Oak Tree Capital co-founder Marks: Goodbye to the era of corrupt loose monetary policy

*Compiled by: He Li, *Financial Times**

Max, co-founder and co-chairman of Oak Tree Capital Management, writes for the UK Financial Times.

Most people hope to see low interest rates. However, low interest rates change investor behavior, distort investor actions, and can have serious consequences. As financial historian Edward Chancellor elucidates in his excellent book The Price of Time: The Real Story of Interest, so-called "easy money" has many negative effects.

Easy money may sustain high economic growth at least in the short term. But low interest rates can lead to overly rapid economic growth, resulting in rising inflation and increasing the likelihood of having to raise rates to combat inflation, thereby suppressing further economic activity. Fluctuations in interest rates can cause the economy to swing between inflation and recession. No one wants that.

Moreover, low interest rates reduce the expected returns on safe investments to unacceptable levels, prompting investors to take on higher risks in pursuit of greater returns. As a result, during periods of low returns, investments are made where they shouldn't be; buildings are constructed that shouldn't be built; risks are taken that shouldn't be taken. Capital shifts from low-return, safe assets to higher-risk opportunities, leading to strong demand for the latter and rising asset prices. This encourages further risk-taking and speculation.

As the late Charlie Munger wrote to me in a letter in 2001, perhaps we have a new version of the saying from 19th-century British historian Lord Acton: "Easy money leads to corruption; absolute easy money leads to absolute corruption." The investment process becomes entirely about flexibility and boldness, rather than thorough due diligence, high standards, and appropriate risk aversion. Investors often underestimate risks, underestimate future financing costs, and increase leverage. This often leads to failures when investments are tested during subsequent tightening periods. Furthermore, low interest rates subsidize borrowers at the expense of savers and lenders. This may exacerbate wealth inequality.

When you consider all the reasons not to keep interest rates low for the long term, I believe the economic rationale for supporting low rates can only be seen as an emergency measure. When I was a graduate student at the University of Chicago, economist Milton Friedman was a leading figure in academia, advocating that free markets are the best allocators of resources. For the same reasons, I believe the so-called natural rate of interest will lead to the optimal overall allocation of capital. The natural rate of interest reflects the supply and demand for money. In the late 1990s, the Federal Reserve became "activist," eager to prevent real and imagined problems by injecting liquidity into the financial system. I believe we have not had a free money market since then.

So, might we see a return to an easy money environment? I think the current consensus is that U.S. inflation is moving in the right direction and will soon reach the Federal Reserve's target of about 2%. Therefore, there is no need for further rate hikes. Consequently, we will have a soft landing with only a mild economic recession, or perhaps no recession at all. Thus, the Federal Reserve will be able to lower rates.

To me, this has a bit of a "Goldilocks" flavor: the economy won't be hot enough to raise inflation, nor cold enough to cause an economic slowdown. Historically, Goldilocks thinking often leads to high expectations for investors, leaving room for potential disappointment. Of course, this doesn't mean it will necessarily be wrong this time.

I believe we will not return to ultra-low interest rates for many reasons. Given concerns about triggering another round of high inflation, the Federal Reserve may want to avoid maintaining a permanent stimulus posture. Additionally, one of the Fed's most important tasks is to stimulate the economy when it falls into recession, primarily through rate cuts; if rates are already near zero, it cannot effectively cut rates. Most importantly, we seem to be witnessing a retreat from globalization and an increase in labor bargaining power, suggesting that inflation may be higher than pre-2021 levels in the near future. Therefore, I will stick to my guess that interest rates will remain around 2% to 4% in the coming years, rather than 0% to 2%.

Of course, these beliefs stem from my views on how the Federal Reserve should approach this issue. The Fed's actual actions may differ. But I believe there is reason to think that the investment environment in the coming years will be very different from the easy money era of 2009-21, which means investors will need to adopt different strategies.