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 are built the same way every time: a huge number, a bad direction, and the suggestion that your money should be doing something. 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 | The money available to lend tends to grow as well. Which side grows more is the open question |
| 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.
The story goes: bigger deficit, more bonds to sell. That part is simply true.
Then comes the step nobody says out loud. If the buyers stay the same, the government has to make those extra bonds tempting to get them sold, and you tempt someone into a bond by paying more interest. Bigger deficit, higher rates.
The whole conclusion rests on that "if." Leave it in and the obvious question appears: what if the buyers don't stay the same?
They often don't. When people watch the government borrow this heavily, plenty of them figure a tax bill is coming eventually, for them or their kids, and they set money aside for it. That money has to sit somewhere, and a good deal of it sits in exactly those bonds.
So there are more bonds for sale and more money chasing them. When both sides move at once, nothing tells you which way the rate goes. It might rise. It might not.
How much the buying side grows is disputed, and nobody serious claims the two match exactly. The narrow claim survives all of it: the deficit alone can't tell you the direction.
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 through 2011.
Now the other end. Around 2000 the government ran an actual surplus, and that same rate paid 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, when 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.
None of which proves borrowing pushes rates down, and none of it 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.
Try it at household scale. You sell a pair of shoes on eBay. They get shoes, you get money. One transaction, two entries: goods out, money in. Nobody thinks you were drained.
A country works the same way, as long as currencies are free to move against each other, which they are now. So when we buy more from abroad than we sell, those dollars don't vanish overseas. They come back and buy things here: government bonds, company shares, buildings, whole businesses. That isn't a theory, it's the bookkeeping, which is why the government publishes both sides in a single report.
The half usually missing is why the other side agrees. Explain why America wants the goods but not why Mexico wants the dollars and you haven't finished the argument. Milton Friedman called it the double coincidence: they have to have what you need, and want what you have.
And what they want is return. Money goes where it expects to earn the most. If American goods cost more than Mexican goods, that's usually a sign the return on capital is higher here, which is exactly why a Mexican seller would rather hold a US asset than pesos. Same reason you took the money for the shoes: you had something better to do with it.
So the trade deficit and the money coming in aren't two events. They're one fact described from either end, and the inflow would stop the day America stopped looking like the better bet. Nobody is being taken on either side, because trade only keeps happening while both parties think they're better off.
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, and neither does the person on television with a target.
We work it out ahead of time instead: what if things go well, what if they go badly, what if they just plod along, then we check your plan holds up in all three. When something does happen it usually looks like a conversation we've already had, so we respond instead of scrambling.
Meanwhile your withdrawal order, your tax planning, and how much cash you keep on hand 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.
