Shall We Repeal the Laws of Economics – Part III

Howard Marks (0:06)

This is The Memo by Howard Marks.

Shall We Repeal the Laws of Economics? Part 3 In September 2024 and June 2025, I wrote memos that were critical of government's attempts to override the laws of economics, based on my conviction that trying to do so is likely to prove ineffective and potentially harmful. Economies are naturally functioning organisms, and trying to steer them will distort their functioning and usually worsen the overall result. Sometimes doing so is necessary to prevent outcomes society deems unacceptable, such as widespread poverty or unemployment, but it should be done selectively and with great caution. The best analogy is to nature. There is a circle of life, as described by a song in the movie The Lion King. The circle has negative aspects, since it works through processes such as survival of the fittest, but it keeps the whole in balance. Humans can take steps to suppress a predator for the protection of prey, but interventions of this kind can have second-order effects, causing other species to grow out of control and throwing the overall environment out of balance. Having one species prey upon another may seem unkind, but human efforts to improve the overall result can easily produce unintended consequences. And that leads me to efforts to dictate the operation of markets. The latest such attempt was announced in response to the fact that long-term interest rates have been rising of late. On August 17th, the yield on the 30-year US. Treasury bond closed at over 5.3 percent, then a 19-year high. A government or central bank might want to stem the rise and bring about lower long-term rates, since higher ones tend to a. depress economic growth, b. reduce the affordability of things that are usually paid for through loans, like cars and houses, c. increase the cost of servicing the federal debt, which has recently reached an astounding 40 trillion dollars, and d. suggest a loss of confidence among market participants.

The Federal Reserve can't directly set long-term rates the way the Federal Open Market Committee sets a target range for the federal funds rate, which strongly influences other short-term rates. The Treasury doesn't set long-term rates either, but it can influence them through issuance and buybacks. Thus, on August 19, in a move it described as intended to provide greater liquidity support in longer-dated securities, the Treasury announced it would at least double the maximum size of its long-dated buybacks, from $2 billion per operation to $4 billion. The next day, Treasury Secretary Scott Bessent indicated a willingness to do more, something approaching a whatever-it-takes promise. All else equal, more buying should result in higher bond prices, and higher bond prices mean lower bond yields. Long rates declined immediately after the announcement, but they bounced back the next day. Will it solve the problem?

I view this action as an attempt to improve the interest rate picture cosmetically. It may constitute a response to the effects of rising rates just enumerated, but it can't be described as solving the underlying problem. First, any effect may be temporary. All else equal, you can raise the price of something by buying it, or you can make the price of something decline by selling it. But the impact of your actions may be fleeting, and once you stop, the market is likely to go back to doing what it would have done if you hadn't intervened. My vision is of a column of water in the ocean. Its upward thrust can keep a ball suspended above the surface for as long as it continues. But as soon as the water stops being pumped upward, the ball will fall.

On August 24th, investor Stanley Druckenmiller responded to Besant's announcement with an opinion piece in the Wall Street Journal. Here are some of my favorite bits from what he wrote.

Every basis point of artificial yield suppression is a subsidy to procrastination. Whatever this operation saves in basis points, it will cost multiples in delay. Governments defending prices against fundamentals always lose. The only variable is how much they spend before conceding.

Druckenmiller knows what he's talking about, as he helped conceive the most famous macro trade in history. He was running George Soros' Quantum Fund on a day-to-day basis in 1992, when it successfully bet against the Bank of England's ability to support the pound in contravention of fundamentals. That trade reportedly earned the fund about $1 billion, at a time when $1 billion was real money.

Second, it doesn't directly respond to the issues at the root of the rate rise. The increase in rates that the Treasury finds undesirable isn't a random phenomenon that's occurring for no reason. Among the likely contributors are these. Inflation is stubbornly higher than is desirable. For example, PCE inflation was 3.7% in July, versus the Fed's long-term target of 2%.