Deep Thought 5: Cockroach Simple

24 January 2021

COCKROACH SIMPLE

We humans like to believe we are complex, sophisticated, intelligent beings.  We are all those things, but some humility may be useful.  It may pay for us to think about how well served other creatures are by some very simple functionality.  Maybe we can learn from the simplicity of the cockroach, for example?

I studied cockroaches for a brief time while attending university (true story – I needed one science course as part of my commerce degree, why not learn about bugs?).  I probably have forgotten a couple of details pertaining to these studies, but this is my story, so here is what I remember.

When the cockroach’s feet are not contacting a surface, a switch tells its wings to flap; when the feet do make contact, that same switch is opened, and the wings quit flapping.  That simple switch arrangement allows the ‘roach’s little brain to focus on other functions and allows the simple foot contact switch to take care of that one vital function.  (You can imagine, you – as a cockroach – are munching on some crumbs on a table when suddenly a human enters the room.  Panicked, you scurry across the table.  As you try and decide where to hide, what to do, you run over the edge of the table in your adrenaline-fueled fluster.  It sure is great, to have that automatic wing flapping system kick in, allowing you to safely descend to the base of the fridge, under which are some more crumbs the human’s son swept with his sock, this morning.  “You” safely descended, and “you” did not even have to think about flapping those wings!)

How on earth does the cockroach story relate to the economy or to investing?  Well, as sophisticated as we are, humans too are better at making decisions in a complicated environment if some decisions are taken care of by convention or expectation (okay, use the word rule).  The precious and necessary action of achieving a government budget surplus and accomplishing periodic debt paydown is one such decision which should be guided by a rule, maybe a flexible rule but still, a rule.

Why bring this up now?  I know, we must spend now, people are in trouble without the help.  It is only at these times of crisis that we are able to focus attention on the need for such rules, that is why!  Remember, only a year ago we were advised that we only have a moderate deficit.  Before we forget that recent history and to prepare us for the next big problem, we should have this discussion.  Never waste a good crisis?

Why a pay-down-some-debt rule?  The reason is simple, we know we have not eliminated the business cycle and events which “never could have been predicted” such as Covid 19 or a Global Financial Crisis (2007 – 2008) or an Asian financial crisis (1997 – 1999), will appear every few years.  This point can be emphasized by reviewing any period of history.  Looking only as far back as the 1970s, there has been a Canadian recession or economic contraction every few years (and lasting for a varying length of time): 1977, 1981, 1990, 1995, 2001, 2008, 2020.  There is always a recession lurking and often it is created by something different than the one before.

The point is, the economy generally expands for 3 – 7 years, recently a little longer, and then it contracts.  We need to expect our governments to operate with a surplus generally, after 3 years, or we will never shrink our debts.  Excessive debt, limits our ability to do the things we need to do during tough times.  Government then often cut needed services when times are tough and expand the same, when times are good.  This is just the opposite of the ideal.  The expectation that government will begin paying down debt, when the economy is expanding, needs to be in place.  Without the expectation, government typically create a narrative such as what we have heard in recent years from Justin Trudeau, Bill Morneau, and others, “the current debt to GDP ratio is moderate” (GDP = Gross Domestic Product – the economic output of the country).  Because no one reliably predicts the next crisis, without a flexible rule, such as a 3-year guideline on deficits, it is easy to say: “there is no recession on the horizon”, “we are okay to spend” or even “we must spend for reason_________.”

A defined, if flexible term where deficits are accepted removes some of the burden of the decision from government.  They already carry the burden of needing to complete campaign promises.  They may also carry the burden of their stated ideology as well.  Sometimes, although rarely, government even has the burden of an existing surplus and that creates pressure on them to spend rather than “selfishly” run surpluses even though the surplus is the safe keeping of our money.  A public narrative that creates an expectation that government must be prepared for the next economic trouble, by running a surplus after 3 years of economic expansion would support better management by all government.

Most governments require public pressure or support to make tough decisions.  Consider the Republican Trump administration which would purport to believe in free markets and fiscal conservatism, yet they were well on their way to a $1 Trillion-dollar annual budgetary deficit pre-Covid.  Even after 10 years of economic expansion, they were creating debt at an accelerated rate, instead of paying it down.  That government was increasingly “becoming” the economy, yet they love to accuse the Democrats of representing socialism.  The Trump administration would have benefitted from a convention or from public pressure that expects debt paydown in the same way a Democrat government would benefit.

Moving to Canada, our Federal Government ran the past two elections in support of strengthening and expanding the middle class.  The argument for deficit spending was that more people needed to be pulled into the middle class.  This is laudable and all of society would benefit if they had been successful.  To achieve this, the strategy needed to include an ambitious plan to re-skill people so more can take on the numerous job vacancies where there is talent in demand.  Education is a provincial responsibility, but the federal government could help by providing a system that connects people to opportunity, across the country.  The federal government could also play scorekeeper / cheerleader.  Many companies are begging for people with specific talents!  Please see: Eight in 10 Canadian manufacturers face skills shortage, report says.[1]

Programs that teach people to make choices that allow them to be successful, are needed.  These teachings are used in some primary schools but why not provide them for adults, especially those that have not learned to succeed?  Strategies which uncover people’s untapped capabilities are needed.  Some unemployed oil worker, forestry worker, automobile assembler or chronically unemployed (maybe some that have been incarcerated) may have the ability to fill in-demand jobs if there was a path to connect the person to the job, with an education component in between.  If the plan is to expand the middle class and create a world beater economy, it really does come down to making our greatest “capital asset” more productive, that is our people, right?

I mention re-skilling because that would create a stronger economy and middle class.  The justification for running a deficit federally – even a year ago and after more than ten years of economic expansion, was to strengthen the middle class (Make Canada Great Again?).  What was accomplished, with the spending, I wonder?

In fact, a major element of the last couple of election campaigns, federally, in Canada and the last Presidential one in the United States was about those who are victims of technological change, those left behind (with a lot of the blame directed at jobs lost to Mexico & China).  An effort to make perpetual re-skilling in both countries would allow economic greatness to be achieved.  Re-skilling efforts initiated 3 or 4 years ago would be paying some benefit as we dust ourselves off from the Covid wreck, now.

Such a perpetual approach to skills forces some long-term thinking.  Running deficits to magically expand the middle class through short term spending does not fit this approach.  Deficits in good times would actually hurt this approach as deficits then jeopardize spending during tough times.  It was the bond market that forced harsh cuts in the 1990s in Canada, after all, not government ideology.  Our governments lost the sovereignty over our own finances when those who lend Canada money said enough is enough.  Is that where we are headed now?

Just as the cockroach has an automated wing-flapping system, preventing a physical crash, a level of automation for our government finances would reduce the risk of a financial crash.  Such discipline applies to personal finance too!  Now is a good time to get off the political soap box and move to the individual.

How does this approach apply to you and me?

First, our success is affected by government.  I hope regular people can demand that government acknowledge the business cycle and expect that after an expansionary period, maybe three years, it is time government pays down some debt.  We know a recession is always coming, so should you, Mr. Finance Minister.  We do not want cuts when times are tough, cut when times are good!  So that point is aspirational (oh yeah, it is political again, I suppose, too.)

Second, in our investment activities, we are constantly juggling risks.  Like the government, we need to have some concern for a recession skulking just over the horizon, also there is interest rate risk, some day there may be inflation risk, and a range of company specific risks.  We need automated wings to ensure we fly over the potholes too!

So, with that in mind, here are a couple of rules or guidelines that should help keep you safe when investing:

• limit an individual company stock purchase to 3 – 5% of portfolio.
• trim an individual company stock holding when it reaches 6 – 7% of portfolio, (10% – on exceptional occasions)

Such rules take the tough decision of when to trim a stock away from your emotional brain.  It is REALLY tough to sell a stock that has doubled, for example.

Sometimes when you do decide to trim a stock, you can emotionally flip and want to sell it all.  That is another emotional phenomenon.  However, if nothing fundamental about the company (stock) has changed, nor the industry it operates in, you need to stand by your rule-based guidelines and just trim back to 3 – 5% of portfolio.  If you make use of such rules, it takes far less mental – emotional effort.

Let’s face facts, you think you make decisions based on logic, truth is, emotion plays a big role too.  The more you normalize these rules, the easier they become.

Go to the RISK tab on the Greedy Farmer Investing website https://greedyfarmerinvesting.ca/risk/ for more thoughts on reasonable rules to guide your investing behaviour.  Likely if you get better at following such rules, you will demand the same from government.  Government will be better at leading us, if we give them good direction on where we need to be led 😀

GOOD INVESTING STAY GREEDY!

I should remind you; I remain proudly greedy while investing and do my best to give back to the community during other activities. In no way does being a Greedy Investor make you less able to be charitable, philanthropic, kind, helpful, generous, even nice in all your other activities. Being a greedy investor actually allows you to be more charitable!

 

P.S.  Central banks would serve us much better if they reverted to an automatic rule, as they once did, too.  Danielle DiMartino Booth @DiMartinoBooth argues this… a return of the U.S. Federal Reserve to an inflation-only mandate AND back to true independence from the administration, in completing their mandate.  It would seem to make sense those rules should apply to Canada’s central bank and others around the world as well.

 

[1] TARA DESCHAMPS

TORONTO, ONTARIO, CANADA

THE CANADIAN PRESS

PUBLISHED DECEMBER 1, 2020, THE GLOBE AND MAIL