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No Laws in Economics and Investing

Like many others I’m far from being an economist, but the current economic environment is showing that no rules apply all the time. It seems like the world is waiting to see what happens next and holding back until we know more. Looking at this a bit more closely is a good reminder for us as investors. And it might even help us see a bit more into the unknown of the economic factors that affect our investments.

With poor economic reports for Canada and the US and big decisions in the US and EU in the last month there’s a lot going on. Even facing a potential decline, governments can’t spend much more and have to make plans to cut back in a hurry. Many people are worried because they think more spending is needed to keep things going but there’s no more capacity for it. Generally I agree that when everyone is too scared to move the government can step in to smooth things over, but everything depends on how others are acting.

Obviously deficits are a big concern after the last few years. At some point the fear of sinking the government finances could outweigh the additional confidence created by the spending. And a decrease in spending might then increase confidence.

Of course this leads to taxes since the government revenue comes from us. But does that mean tax increases need to be avoided at all costs to protect the economy? If people come to realize that taxes are too low now and they need to rise at some point, an immediate increase that actually resolves the problems might restore confidence since it would take away future uncertainty.

Another hot topic is interest rates. After several years of being low around the world (and nearly a decade at low levels in the US), many people are expecting, hoping, and calling for interest rates to rise. Just like with government spending we expect low interest rates to increase economic activity. But again there’s future uncertainty. We know interest rates can’t stay at this level, but we don’t know when they will rise and this has a major impact on many decisions. When interest rates to return to levels that we know are sustainable it will hold back some activity but it will also allow people to predict the results of their actions. Who knows – that might be what it takes for people to stop waiting.

There are many good economic principles, and just as many situations where the opposite of those principles is what the economy needs. None of the above is a prediction one way or the other. But with everyone scared to move, maybe governments need to lead the way in decisiveness even if the precise outcome isn’t clear. One of the few times of certainty in the last few years was when the Bank of Canada committed to keep their interest rate fixed for a year. There are many other ways to signal decisive action but none are being used now.

As investors we need to remember that every good principle has exceptions. And in many cases, deciding one way or the other is better than sitting around and waiting; you can always change your decision later.

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