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.

Reference

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.

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.

Bad Banks

A bad bank is a bank that is set up to hold risky, problematic holdings of a banks. By doing so, the actual bank can clear them off their books. The transfer of assets take place at market price. Bad banks is a simple idea of moving away that bad parts of the portfolio into another one, so that it doesn’t contaminate the rest. Allowing the bank to focus on it’s core activity of lending. The creation of a bad bank can be done even if there are no problematic assets, but if the bank wants to shift it’s core strategy.

This is a good way of reducing the risk of the depositors. But investors will still lose their money. By separating out the risky parts of the assets, it enables investors to better gauge the health of the company. Usually improving it’s overall outlook and making it easier to raise money in the future.

From a systems point of view this make more sense. Divide and conquer. The manager of the bad bank can then focus on managing the risky assets. This gives more room for investment practice as they are not tied to non-risky assets. The time horizon and risk profile are quite different for different underlying assets.

Over speculation of property assets and the exchange rate of the Swedish Krona led to a major banking crisis in Sweden. By 1992, 3 major banks were insolvent. McKinsey & Company were bought in to solve the situation. They proposed two bad banks that moved the toxic assets of the remaining banks at market price. The government in the end had to bailout at a price reportedly about 2% of the GDP. However, it was a backstop measure for this turning into a larger catastrophe.

After the 2008 financial crisis, this idea gained more popularity. It was seen as a method to handle such crisis without leading large financial institutions to insolvency. Recently the Indian union budget proposed to set up a bad bank to clean-up the bad assets in the financial system.

Circular Economy

Circularity is an important concept within economic systems. In an ideal world, a circular economy will have minimal waste and most of the resources will be continuously renewed and reused. This systematic approach gives equal weightage to the business and the environment. Digitalization can boost a circular economies. It provides the right tools without the added overhead to keep track of different chains in the business.

The fashion industry is a good example where a circular economy can be very useful. Sustainably producing different kinds of natural fibres and dyes is challenging. Circular economy promotes the reuse of clothes instead of production. Renewed clothes can be used for all kinds of purposes, and can unlock a new business segment. Fashion brands themselves have begun to focus on durability. Making clothes and accessories that lasts. Durability is becoming a more attractive trait nowadays. It is a testament to the products quality.

Recently Ikea launched it’s own second-hand store in Sweden. It is part of their push towards getting more life from their furniture. Furniture is a bit more tricky. However, Ikea’s modular approach makes it a bit simpler to replace parts of a furniture instead of the complete piece. They are looking into ways in which furniture can be taken apart and put together multiple times without any damage to the components. This will help improve the overall lifetime of the product.

Circular economies will not lead to an infinite economic machine like the theoretical perpetual motion machine in Physics. There has to be a viable exchange of value at each step of the process.

Resources

Deloitte Report

The circular economy in detail

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.

Related

Sovereign Wealth Fund

CBDC

Why do we value gold?

Baltic Dry Index

This is an index issued daily by the London Stock Exchange. It directly measure the demand for shipping capacity versus the supply of dry bulk carriers. The supply of cargo ships are quite tight as it takes a lot of time to commission a ship. It is more costly to park a ship for some parts of the time. So marginal increase in the demand can push the index quite high.

The BDI is a practical economic indicator on a global scale. THe BDi is also a measure for what it costs to ship raw materials like iron, steel etc. The index is calculated by calling ship brokers around the world to see what the prices are for 22 different routes around the world. Ships are divided based on their capacity.

  • Capemax (10 percent of the global fleet): ships that can carry 100,000+ dead weight tons of cargo and are too big to pass through the Panama Canal

  • Panamax (19 percent of the global fleet): ships that can carry 60,000-80,000 dead weight tons of cargo and can barely fit through the Panama Canal

  • Handymax, or Supramax (37 percent of the global fleet): ships that can carry 45,000-59,000 dead weight tons of cargo

  • Handysize (34 percent of the global fleet): ships that can carry 15,000-35,000 dead weight tons of cargo

BDI is a very visible indicator of demand for materials and commodities globally. It is a simple index and is difficult to manipulate. Since the index is directly calculated from prices around the world it is driven by supply and demand, it is shielded from the involvement of government, speculators and other key players. BDI usually goes up when the economies around the world are growing, the demand and there in the prices of commodities grow, companies and stock prices around the world continue to increase in value

Reference

Baltic Dry Index

Bubble

A bubble is an economic event where the market price of an asset rises rapidly. Usually, this sudden rise of price is followed by a crash or a drop. Like most market phenomenon, this too is driven by market behaviour. A bubble can occur at any time. During a bubble, there is a large transfer of money to parts of the market experiencing rapid growth. Once the bubble has burst, the wealth is transferred back.

There can be many reasons as to why the market behaves this way. The dot-com bubble of 2000 was fueled by the collective illusion that internet based businesses will have very high leverage and low costs to run a business. However, that was not the case. Making an internet business viable was hard. The speculation led to a huge increase in prices of such companies.

Why do we value Gold?

From the periodic table, it is easy to dismiss the elements that are gaseous or liquid in normal pressure and temperature. They wouldn’t make a good currency anyway. Then comes the alkaline metals in the periodic table. They are too reactive to be considered for everyday use and exchange. And the same applies to radioactive elements. Then comes elements like titanium, zirconium. Very durable and stable. However, it required specialized equipment back in the day (circa. 1000BC) to extract these elements from its ore. Aluminum was hard to extract as well and Iron rusts. Then we are left with a few elements that are known as the noble elements. “Noble” because they don’t easily react with other elements and that means they occur in nature as itself. They are Platinum, Rhodium, Palladium, Iridium, Osmium, Ruthenium, Silver and Gold. A problem with the noble ones except for Silver and Gold is that they are so rare and would be very hard to forge coins out of them. Silver tarnishes over time, but Gold relatively does not. This inertness is one of the main reason why Man has used it over thousands of years as a form of currency.

Back in the day, currencies were tied to Gold. Meaning that each paper note of a currency is backed by and equivalent amount of physical Gold. But during the Great Depression, countries severed this ties so that they can print more money and reflate their economies. More recently, the US stopped using Gold as a backing in 1973. And with a steady supply of Gold and varying demand, it can swing the price quite a bit. The bottom-line is that gold inherently did not have any value. The society during different times in history assigned it value. This could be the reason as to why many still use Gold in their portfolios.

Reference

Gold, BBC