Billionaire investor Howard Marks has expressed concern that the period of low interest rates, which marked the years between the Great Financial Crisis and the pandemic, may encourage detrimental investment behaviors if it returns.
In a recent memo, Marks, the founder of Oaktree Capital, emphasized the importance of the natural interest rate, which is determined by the market's supply and demand for money without central bank influence, for efficient capital allocation.
Marks believes that a genuinely free market in money has been absent since the late 1990s, attributing this to the Federal Reserve's 'activist' approach. This approach, aimed at preemptively addressing both real and potential economic issues by injecting liquidity, has led investors to focus excessively on central bank actions and their repercussions.
With the recent decline in inflation, attention has turned to the Federal Reserve and the possibility of it lowering interest rates. However, Marks warns against a return to the near-zero interest rates that characterized the pre-pandemic era, citing the negative consequences that arose from that period of 'easy money'.
He points out that while lower borrowing costs can stimulate economic growth, they can also lead to rapid expansion and subsequent inflation, resulting in tighter monetary policies that may hinder economic activity. These fluctuations can lead to financial imbalances, with long-term investments made under low rates losing value when policies tighten, as was evident in last spring's banking crisis.
Moreover, low interest rates can inflate asset prices, diminishing the attractiveness of low-risk assets and driving investors towards higher-risk investments like stocks, real estate, and private equity. This dynamic can encourage speculation and potentially create asset bubbles.
Marks also highlights the impact of near-zero interest rates on savers, particularly those not investing in the stock market, contributing to wealth inequality. He cites an example where US households that saved between 2007 and 2012 faced a collective loss of approximately $360 billion.
The prevalence of low interest rates can lead to a surge in bad investments, as they reduce opportunity costs and promote reliance on leverage. This enables even weaker consumers to borrow, funding ventures that would not be feasible under a tighter monetary regime.
Marks quotes Charlie Munger, "Easy money corrupts, and really easy money corrupts absolutely," to encapsulate the dangers of an environment of excessively low interest rates. While markets anticipate numerous rate cuts this year, the lessons learned from the past may prevent a return to ultra-low rates in the future.
Factors like decreasing globalization and increasing labor bargaining power suggest that the Federal Reserve might maintain higher interest rates to avoid another inflation surge. Marks conjectures that the fed funds rate could average between 3.0% and 3.5% over the next decade, though he acknowledges this as a speculative estimate.
