Lumber Crisis

2021, among other things like toilet paper, boba tea and pickle jars, saw a shortage in limber. Let’s try to understand what led to the shortage and the subsequent high prices.

After the financial crash of 2008, home building took a hit. Causing the lumber prices to fall. In addition to that, a lot of woodlands were lost to bark eating beetles. And this eventually led to the fall of prices in 2008.

Prior to the Covid crisis, in a similar fashion we lost about 6.2m acres of woodlands to wildfires in 2017-18. And when the pandemic came, investors expected history to repeat itself and they were short on the prices (expecting them to go down). Similarly, wood suppliers cut production in anticipation of low demand.

But what happened was that more people wanted to renovate their homes, and complete all the projects they always wanted to do. Now since, they have no other option but to do it. Combine a weening supply and a surging demand led to a 377% increase in the price of wood this year.


Why is lumber so expensive right now?

Special Economic Zones

A special economic zone(SEZ) is a designated area in a country with special economic regulations to incentivize foreign direct investment. Usually these incentives are in the form of tax reductions, labour regulations, customs etc.

A SEZ became popular in the mid 20th century. The primary purpose were to attract foreign investments. Now they are being used to attract domestic investments and for eventually encouraging investments outside of the zone as well.

A second order outcome of having a special economic zone that attracts a lot of companies in the same geographical is the there are more chances of cross-pollination. In terms of employees, competence and technology. Synergies like having a large part of supply chains concentrated in a small area is attractive for businesses. It can save costs and both ends of the chain and improve the pace of innovation. A textbook example is the Shenzen Economic Zone. It really found the sweet spot for manufacturing electronic goods and soon dwarfed global supply chains.

The economic activity from a SEZ usually spills over outside of the SEZ too. SEZ that are big enough can eventually have cities built around them to facilitate the labour market and provide better logistical support for the SEZ.

Big Mac Index

Different currencies around the world have different purchasing powers. Purchasing power is defined as the amount of goods or service you can buy for the same amount of money. Purchasing power not only varies from country to country, but also varies over a period of time.

The amount of goods you could buy for 10$ now is very different from what you could buy in the 1950’s.

Different countries have different interest rates, budget deficits, inflation/deflation, import/exports, GDP. And all of these factors contribute to different purchasing power.

One common way purchasing power is compared across countries is buy calculating purchasing power parity(PPP). PPP is a measurement done across the world that uses the price of specific goods in each country.

To avoid large errors in this calculation a basket of goods is chosen. The categories include Food and Beverage, Housing, Transportation, Medical Care, Education, Apparel, Recreation etc.

The Economist introduced the Big Mac Index on 1986. This became an informal way to measure the difference in purchasing power in various countries. The Big Mac index is the price of Big Mac in the respective country compared to a reference to give an idea of what the purchasing power of the currency is.

However, the index can only be calculated in countries that have a McDonalds. Another limitation is that the Big Mac Index can end up measuring the local willingness to pay for a fast food burger.

Comparative Advantage

Comparative advantage describes how trading parties will choose to produce more of a good that they have a comparative advantage of, and use that to trade for other goods that they don’t have a comparative advantage in. Comparative advantage forms a foundation for international trade.

Comparative advantage is why there are call centers in India, manufacturing in China and highly specialized capital intensive labor in the US. It makes sense for China to do all manufacturing electronic goods and trade it to other countries that are specialized in producing other goods.

Conversely, an oil producing country will have a cheaper access to raw material for chemical products. They have a lower opportunity cost of producing more chemical products compared to countries that do not have access to cheap raw materials. This drives more chemical production in oil producing countries.

However, there are cases where countries, governments and business lobby together to protect niche interests. This can effectively keep foreign, cheaper goods out of the market to protect domestic businesses. However, in the long term, this might not good solution as neighbouring countries will be better off as they have to spend less to get the same goods.

Parimutuel Betting

Parimutuel stands for mutual betting. All the bets of a particular type are placed in a pool after deducting the house cost. This kind of betting is different from fixed-odds betting in that the payout is not known at the time of placing a the bet.

The payout is determined after the event has taken place and the pool is split to the outcome sustained. This kind of betting is common in horse racing.

An important innovation in this betting system was the introduction of a Totalizator. Nowadays, these are computers. A totalizator read the current pool and betting spread and calculates the odds and payout and show it to the public. This encouraged even more betting as it gave a feedback to the ones betting.

Gini Coefficient

The Gini Coefficient is a statistical measure of dispersion. It is an indication of the spread of data similar to standard deviation and variance. In economics, the Gini coefficient is used to represent the income inequality within a demographic.

This coefficient was developed by the Italian statistician Corrado Gini. The Gini Coefficient can be calculated for both continuous distributions and discrete data.

Over the last century in developed countries, there is a trend of increasing inequality. While in developing countries, this is a decline in inequality since the 1980’s. THis can be attributed to all the new jobs created due to technology and globalization. Countries following the nordic model tend to have a lower overall Gini coefficient.

Gini’s coefficient is used in other disciplines. For example, it is used in ecology as a measure of biodiversity in a region. In health, it is used as a measure of inequality of health related quality of life in a population.

Unit Economics

Unit Economics is a neat way to look at the fundamental economics of a business. A sanity check. It starts with defining a “unit”. A “unit” could be a product sold or a customer acquired depending on the kind of business and business model. Unit economics would then describe how much value is created from this “unit”.

Unit economics help you understand how much has to be given to perform a unit transaction that is core to the business. Especially when analysing a business, unit economics provide a quick way to check the feasibility of the business. It would be quite clear if an insane amount of money has to be put into for acquiring one customer. Or if the charges on logistics were eating up too much of the margins.

The unit economics and it’s various components can be projected out in the future. This will give you a fair idea as to how the business would have to perform to stay solvent. Whether that is realistic or not is another question. Comparing figures in a per-unit basis eliminates the possibility of comparing different things all together. We do not want to compare apples to oranges.

An example of a unit economics for a restaurant would look like this. From a basic sense, a restaurant cooks food for their customers with a marked up price to earn a profit for the product(the meal) and service. So the margins of a restaurant meal would be the difference between the price of the meal and the cost that it took for the restaurant to make it. The cost can then be broken down into the hourly wage of the workers, the cost of running a kitchen, the cost of the ingredients etc. This would give us an idea as to how much would have to be spend and what each dish has to be priced to obtain a margin that would justify running a restaurant business.

Perfect Information

Perfect information is a concept related to game theory where every player in the “game” is fully informed of all prior actions. An example of a game that allows for perfect information is Chess. Every move made right from the start of the game is visible to both players.

Applying this to a market, perfect information is when all market participants are aware of the current market prices, their own utility and own cost functions at any point of time. Complete information would mean that all strategies, cost functions, steps of all players are common knowledge throughout the gameplay. Both far from reality, but this concept has been used to solve different forms of games.

The assumption of rationality of buyers is a big one in the case of imperfect information. A rational buyer would not buy anything of lower economic value in exchange for money. However with imperfect information and in most cases also incomplete information it is hard to assess the value of a purchase say in the stock market. In a way, the decision of a “sell” or “buy” is dependent on the decision made by others as it would affect the price of the stock.

Perfect information for all market participants would still not be enough to assume everyone will behave rationally. Even if all information is available, they might not be credible. The future can change and can render the information unusable. Buyers will operate on a layer of personal biases nevertheless. Not to confuse this with complete information. Knowing all possible market scenarios and moves of market participants , although impossible with current technology, will not lead to rational decisions. Even with perfect and complete information we tend to compensate for that in our own way.

Industry Drivers

There is usually an industry or legislation that drives a lot of money towards research and innovation. 2 examples to this is the photography technology and batteries. As smartphones became more and more common and the cost for storage became much cheaper. There came a push to reinvent the camera imaging technology. Technologies like high dynamic range imaging (2010), panorama photos (2012), True Tone flash (2013), optical image stabilization (2015), the dual-lens camera (2016), portrait mode (2016), portrait lighting (2017), and night mode (2019) were all improvements made as part of this. The second example is of batteries. The primary driver for battery innovation was consumer electronics. Starting from devices like the Gameboy, the Walkman to early mobile phones and smart phones. But now the push is from the automotive industry. The scale is much higher and so are the technical requirements on the batteries. There is more focus on profitability and sustainability with emphasis on not just the end product but from the whole supply chain starting from an ore to the recycling plant.

Petrodollar System

A petrodollar is the U.S. Dollar paid to a country for the purpose of buying oil. This system came about in the 70’s during the oil crisis leading to high prices. The petrodollar system helped make oil prices more stable. in a way, this pegs the value of oil to that of the U.S. Dollars. The spending power of this money which is received by oil producing nations will be affected by the core inflation and other economic factors affecting the USD. Petrodollar Recycling is a way in which these USD can be recycled back in to the US. This can be done by purchasing T-bills or by contracts in American companies leading to technology transfer. Most countries maintain a sovereign wealth fund mainly funded with petrodollars for local finances.


Sovereign Wealth Fund


Why do we value gold?