Howard Marks, Oaktree Capital — 2024-09-19
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Memos from Howard Marks 2024-09-19T07:00:00.0000000Z" pubdate title="Time posted: >9/19/2024 7:00:00 AM (UTC)">Sep 19, 2024
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For months, I've been saving up clippings for a memo on the above topic, but favorite subjects such as risk, debt, and uncertainty repeatedly jumped the queue, delaying my intended memo until the U.S. election season got into full swing, making it compelling.
Like me, you've undoubtedly noticed that politicians ranging from former President Trump and Vice President Harris to down-ballot candidates are back to making promises that ignore economic reality. Trump's call for tariffs and Harris's attack on grocery profiteering are merely two examples of proposals that would impose costs the candidate ignores (in Trump's case) or that fail to reflect a meaningful understanding of the problem (in Harris's case). My purpose, of course, is not to promote or dismiss either candidate, but rather to illustrate that there is no "free lunch" in economics, despite candidates' assertions to the contrary.
The Background
In 2016, with an unusually clamorous presidential election in full swing, I published two memos that strayed from investing into the world at large, called Economic Reality and Political Reality . The first explained that economics is largely the study of how we make choices – how people allocate finite resources among the available options. The second stated that in politics – and especially in the land of campaign promises – there's no such thing as finiteness. As I wrote in Political Reality :
I've always gotten a kick out of oxymorons – phrases that are internally contradictory – such as "jumbo shrimp" and "common sense." I'll add "political reality" to the list. The world of politics has its own, altered reality, in which economic reality often seems not to impinge. No choices need be made: candidates can promise it all. And there are no consequences. If something might have negative consequences in the real world, politicians seem to feel free to ignore them.
I followed those two memos with one in 2019 entitled Political Reality Meets Economic Reality . Its main thrust was that politicians can promise whatever they want regarding the economy, but they won't be able to deliver if their promises fly in the face of economic reality because, ultimately, the laws of economics are incontrovertible. Free economies are driven by self-interested decisions made by millions of producers and consumers, employers and employees, and savers and investors. Governments can pass laws designed to encourage or even compel behavior, but in general they can't mandate economic outcomes. There are so many moving pieces and second-order consequences that governments generally can't engineer both prosperity and the specific economic outcomes that policymakers may seek.
History is littered with command economies that didn't succeed. There's proof for this that includes the "control group" required by the scientific method. Eighty years ago, Korea was a single country. Then, following World War II, it was split in two, obviously with similar people, geography and resources: South Korea (under U.S. influence), and North Korea (under Soviet influence). Since then, South Korea has operated as a capitalist democracy and North Korea as a communist dictatorship. There's little reliable economic data regarding North Korea, but according to the CIA's Worldbook , its GDP in purchasing power terms is estimated at $2,000 per person versus $50,000 in South Korea. North Korea's citizens are described as impoverished, but at least it doesn't have a border problem, since nobody's trying to sneak in. There are political differences (democracy versus dictatorship) in addition to the economic ones, but I think it's fair to say capitalism has won .
In discussions of economic systems, I usually ask people what they think has been responsible for the economic preeminence the U.S. has enjoyed since the end of World War I, and thus for its citizens' higher average standard of living. Are Americans smarter? Harder working? More deserving? None of the above. I'm confident it's because of our historical embrace of the free-market system and capitalism.
The incentives provided by free markets efficiently direct capital and other resources where they'll be most productive. They prompt producers to make the goods people want most and workers to take the jobs where they'll be most productive in terms of the value of their output. And they encourage hard work and risk taking. The result is a higher standard of living for society in general, but certainly not everyone benefits to the same degree. Thanks to the way incentives interact with people's different abilities, some people do considerably better than others. Some also prosper thanks to good luck and/or inherited advantage, rather than innate ability. The free-market system doesn't necessarily produce "fair" outcomes in all circumstances, but economic systems designed to do so generally don't provide the incentives needed to encourage economic productivity for the collective good. That's what accounts for their record of failure.
On August 15, the media reported that the next day, Vice President Harris would announce her economic policies. The bulk of the attention went to her promise to ban price gouging in the grocery industry. "Grocery prices ... have jumped 26 percent since 2019, according to Elizabeth Pancotti, director of special initiatives at the Roosevelt Institute, a left-leaning think tank" ( The Washington Post , August 15), and many voters say inflation is their greatest concern. For this combination of reasons, Harris's targeting of grocery prices is entirely predictable. (Ironically, August 15 was also the day U.S. inflation was reported to have fallen below 3% for the first time since March 2021.) I'm certain, however, that this falls under the heading of simplistic economic solutions that are designed to appeal to voters but are unsoundly based and likely to fail.
What Is Price Gouging?
Price gouging is generally defined as sellers taking advantage of market power or temporary supply/demand imbalances to raise prices to levels that otherwise wouldn't prevail. And food prices did rise significantly in 2021 and 2022, leading to suspicion of food retailers. But might there be reasons for the price increases other than a malevolent decision to gouge on the part of sellers? Here are a few possibilities:
When the pandemic began in March 2020, most people stayed home and cooked their own meals, significantly increasing the demand for groceries and depleting inventories.
The production system was disrupted, with inputs in short supply or in the wrong places relative to the needs. This led to the much-discussed "supply-chain problems." Too few goods – when coupled with too much money chasing them – constitute the classic reason for inflation.
The federal government sent taxpayers massive amounts of Covid-19 relief. Many more people received benefits than had been hurt financially by the pandemic. Those people came out ahead, capturing trillions of dollars for future spending.
When the Delta variant of Covid popped up in mid-2021, people again stayed home and shrunk from contact with others, spending more on goods and less on services than they otherwise might have. Demand for goods was strong as a result, outstripping the limited supplies and causing prices to rise.
Profit margins in the sup