8/9/2019 Weekly Update: Remember Me When
by Zach Marsh on Aug 9, 2019
S&P 500 -0.1%
10 Year Treasury +0.85%
Weekly Update: Remember Me When
My reading this week led me to an insightful memo released by Howard Marks, chairman of Oaktree Capital, entitled “On the Other Hand.” In the memo, Mr. Marks dissects the recent Fed decision to lower rates, and poses some serious questions regarding the role of the Fed, the efficacy of their policies, and the unintended consequences of these policies. It is a worthwhile read, and I recommend anyone wanting a deeper dive on this subject to read it. You can find it here: Howard Marks Memo.
Marks sort of follows the discussion we had here last week in my note about the fickle nature of the market and its response to the Fed decision. You’ll recall the market responded negatively to the rate cut because Chairman Powell prefaced it by labeling it a “mid-cycle cut”, implying that there may not be more to follow. The question which this market response raises is, “What kind of market do we have which prefers, or relies upon, a negative economic outlook in order to sustain a rally?”
Touching on this point Marks questions the reasoning behind the Fed decision. To his point, if we take the Fed at their word, and this is a “mid-cycle cut,” is this truly a responsible choice. Marks argues that stimulus is meant to spur an economy that has weakened and needs a lift. When an economy is at risk of overheating then brakes need to be applied to prevent runaway inflationary pressures. Current economic data suggests that we are not, at the current time, in a recession and in need of stimulus. But, Powell, and the Fed by proxy, state that they stand ready to “act as appropriate to sustain the expansion.”
Sustaining an expansion is a far different mandate than giving the economy a helping hand when it has fallen. Sustaining an expansion is like spiking the punchbowl before the party starts to wind down, for the sole purpose of keeping the party going. On the other hand, giving the economy a helping hand is like offering it some coffee the next morning to help it wake up. While the spiked punchbowl may feel good in the moment, it ultimately risks a greater crash down the road with a more severe hangover. Holding off on a rate cut may feel like turning off the music at the party slightly before everyone is ready to go home. It may not be the desirable decision at the time, but it will make the next day much easier to greet, with far fewer regrets about the night before. An over easy monetary policy leads to poor economic decisions. Marks describes a few of these downside effects of low interest rates in his memo. These unintended consequences are hardship on people living on fixed incomes, penalizing savers by reducing the returns available on safer investments, and misappropriated investment in undeserving companies.
The Fed, and President Trump, conclude that since inflation is muted, we can therefore keep the party raging for another few years. While neither the President nor the Fed Chair currently acknowledge the presence of inflationary pressure, I would argue that they are not looking in the right places. Certainly the price of gas, or a computer, or a T.V. are not over inflating, but what about asset prices? Stocks, bonds, and real estate are all at extremely elevated valuations, do these not also pose a danger, perhaps a greater danger, than inflationary pressure of commercial goods. Most people need to invest for future goals such as retirement. Many people below the age of 50 are woefully behind in saving towards their retirement goals. Creating an environment of hyper-valuated investments forces savers to buy in at over-priced levels, perhaps artificially high levels, thus reducing the expected rate of returns on those investments in the future.
This sort of myopic thinking seems to be endemic in Washington over the past 25 years. No one wants the party to end on their watch, thus more and more misguided decisions get made. I don’t have the answer. How can you influence people in power to make decisions which sacrifice the short term for the long term? After all we live in a consumer-capitalist society where our own tendency is to say, “I want it, and I want it now.” When engaging in financial planning, or when I assess a personal financial decision, I try to remember that there will be a future me one day that I’m going to have to live with daily. How is the decision I’m about to make going to affect that person? John Maynard Keynes, a large contributor to the version of myopic economics we now practice, once famously announced, “In the long run we’re all dead.” That may be true, but in the meanwhile we’ll most likely have to wake up tomorrow morning.
Thanks for reading,
Zach and Dave
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