Why Capitalism Works And Socialism Doesn't: Arbitrage
/If you can buy something cheaply and immediately turn around and sell it for more, chances are you will do it. Why shouldn't you? Is there something wrong with that? This is completely normal and pervasive human behavior. This behavior is also a source of a very large percentage of the wealth in wealthy countries where such behavior is permitted. It is also the reason why, in market economies, comparable things almost always trade for very comparable prices.
But of course, in a world of socialism -- that is, where a government attempts to create perfect fairness and justice by means of coercive distribution -- arbitrage poses a mortal threat. Do you understand why? If not, there are some good examples coming out of Venezuela, not to mention the ongoing saga of "affordable housing" here in New York.
At the Washington Post's Wonkblog on Monday, a guy named Matt O'Brien reports on the ongoing disaster in Venezuela. The title of the article is "Venezuela's death spiral is getting worse." I will give serious credit to Mr. O'Brien for actually doing some investigation of what is causing Venezuela's problems. (Contrast that to the likes of idiots from such outlets as the New York Times, CNN and Time Magazine, cited in my posts from May here and here, who purport to give reasons for Venezuela's economic disaster without ever mentioning socialism, price controls, nationalizations, or anything else of significance.)
Venezuela of course has made a run at creating perfect justice and fairness by the device of price controls. Included among items with controlled prices are most consumer staples, as well as the currency itself. As a result, the consumer staples with controlled prices have completely disappeared from stores. As to the currency, you can't buy anything with a bolivar, so you need to get dollars; but you can't get dollars at the controlled price unless you are somehow connected. On the other hand, if you are importing, say, butter, and you have the right connections, you can get the dollars. Yet somehow butter still does not appear in the stores. The government blames "hoarders" -- but is someone really hoarding tons of butter somewhere?
O'Brien describes how this works in the real world. And really, it's extremely simple. It's just people engaging in obvious arbitrage that presents itself. For example, as to butter, O'Brien links to this 2014 article from The New Republic. The essence is this: Suppose you get the government license to import butter, and are given the right to buy enough dollars to do it at the official rate of about 7 bolivars to the dollar. So you buy a dollar for 7 bolivars. Now, are you actually going to buy butter with that dollar, or are you going to turn around and go to the black market, where you can now get well over 1000 bolivars for that dollar? Probably, you'll buy a little butter to cover your tracks, and bolivars with the rest. From TNR:
If you can persuade the state to sell you $17 to import butter, you'd have to be insane to spend it on five kilos of butter that you can only sell for 545 bolivars, because that same $17 in the hands of your local black market currency operator will buy you almost 1,450 bolivars. [It would be far more bolivars today.]
As it turns out, there's a simple fix: fudging the receipt. Say you import 1 kilo of butter—just get your foreign supplier to give you paperwork showing you've imported 2 kilos. The first $17 will buy 5 kilos of butter and net you a modest 545 bolivars. But the second $17 you can sell on the black market, for 1,450 bolivars. In this example, 73 percent of your income comes from the currency deal rather than the sale of butter. . . .
It's easy to see how the actual butter becomes an afterthought in a deal like this. The more the official and black market exchange rates diverge, the bigger the profits to be made out of dollar arbitrage, the more onerous the clean part of the business becomes. In the end, "butter importers" are no such thing: They're currency arbitrageurs, with a loss-making side-business in butter imports.
By the way, the divergence between the official and black market exchange rates has widened greatly since 2014. Of course people more and more spend their time arbitraging the currency rather than distributing butter (or anything else). People are not stupid. A version of the same process goes on with every price-controlled product in Venezuela.
As usual, you would think that here in the U.S. we would not succumb to such idiocy; but you would be wrong. Fortunately, we don't have much in the way of a price-controlled economy. But New York housing is certainly one large exception. We have about a million apartments subject to what is called "rent stabilization," plus we have the big new so-called "affordable housing" initiatives of our genius Mayor de Blasio, whereby small numbers of low and mid-income people win lotteries and are awarded the lifetime rights to apartments at as little as 10% of market rents.
Would anybody be so crass as to think of arbitraging these opportunities? Of course, that's what makes Airbnb such a hit in New York. Needless to say, our legislature is outraged at tenants handed subsidized and discounted apartments and turning around and making a profit for themselves. The Wall Street Journal today reports that a bill has passed both houses of the New York legislature that would impose criminal penalties of up to $7500 on any Airbnb host who advertises rentals of fewer than 30 days in a New York multi-family building, unless the tenant will be present during the rental. The bill currently awaits the signature (or veto) of Governor Andrew Cuomo. Well, this kind of economic thinking sure works in Venezuela! But somehow, literally everyone in New York thinks this "affordable housing" thing is a good idea.