Federal Reserve Chairman Ben Bernanke recently warned Congress:
Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance...Unless we demonstrate a strong commitment to fiscal sustainability, we will have neither financial stability nor healthy economic growth.
The Obama administration projects total U.S. debt to increase by $1.8 trillion in 2009, with more to come in 2010. Funding of large deficits, approximating 12% of GDP for several years, poses a challenge for the dollar and for economic growth.
It should be obvious to all that we can't get out from under our mountain of debt through spending. We will simply have to go back to the old fashioned solution of hard work and productivity, cutting expenses and growing our economy until it regains its balance.
This is simple, but not easy. Yet it is not impossible, either. It takes sacrifice and commitment, but it can be done. And it has been done before. After World War II, total debt-to-GDP ratio in the U.S. was 125%, and by 1980 it shrank to 25%. America has a history of facing her problems and dealing with them (compare this to Japan, which over the past decade has consistently been at a ratio of over 150%).
Furthermore, because of the aggressive fiscal policy and expansionary monetary policy the country has engaged in recently, it appears inevitable that we will experience inflation, and perhaps a significant bout of it. With low interest rates and unprecedented levels of spending, this would be the only logical conclusion. And history shows stocks are almost alone an effective hedge against inflation. Cash and fixed income securities will be pulverized under the pressures of inflation, lose significant real buying power and not provide an appropriate protection.
Assuming we are going to face reality and respond wisely, it makes sense to stick to a disciplined investment program in equities. Consider this: Stock indices plummeted more than 50% from their peak in October 2007 to their March 2009 bottom, erasing 12 years of gains. The only time the stock market had fallen harder was between August 1929 and June 1932, when it lost some 83% of its value. It took the Dow Jones Industrial Average 25 years to climb back to its 1929 peak during the Great Depression.
Nevertheless, those who invested $10,000 in the index every year throughout that time turned a total investment of $260,000 into $1.7 million, an annualized compound return of 12.5%, which was much better than any available alternative.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at firstname.lastname@example.org.
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