Buffett, rates and cigarettes

The government is stimulating the economy while the RBA is trying to cool it.

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So, the RBA put interest rates up.

Again.

Which seemed to have surprised the markets, and many economists.

For what it's worth, I don't do predictions. In part because no-one knows for sure (and the times everyone 'knows' aren't very useful anyway), and in part because they don't really help me invest any differently.

Unless you trade currencies (and if you do, good luck with that) making interest rate predictions is just a parlour game.

So, when I'm asked what the RBA will do, I usually just give my stock line – 'I don't do predictions' – then give a view on what they should do, instead.

And this time around, the RBA did what I thought they should do – raise the rate.

But also, and this is why I'm surprised the market was caught out, it was what they'd foreshadowed last month.

I'm sorry if you're struggling under an enormous mortgage repayment.

I wish the RBA had another option.

But, realistically, with inflation at 7%, they don't.

If you have your foot on the proverbial throat of your opponent (the opponent is inflation, for the record!), we all know the worst thing to do is to let them off the mat.

So while the RBA risks going a little too far, it would be much worse to not go far enough.

Inflation in the UK is 10.1%.

We really, really don't want to end up there.

Sure, there are differences, but that's a glimpse of one potential future if the inflation genie, half-way back into the bottle, is allowed to escape.

If it did?

If it did, we'd probably see another round of rate hikes in a few months' time, to a higher level than if the RBA kills inflation, now, once and for all.

Which, I assume, was their thinking.

And which, I think, is the right approach.

Of course, it needn't be the only weapon in the fight against inflation.

Thanks to – how do I put this delicately – 'less ambitious' government policy, the RBA is doing all the heavy lifting right now.

Not only is it trying to slow an overheating economy, it's also trying to fill the hole created by the government (and the last government – this is a bipartisan shortcoming) running a budget deficit.

Yes, the government is stimulating the economy while the RBA is trying to cool it.

Just let that sink in for a second.

And before you put the boot into the current Treasurer, remember that the last Treasurer also left behind a budget that was also in structural deficit.

Which is why the RBA has to be the adult in the room.

It's a thankless task, of course – everyone is blaming the RBA for raising rates – but it feels it has little in the way of options.

And I think it's right.

Meanwhile, the government is raising a little extra revenue by whacking smokers with another 5% increase in the tobacco excise.

Not a bad thing, overall (though if you're not quitting already, I'm not sure this makes a big difference, but it probably makes those poor smokers, well, poorer).

Would it be too cynical for me to assume that taxing smokers a little more isn't going to draw much in the way of popular ire, while actually doing something about the deficit might be unpopular, and so, politically challenging?

I'll let you be the judge.

And for investors?

Well, other than a lesson in realpolitik, a couple of thoughts:

First, on smokes, there's a lesson here in pricing power and what my economics teacher called the 'elasticity of demand'. If you can raise the price of something and not deter too much consumption, you can make some serious money.

(In case you missed high school economics, if demand changes with price, the product is called 'elastic'. If you can raise the price without impacting demand, that's known as 'inelastic'. It's a continuum, of course, but you get the idea.)

It's why companies with 'pricing power' are so attractive for investors. If you can raise prices and not see much of a fall in your sales volume, most of that extra revenue falls straight to the bottom line as extra profit.

That is a very, very good thing.

It's also relatively rare, as you'd expect. But if you can find it (and if you pay a decent price) it should make for a good investment.

And on rates, a reminder that a temporary increase in the cost of money (i.e. interest rates) is a far, far better thing than a permanent increase in prices (i.e. inflation), even if it doesn't feel like it at the time.

And it often doesn't feel like it, because inflation feels disembodied – it's a general 'thing' that just happens. But interest rates? They're controlled by a board (and usually represented by one man, Governor Phil Lowe).

And so while inflation feels unavoidable, rates feel (and are) deliberate choices. And that means we have someone to blame!

It's yet another example of the psychological forces that are at play for all humans, and which we need to recognise, and hopefully control, as investors.

Yes, you need a basic understanding of accounting.

You absolutely need to know business models, and understand what makes companies tick.

But more than that?

Well, tell 'em what you said, Warren Buffett:

"Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."

The urge to over-trade. To chase last year's winners. To believe complexity is better than simplicity.

The urge to take on too much risk. To try to 'get rich quick'. To do what the cool kids are doing.

We've seen those in spades, in recent years.

We saw them in 2007.

And in 1999.

The answer?

Keep a cool head. Don't over-complicate things.

Focus on the long term.

Luckily for me, I'm not a footy player. Not just because I don't have the required talent, but also because their careers are short, and over by 35.

Fortunately, I'm an investor. A game where compounding not only applies to money, but to experience and knowledge, if you let it.

Don't get me wrong – age alone isn't enough. I know some wise 26 year olds and some, well, less-than-wise retirees.

But if you are committed to understanding the basics, doing the simple things well, and learning from both history and experience?

I think there's a very, very good chance that you'll be very happy with the outcome.

As for politics? Well, that's a whole other problem!

Fool on!

Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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