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Arbitrage: An Answer and an Absurdity

— September 23, 2016

A story I heard on NPR recently highlighted the income potential of retail arbitrage. Fred Ruckel and his wife Natasha make a particularly effective cat toy, and Fred and sold it in his Amazon shop for US$40. Eventually he discovered that scalpers were flipping the toys on eBay for $20 more. It gets worse: when the buyers received their eBay purchases in Amazon boxes, they did a little sleuthing and discovered that they paid much more than they should have, so they would return the product to Amazon at the Ruckels’ expense, costing Fred $10,000 over two months while the many scalpers kept their profits. Perhaps surprisingly, this is not illegal. Arbitrage is the way a lot of money is made in the world.

At its simplest, arbitrage is the purchase of a commodity at a low price, and subsequent sale of that same commodity at a high price. Sometimes this is useful, such as when caravans would purchase tea and fabric in China, load it on their camels and traverse the old silk road, selling those same goods for a much higher price to wealthy medieval Europeans. Similarly, when someone buys a box of individually-sized bags of potato chips at a warehouse store and distributes the chips throughout their vending machine route, the availability of a salty snack in an office break room is a convenience that may be worth double the original price to hungry office fauna. While the middleman didn’t necessarily add any value to the items, he did make them accessible to people willing to pay for them, a service he performed for pay.

Extent of Silk Route/Silk Road. Red is land route and the blue is the sea/water route. Derivative mapwork done by Splette, courtesy of Wikimedia Commons.
Extent of Silk Route/Silk Road. Red is land route and the blue is the sea/water route. Derivative mapwork done by Splette, courtesy of Wikimedia Commons.

The trading of commodities for profit becomes less socially useful when the traders involved not only fail to add value to the items, but raise the price for anyone else trying to buy them in the same market. This is where day traders famously make their money, as they (or their increasingly common computer surrogates) capture the fractions of a penny difference in price between other people selling slightly low and buying slightly high. The few clock-ticks that they spent holding the stock did not make it any more valuable, nor did it increase convenience, but it likely prevented someone’s retirement account from returning a few more cents. Keep doing that over time, and it’s possible to make real money by clipping the world’s economic transactions.

Beyond high-frequency trading and speculating in the currency market, there are other unsavory scams that profit from arbitrage. Researchers Tamar Kricheli-Katz and Tali Ragev discovered that a product sold by a woman on eBay went for an average of 20% less cost than the same product sold by a man. There was even a differential between what buyers were willing to pay for a gift card from male and female sellers, despite gift cards being worth a set amount of money (say, $100). Forbes suggested the possibility of profiting from gender arbitrage as a way to reduce this differential: if enough people purchased items by underpaying women and sold them for a higher price by being (or posing as) men, eventually the market’s invisible hand would solve the sexism problem! (In the meantime, female eBay sellers may wish to adopt more neutral monikers.)

There is even death arbitrage! Insurance is designed to spread risk, so that people who experience a disaster or other setback have the blow cushioned by others who paid into the same risk pool. Minimizing risk was the reason some companies began to issue “death bonds.” These bonds are purchased and held by two people, who might pay $80 for a $100 bond. If one of the pair dies, such as a spouse, the survivor can cash in the bond for its face value. Hedge fund manager Donald F. “Jay” Lathen Jr. subverted this service by finding people in nursing homes and hospice care and purchasing these bonds jointly with them. When his co-signer died, Lathen’s hedge fund would profit, sharing a portion of the proceeds with the deceased’s estate. Because the companies expected that bond buyers would be relatively healthy people with years to live, not knocking on death’s door, the bonds were priced lower than they would have been had they known they were selling them to the terminally ill. If the bonds had been priced appropriately for buyers that were going to die soon, they would lose the risk-balancing insurance function for the intended market. Trust a hedge fund manager to figure out some way to profit from death!

Most arbitrage is far more pedestrian, however. The Marxist view of the relationship between Capital and Labor is a kind of arbitrage that takes advantage of the cost of labor (often low, and lower in some places than others) and the cost of the products of that labor (often higher). If a capitalist invests in a factory or farm that takes commodity labor and turns it into goods (think of goods as lumps of solidified labor), he can pocket the difference as his profit for organizing that sweet gig. The lower price for labor in third-world sweatshops has driven the globalization of industry, as buying labor inputs at even lower cost creates a larger profit, but the economic players involved are beginning to realize that unemployed or low-wage workers cannot afford to buy as high as they would like, if they can buy at all. While capital was busy shoveling jobs offshore, Americans have had to invent other ways to support themselves.

Which brings us back around to retail arbitrage. Taking eBay orders for someone else’s innovation at a higher price is one way that money can be made by people with few resources to invest in other opportunities, if jobs are scarce. However, doing so adds negligible value to the products sold, while making them harder for other low-resource people to afford. The fact that increasing numbers of everyday Americans are turning to flipping makes me wonder how long this situation can go on. If we must rely on the creators of value to be paid abysmally low wages in order to support a country of middlemen, perhaps we cannot afford as big of an economy as we would like.


Why Middlemen Are Taking Over The Global Economy
Bitcoin Traders Should Explore Foreign Exchange Arbitrage Opportunities
Profiting From Gender Arbitrage
Hedge Fund Manager Profited From Death Arbitrage
The Political Economy of Global Labor Arbitrage
The Future Can’t Pay Its Bills

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