Most of the people I know are convinced that the current high fuel and food prices are temporary. “Surely the bubble will burst soon,” they say. “It won’t be long before we can resume living the way we were before,” they proclaim. “A new president will fix things,” they believe. They continue spending and living as they have before, making no changes, certain that things will get back to the way they were.

We all hate to change and it’s understandable, particularly if you are happy with your life the way it is or was. It can be scary and annoying to think about having to cut back or adjust spending to compensate for things that we don’t have any control over. But here’s an interesting question that we should all think about: What if the pain of higher energy and food prices isn’t temporary? What if it gets worse, not better?

Obviously I have no idea what will happen in the future. My crystal ball broke a long time ago. Things could get better. I hope they do. Most things run in cycles and this could be one of them. But if we really have hit “peak oil” and the days of cheap energy are over, then things will probably get a lot worse before they get better. It’s a possibility worth considering, at least.

So what should you do to prepare for the possibility that you will have to pay high energy and food prices for the foreseeable future? That housing values will continue to decline? That unemployment will continue to increase and might impact your job? You could panic and slash your spending to the bone, eliminating everything that’s not strictly necessary and selling everything that’s not nailed down. You may have to do that it you’re already close to the edge. But for most of us, a little preplanning and thinking about the worst case scenario will be enough to get us through.

The most beneficial exercise that I’ve found for dealing with rising prices is to answer the question, “What if we had to live on half of our current earnings?” This question encompasses the possibility of job loss, as well as inflation well beyond what we’re currently experiencing. I find it comforting to know that, if the worst were to come to pass, we could make it on half (or less) of what we currently earn. Obviously I don’t do this exercise every day, but when prices start to jump or it looks like a job might be threatened, I pull out the budget and answer this question.

The exercise is very simple, particularly if you already have a budget and you have a good idea of where you’re money is going. First, I list every spending category that we use in one column. Then I create two more columns, one headed with our current monthly take home pay and one with half that amount. Next to each spending category I list the amount we currently spend on that category under the current earnings column and tally it at the bottom. Reality check number one: The total at the bottom of the current monthly income column has to be below the number that heads that column, otherwise you’re already living above your means.

Then I look at each category and the amount I’m currently spending on that category and I imagine having to slash it in half or more. Some things are easy to eliminate such as travel, DVD rentals, movie nights, meals out, cable, at least one cell phone, video games, books, and DVD’s, new clothes, downloads from iTunes etc. These are the obvious luxury items that we all spend on when times are good and are easy to eliminate when things get bad. Most of them are entertainment oriented and can be replaced with free alternatives. Simply by eliminating these things I am able to reduce my expenditures by fifty percent. But what if I have to go lower?

Then I look at the things that are harder to reduce such as utilities, mortgage, groceries, fuel, etc. I live pretty low to the ground in the essential categories. I’m very conservative with my utility use even when times are good and I actively coupon and shop the sales to reduce my grocery bills. But when I really think about it, there are always more things I can do to reduce those bills even more, if I have to. I can give up the few luxury foods I still buy, and I can reduce my utility use even more by air drying clothes, washing less often, raising the thermostat even higher, etc. I can slash my spending on toiletries by giving up some of the name brands I like and using less expensive brands. I can raise my deductibles on my insurance and reduce those payments. I can reduce my monthly savings and contributions to retirement plans to free up even more income. If worst came to worst, I could sell one car and make do with one.

Because we carry no debt, I don’t have to worry about paying a lot of extra bills. This is the single most important thing that makes it possible for us to live on half or less of what we currently earn. I recommend that, as part of this exercise, if you carry a lot of debt you seriously ask yourself how you will continue to make those payments if your income continues to be squeezed by higher prices. If the answer is, “I have no idea,” take steps now to reduce your debt burden such as selling things, paying the debt down aggressively, and not adding any more debt.

By the time I’m done with the exercise, I’ve proven that I can live on thirty percent of what we currently bring home. I would have to give up a lot of luxuries, conveniences, and things that I consider fun, but I would still have my house, my family and my pets. In other words, I would still have the most important things.

Obviously your numbers will vary depending on your current spending habits and debt load, as well as the size of your family. But it is worthwhile to sit down and ask yourself how you will survive if your income remains stagnant or even goes down while prices continue to rise. This exercise is also worthwhile even if you’re not worried about rising prices but you just want to check up on yourself. You don’t have to panic over rising fuel and food prices, but rather than betting that things will fix themselves, it is prudent to think about what you will do if things don’t improve.

Image courtesy of sheeshoo