U.S. ECONOMY Experts: Plan for possibility of falling wages

With deflation, both stocks and corporate bonds would suffer.
DALLAS MORNING NEWS
Alan Greenspan is worried about deflation. Should you be?
The Federal Reserve Bank, which Greenspan leads, said in early May it was concerned about falling prices, or deflation. While deflation might sound like a good thing, too much of it can push the economy into a vicious cycle of falling prices, lower company profits and lower wages.
A period of deflation is by no means a certainty.
Many economists do not foresee it happening and say the Fed is just being extra cautious. But either way, personal finance experts say, it can't hurt to be prepared.
"If Alan Greenspan is worried about deflation, then I'm worried about deflation," said Stephen Brobeck, executive director of the Consumer Federation of America.
Key points to consider
If it came to pass, how might a prolonged period of deflation affect your personal finances? Here are three key considerations:
Your income and personal wealth would shrink.
That would make it more difficult to pay off your debts.
Meanwhile, many traditional tenets of investing would disappear.
Deflation has been at work in the economy for more than a year in the form of falling prices for consumer goods. But prices for services such as health care and education, measured as a component of overall inflation, continue to rise.
But even service inflation has tapered off in the last few months -- and experts say that is part of what has the Fed concerned.
Full-blown deflation would mean more layoffs, which would lead to a downturn in salaries. Less in the door also means less out -- or a drop-off in consumer spending. That could create a cycle in which companies have to continue cutting jobs, leaving consumers with a dwindling amount of money to purchase the companies' goods and services.
Advice for homeowners
With that in mind, financial planners suggest homeowners think twice before extracting equity from their homes. Refinancing at a lower rate is a smart move, but many Americans have been taking advantage of rising home prices and cashing in some of their home equity in the process of refinancing.
Deflation and debt do not mix. If your income falls, your debt payments will stay fixed. That combination can be toxic for households carrying high levels of debt.
But there is a silver lining to deflation, if you plan for it. Deflation walks hand-in-hand with low interest rates.
"Be very sensitive to any fall in interest rates. Take advantage of that to refinance and pay off your higher interest-rate debt," Zandi added.
Deflation, which squeezes companies' profit margins, would be bad news for stocks because earnings would suffer. It would also be bad news for corporate bonds, as companies struggle to make debt payments while revenues fall.
So that knocks two main items off a traditional portfolio menu.
But government bonds would thrive in deflationary times. If the Fed lowers interest rates, government bonds could extend the rally they have enjoyed during the stock market downturn. Indeed, the Japanese equivalent to our U.S. long bond has been the best performing investment throughout Japan's battle against deflation.
"If we do go into deflation, it's bad for stocks and bad for corporate bonds on the credit side," Fuss said. In the fixed-income fund he manages, he is keeping 40 percent in the longest-term government bonds, "just to protect the income stream in the event that everything collapses."