Should the federal deficit change how you invest?
Deficit headlines come around every few months. Short answer: no, they shouldn't change your portfolio, and here's how to tell that for yourself.
The deficit lands back in the headlines every few months, and a fair question comes with it: should any of this change how your money is invested?
It deserves a real answer rather than a reassuring one, and questions that size are a good part of what we're here for. The headlines themselves are built the same way every time: a huge number, a bad direction, and the suggestion that your money should be doing something about it. One client asked it more memorably than most: should we jump on the lifeboats?
Worth separating two things that get mixed together in all of this. The federal deficit is the government spending more than it collects in taxes. The trade deficit is the country buying more from abroad than it sells. Different numbers, different causes, and the news often treats them as one problem. Both come up below.
The short answer. No, a deficit headline shouldn't change your portfolio, and the reason is simpler than you'd expect: these stories tend to count one thing and skip a second thing that points the other way.
| What you keep hearing | What gets left out |
|---|---|
| The federal deficit is huge, so rates go up | People save more when they expect a tax bill later, so there's more money to lend too |
| A trade deficit means money is leaving the country | Those dollars come straight back and buy things here. Same figure, other end |
| A weaker dollar would help us | It makes everything we own here worth less to the people thinking about buying it |
| Rates are climbing, so something is wrong | Rates climb for three different reasons and one of them is a good economy |
Most of what follows comes out of conversations with Victor Canto, the economist who works with the firm.
The federal deficit story leaves out the buyers.
When the government spends more than it collects, it covers the gap by selling bonds. A bond is just an IOU: you hand over your money for a set number of years, the government pays you interest along the way, then gives the money back. That interest is the rate everyone's arguing about.
So the story goes: bigger deficit, more bonds to sell, and to get them all sold the government has to make them tempting by paying more interest. Bigger deficit, higher rates.
That first bit is true. What gets skipped is who's buying. When people watch the government borrow this heavily, plenty of them figure a tax bill is coming eventually, for them or for their kids, and they set more money aside. So the stack of bonds gets taller, and so does the pile of money looking for somewhere safe to sit.
Which is why, when you actually line the two up, the pattern runs backwards from the story.
Across these 35 years, the five biggest deficits came with short-term rates averaging 0.15%. The five biggest surpluses came with the same rate averaging 4.87%. That is backwards from the story.
Look at 2020. The deficit hit 14.5% of the whole economy, the biggest since the Second World War, and a three month Treasury bill paid 0.36%. Rates didn't climb. They sat on the floor. Same in 2009, 2010 and 2011.
Now look at the other end. Around 2000 the government was running an actual surplus, taking in more than it spent, and that same short-term rate was paying close to 6%. The years with the least borrowing had the highest rates.
There's no mystery to it. Big deficits mostly turn up in recessions, meaning stretches where the economy shrank instead of grew. Tax revenue dries up, spending on unemployment jumps, and the Federal Reserve, which sets the country's baseline interest rate, is busy cutting it. The deficit and the rate are both reacting to the same bad year.
That doesn't prove borrowing pushes rates down either. It means the deficit by itself won't tell you where rates are going.
None of which makes the deficit fine. It's a real problem over the long haul. It just isn't what sets interest rates, and it's a poor reason to touch your portfolio.
A trade deficit isn't money leaving.
When we buy more from abroad than we sell, those dollars don't disappear overseas. They come back and buy things here: government bonds, company shares, buildings, whole businesses. It's the same number read from the other end, and the government publishes both ends in one report.
Worth knowing if you own stocks: as the trade deficit got wider, America's slice of the world economy and of the world's stock market both got bigger. If a trade deficit really were the country being drained, that isn't what you'd see.
Which is also why a cheaper dollar isn't the win it's sold as. Victor puts it as a question: would you rather have money at your border trying to get in, or trying to get out?
Rates going up doesn't mean something's wrong.
This is the most useful habit here, because it changes how a rate headline reads.
The economy is busy. More people want to borrow, so borrowing costs more. Rates going up for this reason is good news wearing a scary outfit.
People are nervous. Lenders want paying more to take the same risk. This is the one that's genuinely unwelcome.
Rates were being held down and are drifting back. After years of being pinned near zero, going back to normal means going up. Not a warning about anything.
All three look identical in a headline. And for what it's worth, the 1980s and 1990s had fast growth and high rates at the same time, which is hard to square with rising rates being bad news by themselves.
What should actually make you change something.
Short list, and none of it is on the front page.
Something changed in your life. A new job or the loss of one, a health issue, a business sale, a marriage, an inheritance, a kid who needs help. These are the real reasons to revisit a plan, and not one of them shows up in the news.
The rules changed. Tax rates, contribution limits, how inherited accounts get treated. Rules reach your plan in a way that mood never does. See tax planning.
One holding got too big. A good run can quietly leave you far more exposed to one company than you meant to be. See investment strategy.
A drop you're set up to use. Lower values make a Roth conversion cheaper, and losses you actually take can cut your tax bill for years.
A deficit projection is on none of those lists. Neither is a rate crossing a round number. For more on telling the two apart, see which market news matters.
What we do instead of guessing.
We don't build plans that need us to know what happens next, because we don't know, and neither does the person on television with a target.
What we do is work it out ahead of time: what if things go well, what if they go badly, what if they just plod along. Then we make sure your plan holds up in all three. When something does happen, it usually looks like a conversation we've already had, so we can respond instead of scrambling.
Meanwhile your withdrawal order, your tax planning, and how much cash you keep on hand will matter far more to how you finish than any opinion about the deficit. And those are yours to decide.
So no, nobody needs the lifeboats. But a question that keeps coming up deserves a straight answer rather than a pat on the head, and that's the part we'd rather be known for.
If you'd like to talk through what any of this means for your own plan, we're glad to have that conversation.
Nothing here is a forecast, a projection, or a recommendation for your circumstances. Economic relationships described are historical patterns and do not establish cause or predict future results. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results. Cosmos Wealth doesn't provide tax or legal advice.
Common questions.
- Do budget deficits cause higher interest rates?
- Not reliably. Look at the years the deficit blew out the most, like 2008 and 2020, and rates went down rather than up. Those were recession years, when tax revenue falls, spending rises, and the Federal Reserve is cutting. The deficit on its own tells you very little about where rates are heading.
- What are the twin deficits?
- The budget deficit, meaning the government spending more than it collects, and the trade deficit, meaning the country buying more from abroad than it sells. The press paired them up in the 1980s and the two get talked about as one problem. They're different numbers that respond to different things, and both are usually described in a way that leaves out half the picture.
- Is a trade deficit bad for the economy?
- It doesn't mean money is leaving. When we buy more from abroad than we sell, those dollars come back and buy things here: bonds, shares, buildings, companies. It's the same figure read from the other end. Whether it's good news depends on what that money does once it arrives.
- Are rising interest rates bad news?
- It depends why they're rising. A busy economy where more people want to borrow pushes rates up, and that's a good sign. Nervousness pushes them up too, and that one isn't welcome. Rates drifting back up after years of being held down is neither. The 1980s and 1990s had both fast growth and high rates.
- What news should actually change my plan?
- Something changing in your life, far more often than something changing in the news. A new job, a health issue, a business sale, an inheritance. On the outside, a change in the tax rules matters. A deficit projection doesn't.
- So what do you do instead of guessing?
- We talk through what happens if things go well, badly, or somewhere in between, before any of it happens. Then when something does happen, it usually looks like a conversation we've already had, and we can respond instead of scrambling.
