The genesis of a memo: In 1990, Howard Marks embarked on his memo-writing odyssey, for a decade sending missives that drew nothing but silence. It wasn’t until the dawn of 2000, when he released bubble.com, a cautionary memorandum about the tech sector, that he finally received attention. The spark for this memo was ignited by the pages of Devil Take the Hindmost: A History of Financial Speculation, an engrossing tome penned by Edward Chancellor, chronicling the speculative frenzies dating back to the South Sea Bubble of the early 18th century. Marks found Chancellor’s account of the irrational exuberance surrounding the South Sea Company alarmingly similar to the mania then gripping the tech/media/telecom sphere. The positive feedback that ensued spurred Marks to continue sharing his insights on the financial world.
Now, 24 years later, another Chancellor book, The Price of Time: The Real Story of Interest, caught Marks’ attention. The profound correlations between The Price of Time and recent market trends steered the course of his latest memo.
In December 2022, Marks unveiled Sea Change, a poignant delve into the 13-year epoch beginning at the close of 2008, marked by the Federal Reserve slashing the fed funds rate to zero in response to the Global Financial Crisis. This period culminated in 2021, with the Fed abandoning the transitory inflation premise and ushering in a rapid succession of interest rate hikes. Marks’ follow-up memo, Further Thoughts on Sea Change, premiered in May 2023 among clients and was made public in October. In these releases, Marks underscored the profound impact of rock-bottom interest rates on both market participants and the broader economy.
Easy Times: The Lure of Easy Money
In his Sea Change missive, Marks likened the sway of low interest rates to a conveyor belt at the airport, propelling travelers at an accelerated pace. However, he cautioned against confusing this swift momentum for inherent prowess, just as market participants erroneously attributed their success to personal genius rather than the favorable backdrop of ultra-low interest rates. The era was characterized by unfettered business growth, surging asset values, and easy access to leverage, all enabled by the lax monetary environment. Yet, as Marks quipped, “we should never confuse brains with a bull market.”
As Marks contemplates the transition from declining ultra-low rates to a more stable equilibrium, he underscores the troubling distortions that low rates inculcate, setting the stage for dire consequences.
As Marks mused over the impact of diminishing interest rates, he couldn’t help but notice the surge in media references to this phenomenon. The fallout from Silicon Valley Bank’s collapse in the wake of “the preceding period of easy money” garnered significant media attention. Similarly, the private equity sector’s waning prospects have been closely linked to prospects of a rate environment that is unlikely to revisit recent lows.
Marks, awakened to the multifaceted and pervasive effects of low interest rates as he perused The Price of Time, sought to compile a comprehensive dossier of these effects:
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Low interest rates fuel economic growth
When central banks pare interest rates to stoke economic activity, they effectively lower the cost of capital for businesses and bolster consumers’ purchasing power. However, this artificial stimulus can propel the economy towards an overheated precipice, resulting in spiraling inflation and necessitating corrective rate hikes, thus quelling further economic expansion.
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Low interest rates diminish perceived opportunity costs
In a low-interest-rate setting, the returns on cash holdings are negligible, effectively nullifying the disincentive to withdraw funds for investment or major purchases. This blurs the opportunity cost, rendering transactions seemingly frictionless.
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Low interest rates elevate asset valuations
Underpinned by financial theory, asset value hinges on the present value of projected future cash flows, discounted by the prevailing interest rate. As rates dwindle, asset valuations ascend, fueling exuberance akin to the land price surge noted by Adam Smith in the 18th century.
