On the Other Hand

Memo to: Oaktree Clients
From: Howard Marks
Re: On the Other Hand

It often happens that just as I’m about to release a memo, I come across something that absolutely has to be incorporated. That was the case on June 12, the day “This Time It’s Different” was published. I was reading a first-quarter report from Ruffer, a London-based money manager, and I came across the following question:

Can the Fed, with its discretions and its firepower, keep a market dislocation at bay, or halt it once it has begun?

That question caused me to think back to remarks made a few days earlier by Federal Reserve Chairman Jerome Powell regarding how the Fed would deal with the possibility of a trade war and its potential ramifications:

We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective. (CNBC, June 4)

Together, these two inputs prompted me to reflect on the role and powers of the Fed. In short, is it the Fed’s job to sustain expansions and keep market dislocations at bay ad infinitum? I concluded that “This Time It’s Different” shouldn’t ignore this subject and, as a result, reworked the end of its section on quantitative easing, adding a new final paragraph:

Can government actions permanently raise the level of demand in an economy, or do they mostly accelerate future demand into the present? If the latter, can QE elevate GDP forever above what it otherwise would have been? I doubt it. But if it could, wouldn’t that eventually cause what I call an “excess,” leading to a recession?

Finally, when I hear people talk about the possibility that the Fed will prevent a recession, I wonder whether it’s even desirable for it to have that goal. Per the above, are recessions really avoidable or merely postponable? And if the latter, is it better for them to occur naturally or be postponed unnaturally? Might efforts to postpone them create undue faith in the power and intentions of the Fed, and thus a return of moral hazard? And if the Fed wards off a series of little recessions, mightn’t that just mean that, when the ability to keep doing so reaches its limit, the one that finally arrives will be a doozy?