Investing: Inflation lurking? Adjust portfolio, just in case
— -- You probably know someone who can find the darker side of anything. You struck oil in the backyard? The Environmental Protection Agency will be all over you. You just won the lottery for $45 million? Don't you know the government will take a third of it in taxes?
Today, we're going to be that nattering nabob of negativism. You know those lower interest rates the Federal Reserve gave us on Tuesday? They could eventually trigger inflation — and we could pay for those low rates in the form of higher prices for a long time.
Fortunately, you can adjust your portfolio to protect your savings by investing in gold, inflation-adjusted bonds or investments denominated in foreign currencies.
Of course, lower rates do bring benefits. The Fed knocked half a percentage point off its key fed funds rate, pushing the rate down to 4.75%. The Fed's actions will have three immediate effects:
•Lower savings rates. Interest rates on money market funds, bank CDs and other short-term savings vehicles will fall by about half a percentage point.
•Lower borrowing rates. Rates on home-equity loans and credit cards will fall about half a percentage point, which means lower monthly payments.
•Higher liquidity in the financial markets. On Wall Street, liquidity isn't the amount you drink after sealing a million-dollar deal. It refers to cash — or assets that can be converted to cash quickly. When there is plenty of liquidity on Wall Street, interest rates are low, and borrowing is easy. When liquidity dries up, rates rise, loans are hard to get and the financial system can grind to a halt.
The Fed lowered rates by making more money available to lend, thereby boosting liquidity in the financial system and easing Wall Street's worries about the credit crunch.
The Fed has earned lots of kudos for its bold action this week. But unfortunately, the Fed's rate cuts also raised the fear that inflation will rear its ugly head. Inflation (a period of rising prices) has its own perverse appeal for some. In an inflationary period, companies are able to raise prices, workers get bigger raises and fixed-rate mortgage payments remain the same.
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