"Maybe we have a new version of Lord Acton's law: easy money corrupts, and really easy money corrupts absolutely."
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A return to low interest rates that characterized decade and a half between the Great Financial Crisis and the pandemic could usher in a return of damaging investment behavior, Howard Marks wrote in a Tuesday memo.
Instead of ultra-low rates being a tailwind for investors, the Oaktree Capital founder argued that the natural rate — which reflects supply and demand for money without central bank input — is optimal for determining capital allocation.
But this hasn't been allowed to lead the way in decades.
"In my view we haven't had a free market in money since the late 1990s, when I believe the Fed became 'activist,' eager to head off problems real and imagined by injecting liquidity," Marks wrote. "Given that activism, investors have become preoccupied with central bank actions and their consequences."
With inflation now falling, investors are again watching for the Federal Reserve to lower interest rates, and both equities and bond markets have been shifting based on Fed signals.
But Marks pushed back on any possible hopes for a return to near-zero rates, given the problems that sprouted from the pre-COVID easy money era.
For instance, while lower borrowing costs stimulate the economy, growth can happen too quickly, spurring inflation that results in tighter Fed policy. Such swings can end up discouraging economic activity.
These swings can also create financial mismatches, where long-term investments made under low rates become discounted when policy tightens. This was true in last spring's banking crisis, Marks said, when the Silicon Valley Bank's bonds were sold at a significant loss.
Low rates also bump up asset prices, as risk-off assets lose their appeal, pushing more investors to compete in spaces such as stocks, real estate, and private equity. This can make risky investments perform well, spurring further speculation and possible asset bubbles.
Near-zero rates on safe assets mean that consumers who do not put money into the stock market are not earning on their savings, contributing to wealth inequality. US households that tried to save between 2007 and 2012 were penalized by around $360 billion, Marks cited.
Bad investments also run rampant, as low rates eliminate opportunity costs and encourage broader reliance on leverage. Even weaker consumers can borrow, financing investments that would be untenable in a tighter monetary regime.
"Maybe we have a new version of Lord Acton's law: easy money corrupts, and really easy money corrupts absolutely," Marks wrote, quoting the late investor Charlie Munger from an interaction the two shared.
While markets are forecasting a slew of rate cuts through this year, these lessons may fend off a return to ultra-low rates in the coming years, Marks said.
That's as disinflationary factors won't be as strong moving forward, with globalization retreating and the bargaining power of labor on the rise. The Fed might want to keep interest rates restrictive enough to avoid another bout of inflation, in which case the fed funds rate will have to remain above the future inflation rate.
In Mark's view, the fed fund rate could average 3.0%-3.5% over the next decade, although he emphasized this was no more than a guess.
