the tentacles of arbitrage
(and no, this is not hentai)
During the last few posts about green energy and then mechanized weaving it was necessary do some research into how things used to be. Thanks to the good folks at Google Library (or whatever it’s called) I found a number of studies from around the turn of the last century, studies that compared working wages here with those in other countries of our class (at the time) and with the relative pricing of goods and services.
While this could be seen as dry stuff, it’s nonetheless quite fascinating if you try pricing the goods of the past in terms of what you can afford now. Would you have had to save up for 3 weeks or more to buy a good dictionary? What percentage of your weekly pay had to go toward each month’s rent? What might you have done for work back then? How did the wage scales relate to the things it was necessary to buy? How many hours of work did it take to buy a pair of shoes or a sandwich or a ticket on the train into Boston?
One of the techniques you can do is convert all the numbers into gold value (if you have the table of gold prices per month/year going back that far) so that you get the added dimension of being able to see how prosperous things were then compared to things now, without calculating it through the usual set of currency inflation numbers.
Anyway it was during this process that I realized that our romantic take (have you got one? I’ve got it bad and always have) on the economy of the turn of the previous century (call it 1880~1910) is in fact vastly tainted by the forces of arbitrage.
For those of you not familiar with the term, arbitrage means making use of arrangements or resources that are/were valued at different times (usually with older valuations carrying forward into a present arrangement) so as to be able to make a profit by gaming the system ever so slightly.
One contemporary example of this would be Southwest Airlines and how it bought (and made use of) fuel futures priced far below the high fuel prices seen this past summer. SWA had a huge advantage over other carriers because it was getting today’s fuel at yesterday’s prices, while its competitors were paying then-current high prices.
Another example, slightly less well-known, is the way the Abathasca Tar Sands project is scaling down. While we all know that they’re not making dinosaurs anymore and that we need to keep finding new sources of oil (if we wish to consider using liquid fuel so extravagantly, that is) what we’re seeing now is all of those “oil alternates” (like shale oil, biomass, tar sands, etc) and new deepwater projects being canceled. Why? Because the economics of these things required that oil prices be constantly increasing over the time span between when the project’s outlays were purchased and when the product got to market. In other words, it was arbitrage at work again.
In the case of the Abathasca tar sands project, they were able to make it generate profit only as long as they were still getting natural gas energy rather cheaply relative to the high price of oil they were able to get for their main product .. and as we know, Abathasca goes through vast quantities of natural gas and water. It is in fact a pollution disaster of epic proportions.
Another contemporary example is ethanol made from vegetable crops grown on cropland normally devoted to food. As long as the project’s input costs are scaled lower than the profit of its outputs, it’s cash-positive, but without constantly raising the scale of the numbers, it falls apart.
In this case, for example, corn-based ethanol was “profitable” only as long as agricultural fuel was cheap (due to subsidies), as long as federal subsidies were poured into ethanol projects (above $1.50/gallon in subsidies), and as long as retail fuel prices continued to skyrocket. Had prices been stable and not subsidized, it would have been more obvious to the people involved (whose heads were deep up their asses at the time) that they were essentially spending 100 gallons of diesel, plus a bunch of money, just to make 60 gallons of ethanol. (remember just 7 or 8 months back, when congress was summoning fuel refiners to Washington to ask them why fuel was so expensive? it was a strange time indeed)
Sadly, this arbitrage thing is not new and neither are the effects of it. To return to the example I mentioned in a sarcastic comment over on ZK, Jim Kunstler has often said that in the low-energy economy of the future, he’d probably be running a local newspaper or some other local venture involving the printed word. Umm, no. In the same way that I looked into the energy/materials/profit arrangement of a spinning-weaving-sewing line, I also looked into paper-making. It takes tremendous amounts of heat, mechanical energy, water, and sawn/shredded lumber just to make paper. In fact, it is so expensive in energy & materials that if you had to make the stuff without the artificial energy support of fossil fuels (even coal) your tremendous expenditure in time & calories would mean that you’d have to charge very steep rates for your paper. The only way to make it “cheaply” (and this involves tremendous environmental costs) is if you’ve got lots of dense artificial energy (coal), lots of fresh water you can freely pollute, and lots of mechanical power.
In other words, no more newspapers if you’re living in a low-energy economy. The only way to do that would be if you could get the paper cheaply from someone else manufacturing it elsewhere .. someone who’s still using fossil fuel and mechanical power. Probably no more toilet paper or paper towels either. Hello arbitrage.
Other forms of arbitrage take place when resources are undervalued compared to what they will later be. For example, much of the metal made during the early part of our country’s economic expansion was smelted using charcoal that was obtained by burning the vast hardwood forests that once covered the land east of the Mississippi. At the time, the wood was so undervalued that the forests were wantonly felled just to make charcoal. How much would all that virgin timber be worth now?
The economy of 1880~1910 was expanding madly. European immigrants were still arriving at a rapid rate, and for sure our nation benefited tremendously from not having borne the costs of birth and basic education of most of those imported people .. in essence, we got ready-to-use adults instead of infants requiring years of care and education before entering the workplace. More arbitrage at work.
Not sure if it is possible to find what parts of the 1880~1910 economy were stable and not part of the mad expansion, but it should be interesting to try to find them.