Dads Against Deflation: Four Ways To Win

The deflation threat that so many prognosticators are talking about is unlikely to develop. Yet persistently falling prices for consumer goods is such a nasty condition that extra caution with your personal finances is in order -- just in case. And playing it safe won't hurt a bit; the best strategies for deflation are good Bank of Dad practices almost anytime. They'll help you preserve your wealth for retirement, and set a good example for your kids, too.

On the deflation bandwagon is an impressive lineup of Wall Street elites -- plus the perpetually gloomy columnist Paul Krugman at the New York Times. Krugman writes that deflation is on the way; he knows because he's "seen this movie before, in Japan." Among the moneymen in this camp are Bill Gross, Jeremy Grantham, David Tepper, and Alan Fournier. They have begun to hedge their massive portfolios against falling prices.

Again, I say, these heavyweights probably have it wrong. Barely three months ago Wall Street was dead certain that the economy's biggest looming problem was an upward spike in prices; that's right, inflation -- not deflation -- and its attendant horrors which most notably include rising interest rates that would squash the recovery. All interest rates have done since then are fall through the floor; mortgage rates, for example, are down nearly a half point to lows not seen in many decades.

Now we're to believe that, whoops, it's been falling prices all along that we should have been worried about. As chairman of your own Bank of Dad you may feel like you're supposed to know which of these threats you should be defending against. But it seems to me these economic elites don't have a clue either; they're wrong at least as often as the weatherman.

I like to say that there are three phases to becoming a competent pundit. In the first phase, you understand nothing about why stocks and the economy go up and down -- and you assume the experts do. In the second phase, you think you have figured it out -- even though you haven't. In the third and final phase, you realize that you haven't figured it out -- but that's OK because no one else has either. That's when you've earned your chops.

No one can predict the future. Besides, the fact that such Wall Street royalty -- Gross is often called the Peter Lynch of bonds -- is worried about deflation practically guarantees that policymakers will take it seriously and act to combat it.

Still, that doesn't mean you should carry on blissfully ignorant. Bad things really do happen, like, well, imploding subprime mortgages, toppled banks, and a vicious recession. So here are four changes you can make to protect your and your kids' futures, just in case the bigwigs are right this time:

Refinance your mortgage. Rates are at historic lows, and after two miserable years without a refi opportunity for jumbo borrowers that market has at long last opened up again, too. Don't wait for even lower rates. They may or may not come. Meanwhile, if deflation occurs and your home value declines it will be that much more difficult to qualify for a new loan.

Pay off debt. This is almost always a good idea -- and as example for the kids it's top of the list. But it's critical in a deflationary environment where you can expect less income. Deflation leaves you to pay old debts with fewer dollars, which makes the debt harder to repay and makes that thing you bought last month look awfully expensive today.

Buy government bonds. As interest rates fall -- and you can count on it in a deflationary period -- the values of bonds that do not default rise. This would be a tricky period for many companies. Corporate bonds, which pay more interest, are much riskier than Treasuries. Stick to the best government bond funds.

Secure income through dividends. Deflationary periods are tough on corporate profits. Stocks likely would fall or be dead money. But companies with stable cash flows like blue-chip utilities and food and beverage companies should hold up best and be able to keep paying their dividends. The bonds of these kinds of companies are also a good place to seek safety if you're bent on chasing higher yields from fixed income.

Photo by Tobo from Flickr

Dan Kadlec

Daniel J. Kadlec is an author and journalist whose work appears regularly in Time and Money magazines. He is the former editor of Time’s Generations section, which was written and edited for boomers. Kadlec came to Time from USA Today, where he was the creator and author of the daily column Street Talk, which anchored the newspaper's business coverage. He has co-written three books, including, most recently, With Purpose: Going from Success to Significance in Work and Life. He has won a New York Press Club award and a National Headliner Award for columns on the economy and investing.

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