully we will never get there.
  • Keep things in perspective. The rest of the world has worse financial problems. You’ve read about Europe—but did you know that Japan has a debt-to-GDP ratio twice as large as ours, and larger than Greece? They’re wondering how to pay off their debt, too.
  • Everyone in the world is wondering where to put their money so it will be safe. Despite our problems, much of that money is still rushing to buy short-term US Treasuries. That has created disappointingly low yields for savers. But don’t stretch for higher yields. Keep your maturities short—less than one year. You don’t want to lock yourself into low rates for many years—because those bonds will lose value if rates rise.
  • The “smart money” is buying assets at bargain prices that others are selling out of fear. That includes stocks of large US companies. (According to Ibbotson, the market historians, there has never been a 20-year period going back to 1926 where you would have lost money in a diversified portfolio of large-cap US stocks with dividends reinvested—even adjusted for inflation.)
  • Given the incentives for the government and Fed to create money to pay their bills, you must have a portion of your assets “hedged” against inflation. Don’t rush to follow the crowd. But there are exchange traded funds (ETFs) and mutual funds designed to increase in value to offset dollar inflation. These funds allow you to invest in gold, commodities, and foreign currencies such as the Canadian or Australian dollar.

And there’s one more thing you should do to protect your personal finances. Go to www.ContactingtheCongress.org. You can easily find your representative, based on your address.

Then click the link to directly send a message to your Senators and Representative. Let them know you care—both sides of the aisle.

Don’t just sit back and watch the debate on TV. Whatever your views, speak up now, when it counts.

You’ll feel better for getting involved. And that’s The Savage Truth.

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