Fear the Deficit?

Stocks are the ideal investment vehicle to ride out higher inflation and interest rates.

You can scarcely listen to the news without being bombarded with dire predictions about the economic consequences of the current U.S. budget deficit. At a projected $1.6 trillion this year, it’s by far the largest, relative to the size of the economy, since World War II. And it has prompted some people to recommend that investors shun U.S. financial assets and plunge into gold, silver or assets from countries such as Germany, which has relatively small deficits and low inflation. Should investors follow this advice?

To answer that, we should consider the economic repercussions of an outsize deficit. Holding all other economic variables constant, a big budget deficit should result in higher interest rates because government debt competes with other debt, such as corporate bonds and mortgage securities. It could also mean higher inflation, if the Federal Reserve helps the government fund its debt by buying government bonds. That creates bank reserves that fuel spending.

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Jeremy J. Siegel
Contributing Columnist, Kiplinger's Personal Finance
Siegel is a professor at the University of Pennsylvania's Wharton School and the author of "Stocks For The Long Run" and "The Future For Investors."