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Yoshikami: The 'Fiscal Cliff', Inflation and Your Investments

CNBC

With news of deficit reduction strategies and revenue increases surrounding "fiscal cliff" talks, the real issue has been masked from view; the solution to the deficit is far more complicated than meets the eye.

Current talks are a great first step towards a sober perspective on spending and taxation. But will the American public and politicians have the appetite to adopt the austerity necessary to reach a balanced-budget?

Are citizens ready to make the hard choices needed? Or more particularly, are politicians from both sides of the debate ready to make difficult decisions?

(Read More: Wall Street Titans End Fight Against Higher Taxes)

Given what appears to be apathy and outright rejection of fiscal sobriety, it leads one to conclude that the following possibility must be considered: Inflation might be allowed to surge higher to reduce the deficit.

Inflation as a method of paying off deficits is a misunderstood concept. Essentially, it allows for the increase in inflation thereby increasing tax revenues and seemingly stimulating economic growth. But this growth comes at a huge cost; the reduced standard of living for Americans as inflation eats away at purchasing power.

It's happened before and could likely happen again unless a radical perspective change grips the American public and politicians. That appears unlikely given the wrestling over just the beginning steps in deficit reduction efforts. And the consequences for investors are significant if inflating away the debt becomes the preferred choice in resolving the fiscal woes in United States.

Bond assets will be devalued as interest rates rise resulting in an unwinding of the bond bubble. Shocked investors will find that bonds are not quite as safe as they might have thought as interest-rate increases reduce bond prices.

Businesses that rely on commodity input costs would be under pressure as raw materials costs rise. Companies such as McDonald's would face increasing margin pressure as food input costs rise. Companies like Federal Express and UPS could see the cost of energy rise such that alternative forms of information delivery become preferred. Technology companies that help create efficiencies will be in demand.

There are many other investment consequences if inflation is allowed to rise. The impact would be far-reaching and significantly impact returns of asset classes for years to come.

Some wonder if the inflation fear is just a long-term concern. Perhaps, but as it is evident that QE3 shows no signs of abating, free and easy money in the system could very well spur phantom growth in the next several years. And with growth comes inflation. And if this scenario plays out, higher inflation as a method to reduce deficits could come into play in the next few years.

(Read More: All Eyes Are on the Fed, but 'Fiscal Cliff' Looms Larger)

If this shorter term scenario plays out, the time is fast approaching when investors will need to adjust portfolio strategies in advance of higher costs and reduced purchasing power. Inflation isn't likely in the next 12 to 18 months as there is still massive excess capacity around the world as economies attempt to bounce back from the great recession of 2008. But just because you cannot imagine inflation in the next 12 to 18 months, doesn't mean it's not lurking around the corner.

Keep higher inflation in mind as you make your long-term investment decisions. Recognize that adjustments are necessary as conditions change. And recognize that just as easily as we have seen record low interest rates, we could see a rebound in inflation with huge investment consequences.

(Read More: 'Let's Just Do It,' Dimon Says of Avoiding 'Cliff')

TV Programming Note: Mr. Yoshikami will be a guest on CNBC's "Power Lunch" all this week.

Michael Yoshikami, Ph.D., CFP, is CEO, Founder and Chairman of the DWM Investment Committee at Destination Wealth Management. Michael is a CNBC Contributor and appears regularly on the network. DWM is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutions and individuals around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009, 2010 and 2011.

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