By Sara Nunnally, Editor, Smart Investing Daily, TaipanPublishingGroup.com
Earlier this week, the Associated Press ran two very different stories about the Federal Reserve. In fact, these two stories ran side-by-side on Monday evening about two hours apart. Here are their titles:
“Fed boss: More securities buys could help economy”
“Fed boss: Threat from deficits ‘real and growing'”
Federal Reserve Chairman Ben Bernanke warns that if we can’t get our budget deficit under control, we’ll endanger our economy down the road. We’ll see higher interest rates and higher taxes, which will cause the American consumer to stop spending.
But while Bernanke is calling for reining in deficits, he’s also calling for an increase in deficits.
Here’s why… During the recession, the Federal Reserve purchased some $1.7 trillion in mortgage securities, corporate debt and government bonds. Now Bernanke is hinting at buying more government debt.
While buying bonds certainly helps the government pay for things in the near term, those bonds will eventually have to be paid back — with interest. It’s just a way of deferring debt for a period of time.
It therefore increases the amount of debt the government will have to pay back.
What that means for your portfolio is clear… It’s just a matter of timing.
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There’s no doubt that debt has a huge impact on an economy, and on individual investors, particularly with the threat of inflation. Inflation is, in its simplest form, an excess of “dollars.” Too much money for too few goods produced means the value of a dollar is diminished.
Inflation eats away at your portfolio like a silent killer… even at low levels. A small gain in your retirement portfolio could be eroding as government debt continues to rise.
When the U.S. went into a recession in 2007, the government took on an unprecedented role in the economy. It increased spending drastically to make up for the falling private sector. It sold billions of dollars in Treasury bonds and flipped the switch on the printing press.
The U.S. government was printing money like mad… Anything to staunch the flow of the bleeding economy.
But this created an “oversupply” of U.S. dollars, and to top it off, the increase in the debt burden through issuing the Treasury bonds leaves less money to support the economy.
We have a massive mound of debt… about $8.5 trillion, or 58% of our entire economy. But some estimates put the numbers much higher. If you take away the Social Security trust fund surplus, you’ve got a figure of about $13 trillion, or 90% of the economy.
This makes a strong case for inflation down the road.
One of the ways to prepare your portfolio for inflation is to buy gold. We talked about gold on Monday, wondering if prices were too hot for investors. Turns out they aren’t, and futures for December topped $1,360 yesterday.
I said I like gold at nearly any price when you’re hedging your portfolio against inflation, and with the Fed talking about buying more government debt, I still like it.
(Want to get my articles on gold and other investing topic? Sign up for Smart Investing Daily and I’ll simplify the market with my easy-to-understand investment advice.)
But the heavy inflation that comes from such a large burden of debt might not get here for a while. Perhaps years… We will, however, see the dollar fall in the meantime.
On Monday, I showed you a chart of the U.S. Dollar Index, which compares the value of the dollar to a basket of other major currencies. Since mid-June the dollar has fallen from a reading of 89 to below 79 — a drop of more than 11%.
Now, in the currency market, when one currency goes down, another goes up. Everything is relative. When the U.S. dollar falls, a number of other currencies go up…
Take a look at the Australian dollar:
I’ve liked the Australian dollar for a long time. We even included it in the Ultra-Resource Basket CD that we constructed with EverBank a couple years ago.
Australia was the first to raise rates after the global financial crisis, and it’s incredibly resource-rich with gold, coal, uranium, natural gas and iron. Its proximity to China is also a benefit, as Australia has surely cashed in on China’s growth and near-insatiable need for commodities.
The Australian dollar could be a good way to play growing deficits now, before the true effects of full-blown inflation hit the greenback.
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This chart is a one-year view of the CurrencyShares Australian Dollar Trust (FXA:NYSE). This trust tracks the movements of the Australian dollar by holding this currency in a deposit account and distributing interest to shareholders after all fees have been paid.
You could use this ETF and other currency ETFs to ride the fluctuations in the dollar.
Or you could go to the source, and there are a couple of ways to do that. You can buy Australian dollars, or futures on Australian dollars. It’s the sixth most-traded currency, and the Australian and U.S. dollar pair is the fourth most-traded currency pair.
You could also invest in EverBank’s Ultra-Resource Basket CD, which holds the Aussie dollar, along with a handful of other currencies.
Or you could open an EverBank account for just the Australian dollar, and reap the direct rewards from a rising currency.
All of these ideas, from ETFs to Forex, accounts come with risk, so talk to your broker about which method is best for you and your portfolio.
While holding gold in the long term is the purest way to protect your portfolio from inflation, playing currencies is an effective way to manage fluctuations in the dollar during economic turmoil.
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About the Author
Sara is Co-Editor of Smart Investing Daily. As Senior Research Director and global correspondent, Sara Nunnally’s diverse resume includes studies in art history, computer science and financial research. She has appeared on news media such as Forbes on Fox, Fox News Live, and CNBC’s Squawk Box, as well as numerous radio shows around the country.
As Senior Research Director, global correspondent and co-editor of Smart Investing Daily, Sara has traveled all over the world in search of the best investment opportunities to recommend to her readers, be they in developed economies like France and Italy, in emerging markets like the Czech Republic and Poland, or in frontier terrain like Vietnam and Morocco. Her unique “holistic” approach of boots-on-the-ground research has given her an edge in today’s financial marketplace as she searches for the next investment opportunities in hot sectors like alternative energy, currency markets and commodities.