Market Crashes, Feds, Interest Rate, and Inflation - Part 3

Hello Everyone,

We are the Antifragilist, where we like to combat the hot weather with some cool content. And what’s cooler than talking about interest rates, and Fed?

In the last post, we looked at the origins and making of the US Central banking system, the Federal Reserve.

In this post, I wanted to explain, why the Fed is the shit.

Federal Reserve has 3 important responsibilities.

1. Setting the Interest Rates

2. Managing the Money Supply, and

3. Regulating the Financial Markets

Honestly, 2 and 3 don’t matter much to regular folks like us. However, it is beneficial to understand the why, and how of #1. Interest Rate is one of the most important factors, and if you don’t think so then go, and log into your investment accounts and come back to this.

We all look at this world through our own lenses, which are generally formed by the life we have lived and the things we were taught. But at the end of the day, the world is nothing but a flow chart for capital, and interest rate is at its toll. Since the Federal Reserve System manages both the capital and interest rate, it is the most powerful economic institution in the world.

Let me explain how with a simple example below.

Amazon’s product sales (excludes sales like AWS) grew from $41 billion in 2011 to $241billion in 2021 (my wife and sisters have made a material contribution to the huge growth). That’s $200 billion more in 10 years. To support the huge demand, it has built fulfillment centers left, right, and center. The cost of building an Amazon Fulfillment Center ranges from $100 million to $350 million. The new center also creates more jobs which adds to the economy (please unsubscribe if you lean towards AOC’s theory. This is a rational newsletter, not some make-believe world of socialism and all that bullshit).

So, to build those fulfillment centers Amazon can either use their own cash or borrow from the bank. If I were Amazon, with unlimited access to bank funds, I would be crazy to use my own cash. So, here is how it plays out.

Amazon has a plan to build a new fulfillment center with a cost of $100 million dollars. Before the rate hike and with a 5% commercial interest rate (used 5% for simplicity, the actual rate is lower), it would have paid $ 5 million in interest expense. However, now with an increased rate of say 10% (fed funds rate has doubled this year), their interest expense is $10 million. Now, multiply everything 480X because the total long-term debt of Amazon is $48 billion, and it pays $ 1 billion/year in interest.

This has two-fold implications.

1. Amazon’s interest expense goes up significantly. This results in lower income and cash which they would have otherwise invested in building more sites and creating jobs.

2. Amazon will hold off on borrowing huge sums of money to build new sites since the cost of capital will be much larger to support the payback.

So, we can see how the increase in rates has a material impact on companies like Amazon. But the US economy’s nominal value for 2022 is some $25 trillion, including businesses, household spending, etc., so the impact is much more significant. On top of that, US policies have a direct effect on the world economy due to globalization.

Next week, we will dive into behind the scenes on how the fed actually makes those changes. Stay tuned…