It’s no surprise that our country’s debt continues to rise at unparalleled levels. Currently our nation’s debt is $26.5 trillion and rapidly rising. And further talks of coronavirus stimulus will only push the debt higher. This could create serious implications for us as citizens and you need to be prepared.
I recently read a fantastic article from Gary Halbert of Halbert Wealth Management. It’s one of the best articles I’ve seen on the national debt subject and it’s motivated me to share my own thoughts on the subject.
So, with that in mind, following are 4 possible implications of our country’s debt:
Implication #1: Taxes May Rise
This is the most obvious implication. I won’t belabor the point here as I recently wrote about this in an article titled 3 Strategies to Protect Yourself from Higher Taxes. But suffice it to say that our country’s debt will have to be paid at some point. The deficit cannot continue on forever without consequences.
In order to pay the debt (or at least start paying down the debt), I expect that Congress will eventually raise taxes.
Implication #2: Low Interest Rates
Currently, the Fed is keeping interest rates low. One of the reasons I believe they are doing this is because it keeps the cost of their debt low. The government has to pay interest on the debt that is purchased. And as long as the rates are low, the interest payments the government has to pay is low.
You may be thinking that low interest rates are a good thing since it lowers your mortgage interest, auto interest, etc., but prolonged low interest rates do have some nasty side effects.
First, savers are hurt in a low interest rate environment. Any money you have in a savings account earns very little interest. This is especially true for seniors who supplement their Social Security income with interest from their CDs. Lower interest means lower income.
Second, local states, corporations, and even other countries may start to offer higher interest rates to investors while the U.S. government keeps the interest on its own debt very low. This would result in investors selling their U.S. government investments in order to purchase higher interest rate investments. And how will the U.S. government be able to afford to repay investors? Perhaps higher taxes.
Third, lower interest rates really hurts banks and pension plans. Banks won’t make as much money when it’s lent out. And pension plans possibly won’t earn a high enough return to make good on all their promised payouts. This would actually then require employers to invest more money into the pension plan, but that might be difficult if revenue is down due to a continued economic shutdown. And if pension plans fall apart, that impacts the livelihood of citizens.
Implication #3: High Inflation
Purchasers of our debt will demand to be repaid at some point. Currently Japan and China are the top 2 countries that own the most U.S. debt. As of April 2020, collectively they own $2.3 trillion. If they, or even U.S. investors demand to be repaid, then this money has to come from somewhere.
Granted, since we have the ability to print money at will, we should be able to repay the investors. However, the more money we print, the greater the supply of dollars will be in the U.S. system. And when you have a lot of money in the system, this will serve to devalue the dollar and possible lead to very high prices and inflation. That is not a good place to be, just ask Venezuela.
Implication #4: Cost to Service Debt Will Eventually Rise.
Currently the U.S. government pays approximately $400 billion annually to cover the cost of its debt. As mentioned above, the Fed is currently keeping interest rates low, but it can’t stay that way forever. When interest rates rise, the cost of this debt will double, triple, or more, possibly leading to further debt and again higher taxes.
Furthermore, if unemployment remains high or gets even worse, then the government won’t have as many people to tax. Who knows what will happen at that point if it coincides with higher interest rates? Your guess is as good as mine, but it likely won’t be a good scenario.
How to Protect Yourself
Continuing to print more money and increase taxes is a vicious cycle. In my opinion, the only way out is for the government to spend less than what they bring in. But that doesn’t look like it’s going to happen any time soon. So in the meantime, what can you do to protect yourself from these possible implications.
#1 Refinance Your Mortgage
It’s hard to believe, but rates keep falling on the 30 year mortgage. As of this writing, U.S. Bank has a 3.125% 30-year mortgage rate (the day before it was only 2.99%). Refinancing will help to lower your mortgage payment for the life of your loan which will help if you get laid off, if taxes go up, if you need to save more money, etc. Refinancing doesn’t make sense for everyone, so be sure to check out my article on How to Truly Know if You Should Refinance Your Mortgage.
#2 Build Up Your Emergency Fund
Many people lost their jobs as a result of the coronavirus and they needed a stimulus check to get them through. However, that shouldn’t have been the case. If you are employed, you have to put yourself in a position where you can handle a crisis (emergency) if it comes your way.
Too many people spend everything they make and they say they don’t have any money leftover to save. But this is generally not true – especially in America! Most people do have money to save, they just choose not to.
While you’re employed, be sure to save some of your income to an FDIC-insured savings account. Your goal is to have enough savings to cover 3 months of expenses at a minimum – but likely more. For a closer look at how much you should have in your emergency fund, check out this blog post I wrote.
#3 Employ the 3-Bucket Strategy
Long time readers and clients will know that I am a fan of the 3-Bucket Strategy. This is where you have your investments in 3 different types of tax buckets (tax-deferred, tax-free, and taxable). Essentially you are diversifying where you hold your investments just like you diversify your actual investments.
But of course, this strategy actually requires you to invest money. So, while you are employed, use that opportunity to invest a good chunk of your income (above and beyond your emergency fund). Don’t count on pension income, Social Security, inheritance, etc. Do what you can today to protect against an unknown future.
#4 Do Roth Conversions
A Roth conversion is where you move money from your tax-deferred IRA to your tax-free Roth IRA. It’s generally a no-brainer to do a Roth Conversion if you have a very low income tax bracket (12% or less). However, with our country’s rapidly growing debt, higher taxes could be on the horizon. If so, then you’ll be glad that you have some money in a tax-free Roth IRA, even if it means you pay 22% (the next tax bracket after 12%) or more in taxes today to do the conversion. For more information on this topic, check out my blog post titled 3 Reasons to do a Roth IRA Conversion.
We certainly do live in unusual times. Our country has reached record-breaking levels of debt in a very short period of time. Deep down, we know this can’t be sustained forever. Even in your own life, you may have experienced the pain that comes along with spending more than you make. Be sure to protect yourself against the government’s actions. You don’t know what the future holds, but hopefully now you can see there are things you can do today to help prepare for whatever comes.
I would love to hear your thoughts on this article and how you are preparing for the future. Please leave any comments or questions below. Also, if you’re new to our blog and wish to receive future financial tips, then please click the image below to sign up.
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