Word of the day: arbitrage

I had to look this one up:

ar•bi•trage noun \’är-b∂-,träzh\

1 : the nearly simultaneous purchase and sale of securities or foreign exchange in different markets in order to profit from price discrepancies

2 : the purchase of the stock of a takeover target especially with a view to selling it profitably to the raider

I’m probably still not confident enough in what that means to try to use this word in conversation. But in the context of the following posts, I think I understand it well enough.

Felix Salmon on the American economy and the desperate need for more government borrowing and spending:

To spell this out: high corporate profits and low levels of job growth are two sides of the same coin. If things were working properly right now, companies would take their excess revenues and use them to hire more people. Instead, they’re basically just letting those excess revenues sit on their balance sheets as cash because they’re scared to invest in themselves. It’s frankly pathetic.

The solution to this problem is nothing complex — the arbitrage is sitting there in the first chart, plain for all to see. The government can borrow at 1.45 percent: it should do so, in vast quantities, and invest that money back into the economy itself. Take a few hundred billion dollars and use it to fix our broken infrastructure, to re-hire all those laid-off teachers and firefighters, to provide some kind of safety net for the millions of Americans who have been out of work for more than a year. Even if the real long-term return on any stimulus package was zero, the nominal long-term return would be well over 1.45 percent, making the investment worthwhile.

Dan Crawford on a financial transactions tax:

There are some significant factors in favor of a financial transaction tax that would reap a few pennies from each transaction. First, it would raise much-needed money from a group that generally can afford the cost. Second, it could act to discourage flash trading, where computer-run programs arbitrage the markets in a way that only those with the sophisticated programs can take advantage, leaving ordinary folk out in the cold. Third, it could be one factor in returning everyone to more prudent approaches to investment — investing for the long term, rather than profiting from arbitraging tiny differences in multiple trades.

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ScoobyDoo

The few cents tax on financial transactions is probably more real in terms of assets than the so-called assets of the flash trader making his casino gamble.
Jay

The net effect of arbitrage is to make separate markets align. For example, if prices of a stock are different in London and New York, then you can make some money buying in the cheap market and selling in the expensive one. The net effect will be to push up prices in the cheap market (because you are demanding stock) and push down prices in the expensive market (where you are supplying stock) until the price is identical in each market. Since the ’80s, this has been done by computers.

In a more relevant note, if workers are expensive in America, but the work can be done more cheaply in someplace like India (even after shipping costs), labor markets can also be arbitraged.
Invisible Neutrino

The problem is, hiding behind those very benign-looking words are very real unpleasant consequences for ordinary people. Since we no longer have an official supranational regime of fixed exchange rates, currency valuation changes are detrimental for countries whose businesses do a lot of importing and exporting. And my country, Canada, has historically had a higher exposure to ex-im than today, but even so it’s still substantial.

Now, our economic policy has been built with the idea of our exchange rate purposely being the shock absorber which keeps governments and the Bank of Canada from having to adjust our economic conditions to external events, but even with that in mind it’s still having an untoward effect: as out exchange rate rises against the US dollar, exports become less competitive and this particularly hurts the auto sector, which drives a large chunk of Ontario’s economy.

So it would be nice if we could maintain a fixed exchange rate against the US dollar and adjust that at yearly intervals, but as it is a dude like George Soros can make a pile of money out of something most of us can’t benefit from – which is slight shifts in the exchange value of one currency relative to another.

This is why a financial transaction tax is a good idea – not primarily to raise revenue, but to slow down capital flows. There’s a reason why China remains nonconvertible on the capital account.
DiscreteComponent

Nice idea that flies in the face of the accepted constitutive beliefs in no taxes and micro government will solve all our economic woes. Like the leaders of the late Communist states denying facts that go counter to the ‘one true faith’ of our true economic theory is the only answer that is politically palatable. That this economic theory is just as out of date as its contemporary opponent is just not relevant to the to these ‘true believers’. That the facts have changed, that the premises are not longer valid just don’t matter. All that matters is holding to the faith in ‘their one true answer’.
TheFaithfulStone

I’m not sure that definition of arbitrage is entirely correct. My understand is that it’s basically anything where you’re taking advantage of price or cost differentials to make a buck without risk.

The arbitrage in those examples is the fact that 1.45%, the interest rate at which the government can borrow is less than the inflation rate. What’s happening effectively is that some investor gives the government money, and then the government pays him back some fraction of that in real terms. That difference is the arbitrage. I’m not entirely sure it qualifies – since I guess it’s theoretically possible for there to be deflation or inflation of less than 1.45% on the 10 year horizon, but that seems pretty unlikely.

But yeah. Here’s a bunch of free money! Why aren’t we taking that again?
ftf123

Financial Transaction Tax: Last gasp ideas out of a dying Europe are spreading like the plague.

UK’s European Scrutiny Committee citing the EU Commission’s FTT Impact Assessment (Even Before the Damaging Relocation Effects): “a 3.43% fall in EU GDP equates to a fall in economic output worth €421 (£362) billion and a 0.34% fall in employment equates to a loss of 812,000 jobs.”

UK’s Economic Sub-Committee of the House of Lords, “The FTT is likely to induce a loss in GDP between five and 20 times larger than the revenues raised from the tax.”

Sweden’s short-lived FTT raised 3 percent of projected revenues, not enough to cover the cost of collecting the tax.
Invisible Neutrino

You need to do more than throw out the last gasps of the wealthy and powerful’s alarmist predictions.
Michael Chui

Arbitrage is a word that needs an encyclopedia, rather than a dictionary, to understand.

There isn’t supposed to be significant risk when it comes to arbitrage. But there are a lot of things that aren’t supposed to happen when it comes to economic theory built off a notion of physics stolen from a time before thermodynamics.

The clearest illustration of arbitrage, to me, is the joke about two economists walking down the sidewalk. The junior says, “Look, a 20 dollar bill!” The senior scoffs, “Nonsense. If there was, someone would have picked it up.”
Chris Hadrick

people who trade for a living would be hit by this too. The huge companies can afford these fees, the little guys won’t. The effect will be to leave only the big players in the game. it’s just another tax anyway.

borrowing a ton of money and spending it is silly too “Instead, they’re basically just letting those excess revenues sit on their balance sheets as cash because they’re scared to invest in themselves. ”

they are afraid because guys like this have the presidents ear. lets borrow tons of money!! what an amazing idea .
RowanS

The definition of arbitrage is simultaneously buying and selling the same thing at different prices. This is, as you might expect, incredibly rare. In finance people tend to use the word in a looser sense to mean the buying and selling of similar things at about the same time, or even just an advantage that one investment or firm had over its peers. It can be one of those jargon words that make their way into all sorts of sentences because no one knows exactly what they mean but everyone has a rough sense of what it means.
Invisible Neutrino

Yeah. I’ve usually heard the term used as a verb (“arbitraging away differences”) and usually with respect to exchange rates.

It is to be noted that if the G20 could sit down and hammer out a new Bretton Woods, a trillion-dollar “industry” (forex ‘trading’) would vanish overnight with few people being the worse for it except people who’d have to actually do honest work for a living instead of moving around bits and bytes in computers to take advantage of little jiggles in currency exchange rates.
TheFaithfulStone

they are afraid because guys like this have the presidents ear. lets borrow tons of money!! what an amazing idea .

I’m reading some sarcasm there.

I sincerely hope you’re not part of the finance industry – because the situation is that you’re borrowing money for an investment which is as close to guaranteed to have a positive return as exists, and then you don’t have to pay it all back. That’s not only a pretty good deal, it’s going to help out actual real people, and accomplish something that desperately needs to be accomplished.

I’m failing to see why it’s NOT an amazing idea, actually.

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Word of the day: arbitrage