So in my last blog I outlined the real danger of government spending without a balanced budget.  If the government continues to borrow and spend, borrow and spend, borrow and spend, pretty soon Uncle Sam won’t be able to borrow any more.  If that happens – if foreign governments don’t lend the U.S. money, if investors don’t buy U.S. Government Bonds – how will the government pay for its expenditures?  This is a difficult question, and one we hope we never have to answer, but rather than cross our fingers and put our heads in the sand, we need to face this potential reality head on.  We know that the government’s going to have to do something, so here’s what you can do to be prepared:

The first thing the government can do is balance the budget by making sure the amount going out is the same as what’s coming in.  It could do this by reducing what goes out, or by increasing what comes in.  It could reduce what goes out by reducing the national debt, thus reducing the amount paid in interest.  It could also reduce funding for programs like Medicare, unemployment benefits, and financial aid for education.  Here are some things to do in case this happens:

Increase contributions to your retirement accounts – Medicare is a primary source of medical insurance for most Americans age 65 and over.  Since medical expenses are expected to increase when you are retired, if less is available from this federal source of health insurance, you will need more personal savings to compensate.

Increase the size of your emergency fund – Losing your job unexpectedly is hard enough, but realizing there may be little assistance from the federal government could make it harder.

Increase savings for college – I think we all appreciate the benefits of a college education, so don’t let a lack of federal financial aid be a barrier to your child’s future.

Another step toward balancing the budget could be increasing revenue, which could mean raising taxes.  If the government does have to raise taxes, here’s what you can do to reduce the potential impact:

Contribute to a Roth IRA – Funds contributed to a Roth IRA are contributed on an after-tax basis, so go ahead and get the taxes out of the way now so that you won’t have to worry about higher taxes in the future.

Fund a cash-value life insurance policy – Life insurance agents have been saying this for years, but the truth is cash value is accessible tax free through policy loans.

Pay off your mortgage – When you sell a primary residence that you’ve lived in for two of the previous five years you can exclude up to $250,000 ($500,000 if married filing joint) in capital gains.

Invest in capital assets – Currently, capital gains are taxed favorably when assets are held longer than a year.  Because of the popularity of capital gains tax treatment, this tax rate will likely remain lower than your income tax rate.

The U.S. government also has the power to do something no one else on earth has the power to do: print U.S. dollars.  (Some have attempted to assist the government in this enterprise, but without success.)  If Uncle Sam can’t borrow money, and if he can’t raise it by levying more taxes, he’ll simply print more.  When the U.S. prints more money, the dollar loses value and things get more expensive.  What’s that called again?

Inflation (in•fla•tion/inˈflāSHən/) noun:  A general increase in prices and fall in the purchasing value of money.

Inflation in the U.S. has a historical average of 3%, but there have been periods of time when it has been much higher than that.  To reduce the impact of a potentially high rate of inflation, consider the following:

Invest Internationally – Whether it is bonds, stocks, or real estate, investing in assets that are valued in foreign currency is favorable when the U.S. dollar weakens.

Invest in Commodities – In an inflationary environment, assets such as gold and oil may cost more in the future, so why not buy them now and take advantage of their increase in price.  There are several ways to invest in commodities, but the simplest may be using traditional mutual funds and/or exchange traded funds (ETFs).

Invest in Treasury Inflation Protected Securities (TIPS) – It may sound ironic, but if the government is going to print more money to pay for its obligations, you might as well be one of them.  Since TIPS are designed to generate a yield which adjusts for inflation, Uncle Sam will pay you more to make up for the fact that what it is paying you is worth less.  Now isn’t that generous?

Now as I’ve said already, I hope that none of this comes to pass, but as my boss always says, “It’s better to hope for the best and plan for the worst.”  Do yourself and your loved ones a favor and be as prepared as possible.