Why Interest Rates Matter (and Which Rates Matter)

People tend to sum up Arnold Schwarzenegger’s career progression like this: He became a bodybuilder, later became Terminator, and eventually became the governor of California. And while those waypoints sound rather discontinuous, it’s pretty easy to see how they connect. He leveraged his marble-sculpted biceps to stand out for acting roles fit for enormous men, and then leveraged the resulting fame to become governor.

But to assume that his riches were generated entirely by leveraging the body he built and the fame he accrued from it would be inaccurate. Arnold was a millionaire before his acting career really kicked into gear, and it wasn’t winning bodybuilding competitions, product endorsements, and contracting work that made it happen. He chose to parlay his earnings into a bet on inflation and interest rates. 

That may sound opaque, but it’s really not all that complicated. In the ’70s, Arnold started buying apartment buildings with mostly borrowed money, and inflation pushed up the price of the real estate (good) while reducing the real value of the loans (extra good). It turns out that his roles in movies and politics are less career progression waypoints and more fun side hustles for a real estate investor.

As you can imagine, interest rates matter to more people than just Arnold. They’re the price of money over time, so they affect the payoff of literally every decision you make that involves doing something now with the expectation that it will affect your future. 

Interest rates matter the most for two diametrically opposed kinds of businesses:

1. Highly levered, capital-intensive old economy firms like real estate, oil, and gas, heavy manufacturing, airlines, etc.
2. High-growth, future-focused companies that are typically asset-light and that have most of their expected profits in the distant future.

To understand why interest rates matter the most for those businesses, you need to understand two different mechanisms and to understand those mechanisms, you first need to understand one simple concept: Giving me $100 today is more valuable to me than promising to give me $10 every year for the next decade. After all, if you have the $100 now, you can invest it and end up with more than $100 at the end of a decade.