September 8th, 2015

Qualifiers Matter: Planet Money Misunderstands the Law of One Price

I apologize for this, but I cannot find the transcript for this episode. I was sort of annoyed that I actually had to listen to the whole thing.

This is a Planet Money episode/podcast about retail arbitrage. Specifically, it is about people who go to big box stores such as Target and Toys R Us, buy stuff retail, and then warehouse it for later sale through Amazon as 3rd party sellers/FBA at a sufficiently higher price to justify the activity (cover costs of driving around, storing, shipping, fees to Amazon, their time vs. whatever other job they could get, etc.). Planet Money mentions that this appears to be a violation of the Law of One Price. Here is the wikipedia entry on that idea from Econ:

They discuss _why_ someone might pay $45 for a Big Box of Wipes from Toys R Us, vs. driving to the store and buying it for less than $20. Here, in case you didn't pay attention or didn't look at the wikipedia page, are the relevant qualifiers:

"Assume different prices for a single identical good in two locations, no transport costs and no economic barriers between both locations."

Okay, so right there. "No transport costs" meas that it costs _someone_ gas/time to move the Big Box of Wipes to the desired location (the address the buyer on Amazon supplies, presumably). Let's assume that the person buying the $45 Big Box of Wipes on Amazon either lives in an very urban area (lots of bodegas where you can buy tiny packages of wipes for $20) or a very rural area (where it will take at least 3 hours to drive to the nearest Toys R Us, and the nearest C store is an hour away and again, either carries no wipes, or only very tiny packages, or ones which have a fragrance or wtf which is objectionable) or on a military base (an APO, FPO, etc. address) in a country which sells small packages of wipes for an astronomical price, if at all, and which ordinary shipping of a Big Box of Wipes would be > $20.

And now we are done! The Big Box of Wipes is actually a screaming deal in all these locations! Did Planet Money enumerate any of these? No, they assume that people buying shit for pets and babies are relatively price insensitive because They Just Need the Gosh Darned Wipes. Which, I will admit, is possible. And as long as we are exploring that territory, let us contemplate the prototypical Prime customer of long standing: above median income, two full time jobs, hiring some amount of help around the house (typically cleaning and some child care). I didn't know this before I was hiring child care on a regular basis that some times, the child care actually isn't there to care for the kiddo, but actually to do things that desperately need to be done and which you cannot do because the kiddo is sick or objecting to going grocery shopping or whatever. Given the choice between paying someone to care for the kid while you go to the store or sending the person to the store with a list, it's almost a coin flip what's gonna happen on any given occasion (unless there is live flame shooting out of the baby's orifices in which case, def sending the help to the store).

Let me tell you a little secret: it is almost always cheaper, and it is _always_ more likely to get you precisely what you wanted rather than whatever the person doing the shopping saw first, if you have _Amazon_ employees pick stuff out and ship it to you, versus sending someone to the store to do your shopping. Even if you pay $45 for a package of wipes (which I do not believe I have ever done, altho I certainly overpay for my fragrance free shampoo and conditioner, and am happy to do so because it takes way too many phone calls to find it on the shelf at any actual store, never mind driving there and finding out they are out of stock).

So. No violation of the Law of One Price. Most people paying $45 for a Big Box of Wipes which they "should" have paid $20 for are actually getting a huge price break, because they didn't send the doctor/lawyer/dentist/engineer parent who would really rather go for a bike ride on a special run an hour each way to Costco to buy more wipes, never mind the health care savings down the road when the manager/accountant/administrator is in good shape because they got enough exercise and thus doesn't have to spend a bunch of money on water pills, statins and a personal trainer to get _back_ into decent shape.

Bubble or No?

Obvs, the strongest argument _against_ the idea that Silicon Valley or some portion thereof is experiencing a bubble is the enormous quantity of people asserting that publicly and at some length. Here is a recent sample of We Are In A Bubble, People, How Could You Have Any Doubts coverage:

In much the same way someone assembled a bunch of Wow Amazon Is Kind of a Tough Environment stories and used them to argue something or other along the lines of Amazon is Teh Evil and Must Be Something Or Othered, Nick Bilton here has taken a number of stories involving SF being more expensive than other places, and foolish people having a bunch of cash for the first time in their lives and turned it into a morality story of Yes It Is All Going To Crash. Again. (Apparently, people building really tall buildings is a sign of incipient bubble popping. Who knew?)

On the other hand, there are some odd bits of commentary out there that make me feel like some generally sensible people seem to be collectively losing their mind whenever they talk about companies like Uber.

Basically, Uber will get into carpooling and they will Make A Ton of Money Doing So. Self driving cars. Not _actual_ self driving cars, and no one addresses what happens to the car when the car poolers get out of the car at their destination (how is this not ZipCar, anyway? Or maybe ZipPool?). In much the same way that El Jefe got a little confused by the margin on used books back in 1996/7, Thompson is a little confused about per mile costs and how you should calculate them. (Heck, I was just complaining this morning about Planet Money misunderstanding the Law of One Price.)

These are easy mistakes to make. And it's okay to make mistakes. But bubbles happen when people forget that mistakes will be made and start valuing things based on permanent perfect performance. I don't think we're there yet, but commentary of this sort gives me pause.

Of course, it is sort of important to an investor whether we are in a bubble or no, and if so, the extent and nature of the bubble. And it is important to _everyone_ what public decision makers and the investors conclude and what they do based on their conclusions. For example, nearly everyone in favor of the bubble theory has a single goal in mind: Raise Interest Rates. Raising interest rates will starve the bubble of fuel (no more free money and no more unicorns). Of course, starve a bubble of fuel and it doesn't stabilize or deflate slowly or "come in for a soft landing". It's ugly. That's what raising interest rates tends to do: cause a recession.

I have observed before that there is a specific group of people that _desperately_ wants to raise interest rates (when I'm mean about it, I call them "parasites" and "the olds" -- these are retired or would be retired people who have amassed a pile of money or very conservative investments and they are pissed that in the current free money environment they cannot get any return for the risks they are prepared to take, forcing them to "sell principal" -- goddess, I cannot tell you how much I hate that investing meme -- in order to have money to live on/play with). It is my firm belief that most of the bubble talk exists because this audience is slavering for proof of a bubble -- or a bubble in its early, formative stages -- or really, any kind of fucking asset appreciation at all, so that interest rates will rise and they can leave their money in CDs and Treasuries and similar, and live of the few percent they get annually. Asset inflation! Oh, woe! Or, perhaps, Oh, whoa.

Are assets increasing in value inappropriately? Let us imagine a three bedroom house which is served by adequate to good schools at a reasonable commuting distance from a stable and increasing source of jobs. If that particular house is located in certain neighborhoods in, say, Seattle, the owner of the house is experiencing a whole lot of pain. Every year, their property taxes go up (my sympathy is limited -- the millage in Seattle is very low, especially when you consider all the amazing services you get, like good public pools). Worse, around them, houses are being torn down and replaced by multiple houses, often connected together. The yards are going away, traffic is getting worse and honestly, the sewer is a hundred years old and was not designed for the number of people now living in the neighborhood.

This is a bubble, if you are an idiot and think that the only measure of a bubble is an increase in price. But that's not the only measure of a bubble. The real measure of a bubble is _oversupply_. That fucker pops not because the price soared to some insanely high level. That fucker pops because the buyers either lost interest at that price point -- or lost interest, period.

Let us consider these in order. The buyers lose interest, period. In this case, Seattle becomes a bit of a ghost town after the crash: Will the Last Person Leaving Seattle Please Turn Out the Lights. The second case: the buyers lose interest at the current price, in which situation the price drops until buyer interest resumes. There was a really good reason why that sign got posted in Seattle, and it was experienced by urban neighborhoods full of nice houses served by adequate to good schools at a convenient distance to a stable and increasing source of jobs all over the country. That was white flight. Is white flight happening in a city near you?

I didn't think so.

The only time a seller gets burned when they cannot find buyers at a price point is when the price point is higher than what the seller paid (with some fudge factor to account for transaction costs and a few other odds and ends). In order for that to be a significant problem for ordinary people, there has to be a lot of flipping. Which I am not seeing. Are you?

Let us now turn this framework and point it at Unicorns. Let us take the canonical unicorn: Uber. Who wants to see Uber go away, and is not a medallion owner? Precisely. There is, I am sure, a lot of room to maneuver around the value of a given share of Uber, but should Uber IPO (wait, has it already? No, no it has not), I am reasonably certain there are a lot of people who want to own Uber at _some_ value. Will that value be higher or lower than what people paid for Uber shares in the private market? An interesting question! And if it is lower, will it be enough lower to really hurt? Yeah, I didn't think so either.

Much less clear is the case of the House No One Wants At Any Price. Supposedly, an Italian town is giving away houses (there are a lot of qualifiers on this), and of course there is always Detroit (but honestly, given Detroit's millage, people should be _paid_ if they are willing to take that burden on). Which Unicorns are Detroit houses?

I don't know. I'm sure there are at least a few of them. But Bubble or No, a smart investor is supposed to be buying houses they'd be happy living in for a period of several years. If you buy a house intending to flip it for a profit quickly -- or you buy shares, intending to sell them for a profit quickly -- then you are not a bull (like me) or a bear (like Robert Shiller). You are a pig.

And pigs get slaughtered.

In the meantime, the idea that we should be raising interest rates when there is zero indication of inflation (and some risk of deflation) and some parts of the world's economy are already in fucking free fall is offensive at the core. Suck it up, do your due diligence, and try to discourage your more foolish friends from participating in penny stock schemes or whatever the Fraud of the Month is. We do not need to cut everyone off from cheap/free money just because someone, somewhere is being rewarded for innovation that is making a whole bunch of people's lives better (at the expensive of some others, obvs).

ETA: Further evidence that there might be some kind of tech bubble: I now receive emails (clearly automated) trying to get me interested in jobs on offer. Given that I have been retired since 1998, and this hasn't happened for over a decade, it is clear that the tech sector is enjoying a high degree of employment.