Stock markets, I can see- they existed and exist to share risk and profit. But shorting and arbitrage, it's much harder for me to understand those.
(and yes, that VP was a sociopath)
If there is an imbalance in the market, someone will balance it. That's how it works. Let's say you have two different securities, that both represent the same underlying aspect of the economy. This happens all the time; there are multiple ETFs that represent the same basket of stocks, there are options and futures on those ETFs, including different types of futures that represent the same ETF but at different levels of leverage, there are options on those futures, and so on. All of this exists because there is no reason for them not to—people believe they can make money, reduce risk, or whatever by using these derivative instruments, and maybe they can.
But all of these stocks, funds, and derivatives are valued by one thing, and one thing only: their price on the open market. So, what happens when one of these funds get out of whack with the value of its derivatives, or even the underlying stocks themselves? Remember how we had multiple securities representing the same underlying aspect of the economy? Well, one is now worth more than the other, despite the fact that they represent the same thing. There's an imbalance, and if it gets too far out of balance, people are going to realize, wait, I can just buy 500 shares of SPY and short one ES contract, and that's free money! And that's entirely correct, you can. But the result of doing so is a minor market correction; the price of SPY goes up and the price of ES goes down, and boom, we're back in equilibrium.
So, arbitrage is a necessary and unavoidable aspect of the stock market. You can't have a stock market without arbitrage, because the stock market reflects so many different facets and ways to trade ownership and value of companies. Arbitrage is, in essence, the means by which information flows between various aspects of the market, and it connects them together so they effectively move in lockstep. It is nothing less than the market leveling itself, just as water poured into one side of a swimming pool fills every part of the pool.
It means you can actually ask the question "how many dollars is a pound worth" and get a meaningful answer.
If arbitrage wasn't possible for some reason, and it's a natural phenomenon so that would have to involve pretty horrific levels of state-backed control, then the answer would be:
"It's $X in London and heading down, was $Y in New York yesterday and heading up, and $Z in Chicago but you probably can't get an account there because it takes ages and requires special paperwork, and <thousands of additional prices>"
You would then spend the rest of the afternoon attempting to figure out how the hell to do a basic international trade or FX transaction and by the time you'd finished reviewing the prices they'd have all changed again.
Arbitrageurs seek out and correct fixable price disparities, thus enabling you to talk about one global price for a particular type of trade. This has tremendous value for everyone.
2/ people do it for their own (expected) personal profit
3/ at the market level, these transactions contribute to price discovery
You could imagine banning currency arbitrage, but then you’d have to at the same time enforce somehow consistent prices on all markets (I.e. literally do the same thing as arbitragers do)
Someone outside of finance exchanging one forex for another could get a more fair rate if their exchange is more efficient due to increased liquidity.
But by the same token, the other side of that trade is getting a less favourable (but still more "fair") rate
Longing == buying a share
Shorting == selling a share
Robber Baron Capitalist comes in and says "hey wait a minute, there's money to be made!"
He starts buying goods in A, then selling them in B.
This is a very, very stupid idea, your 5 year old could have it. So that means as soon as Business A figures it out, B , D, E, and F aren't far behind.
The net for people in Market B is that now they don't pay the previous scarce price, but something closer to Market As, and more people can afford the good. This means that someone does all the work of building out all that logistics for us, simply to exploit the price differential.