The Deficit Hits Home And What You Can Do About It

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OCEAN CITY — First, some perspective: The gross domestic product of the U.S. remains the world’s largest, by a wide margin. Its government bonds are sought by investors around the globe and are considered virtually risk-free. And the nation’s consumers continue to have a formidable, if somewhat tempered, appetite for the goods and services the world provides.

These fundamental strengths make the U.S. a very different case from, say, Greece, Ireland and Spain — three developed countries whose financial woes have been in the headlines recently. Still, there is one thing that all of these nations share: unusually high budget deficits. The U.S. budget deficit is currently running at around 10% of GDP —higher than it has been since World War II. To put that in perspective, most economists consider a deficit exceeding 5% to be in dangerous territory.

Greece and Ireland, for instance, have had to accept European Union bailouts, which come with strict austerity measures that may well dampen economic growth in those nations for years. The U.S. is highly unlikely to find itself facing that level of insolvency, in the view of BofA Merrill Lynch Global Research. But the massive debt burdens of the federal government and most states are bound to have a significant impact on financial markets for a long time to come—and will be a major influence on our personal finances.

The perils of the deficit, of course, have become a hot topic, and both Republicans and Democrats have recently unveiled plans to reduce the red ink significantly during the next decade or so. Meanwhile, last spring’s budget compromise cut spending by $38 billion. But to get the deficit back to a more reasonable level of around 2% of GDP will almost inevitably mean making difficult, unpopular choices, such as paring back outlays for Medicare, Medicaid and Social Security — giant programs that together now account for about 40% of the federal budget — and probably raising taxes on at least the highest earners, as President Obama has proposed.

Although Congress and the president may eventually reach an agreement on how to rein in deficit spending, not everyone has faith that they will. In April, Standard & Poor’s revised its outlook on the AAA credit rating for U.S. government bonds from stable to negative, noting that it saw a one-in-three chance of downgrading that rating, the organization’s highest, in the next two years. The problem, noted S&P, was that “more than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on a strategy to reverse recent fiscal deterioration or address longer-term fiscal pressures.”

The lack of clarity about how, when or even whether Washington will shore up the U.S. balance sheet makes it difficult for investors to plan their next moves, says Christopher Wolfe, chief investment officer of the Private Banking and Investment Group at Merrill Lynch Wealth Management. A prolonged stalemate could trigger the extreme consequences that everyone wants to avoid. Still, Wolfe says, there are strategies that make sense whether or not the deficit is reined in. Understanding what the present deficit level means — as well as what it doesn’t mean — and knowing what to watch for in the months ahead could help you and your financial advisor make any necessary adjustments to your portfolio and your personal finances as events unfold.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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