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Zero Sum Game (ZSG)

Wednesday, October 11, 2006 | 07:04 AM | Permalink | Comments (74) | TrackBack (4)
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Barry,

I am shocked to see that such an intelligent person does not understand ZS! Stock markets are not ZS by any means. Wealth is actually created by the stock market, whereas futures and currency markets simply transfer wealth.

http://www.investopedia.com/terms/z/zero-sumgame.asp

So long as someone is willing to buy ABC from you at a higher price it could in theory rise infinitely.

A simple example. John Joe and Dave all like ABC Corp. John buys 100 @ 25. The stock rises to 30 where John sells to Joe. The stock then climbs to 40 where Joe sells his shares to Dave. The stock climbs further and Dave sells his 100 shares back to Joe who likes the stock again.

You see, wealth was created. No one lost money, except in the sense of an opportunity cost. Although John sold at 30 for a small gain, he did not lose any money in this whole process.

Brush up on your homework and keep up the great blogging.

~~~

Mark,

I understand ZSG; I just do not agree with the way it is defined and applied by most folks.

And, I am still waiting for your (or anyone else's) example of that stock that risies but never falls . . . Once you get me that, we can look into the reality of zero sum.

-BR

Posted by: Mark | Oct 11, 2006 7:54:23 AM

I am not an economist. I am a biologist, and our discipline has fought this battle over the laws of thermodynamics in regard to evolution vs. creation for over 150 years.

The earth is not a closed system and human society is not a closed system. We have energy in the form of solar and other sources added all the time.

Sure in any given instant the economics of the human condition appear zero sum, but the reality is that order and entropy are in a constant dance which is affected by the constant influx of outside energy.

Robert Wright, a sociologist, wrote Nonzero Sum almost a decade ago, but his premises are still applicable today. We definitely benefit by cultural collectivism in a nonzero sum fashion-- or why else would be have grouped ourselves into social units rather than fight each other individually.

The economic markets are no different. Yes, individual trades have zero sum characteristics, but the overall benefits of regulated markets is that they create wealth (actually in reality, it is the transfer of energy from solar or geothermal to make order out of disorder.)

Posted by: grodge | Oct 11, 2006 7:56:32 AM

Barry, please, unlike a futures contract, stocks don't require a long holder and a short holder to actually exist (unless you count the issuing company as being short as someone pointed out).

Equities are absolutely not a zero sum game and like I asked before, what does a share of stock represent, figure it out and see why you're wrong

Posted by: Will | Oct 11, 2006 8:08:40 AM

You want something that's always gone up over time? How bout the US stock market, and it's investable. DJIA is now higher than it was in 1990, so who's lost out Barry?

Posted by: Greg | Oct 11, 2006 8:12:01 AM

I think Barry's last paragraph makes the point... "in any non-infinite system, apportionment of costs and benefits is zero sum."

The debate here seems to revolve around the idea of non-infinite. So maybe one believes that the earth has an infinite supply of energy, but I can't imagine that a scientist would postulate that our solar system is infinite. I suppose such definitions depend on your timeline. The same is true for social systems. We may want to believe they go on forever, but they always have an end.

Modern capitalism is premised on the illusion of infinite growth and thus infinite wealth. There is a belief that the government can print infinite dollars or that an individual stock can go up an infinite amount. Somehow I doubt it, but I'll let someone more knowledgeable debate the point.

Posted by: Wimpy | Oct 11, 2006 8:12:07 AM

Is "non-infinite" a fancy way of saying "finite"?

Human systems are not finite, so the premise is faulty.

BR, if you're looking for something to consider, write a blog about how technical analysis is akin to complexity theory, ala Stephen Wolfram.

I started reading your blog as a link from Cunning Realist, and my first impression was how you are a closet complexity theorist.

Posted by: grodge | Oct 11, 2006 8:23:41 AM

Finite systems LOL

I bet next we're gonna hear how world production is actually lower in 2006 than it was in 1896.

Posted by: Craig | Oct 11, 2006 8:29:11 AM

"But do not misunderstand this: In any non-infinite system, apportionment of costs and benefits is zero sum. We have corporate profits at a 53 year record high -- and the wage and income percent of GDP is at a record low. If you think that is a mere coincidence, you have not been paying much attention."

Right, and so we have to dissolve the evil corporations to allow the working man to get his fair share.

Talk about missing the forrest through the trees.

Are you trying to destroy your financial advisory business? You're definitely losing credibility quickly and the credibility pie is definitely "finite"

~~~

BR:

Whatever credibility I have comes from calling them as I see them. If profits are at a record high, while wages are at a cyclical low, knowing and understanding that provides insight into what can and is increasingly likely to happen as we mean revert.

Thats as true for corporate profitibility as it is for GOP control of the House and what that might mean for minumum wage legislation and the impact on Walmart and McDonalds and . . . you get the picture.

Understanding various ways to slice the data and perceive reality -- without fabrication or spin -- is one of the tenets of good investment startegy

Posted by: dan | Oct 11, 2006 8:33:27 AM

Not your best. I had a longer response, but it keeps getting spam blocked.

The above comments seem to cover what I was going to say pretty well.

Posted by: russell | Oct 11, 2006 8:34:31 AM

"So long as someone is willing to buy ABC from you at a higher price it could in theory rise infinitely."

That sounds a lot like the greater fool theory of investing. Although there's always going to be gain in the value of the market (primarily based on GDP growth and inflation) any excess returns away from that baseline are essentially a ZSG. It doesn't have to be linked to a single stock, either -- when one company wins a larger share of the pie (say, UARM), another is probably losing share (NKE). Growth via true market expansion, rather than capture of alternatives, is very rare and doesn't tend to last long.

Pointing to the DOW as a counterexample here is silly, considering it's the only one of the three major indices to be price weighted. It's fine for day-to-day changes, but it's essentially useless for long-term views -- a basket of DOW stocks purchased in 2000 would not track with the growth rate of the nominal index value.

Posted by: T | Oct 11, 2006 8:51:36 AM

Subtle. Good job BR. I almost fell for it too.

Posted by: Robert Coté | Oct 11, 2006 8:56:07 AM

Markets are not a zero sum game. Markets are a "negative" sum game when you factor in spreads and transaction costs.

Posted by: PC | Oct 11, 2006 8:57:35 AM

I am shocked at all the negativity directed at Barry lately. Am I to presume that all of you are big winners in your stock market investing recently? You can only do so much with the data presented by the government.

Posted by: teddy | Oct 11, 2006 9:02:15 AM

I can't imagine, other than sheer bad faith or ignorance, why many commenters have been against Barry's absolutely clear, correct, unobjectionable points, which are very valuable for investment analysis.

His main points are:

* Allocation of finite resources is a zero-sum-game.
* One finite resource is percentage, e.g. market share.

What's wrong with that? They are both entirely obvious. And they are both very important to investment analysis, especially "The Big Picture" macro investment perspectives.

For example in the investment game the goal is outperformance, and performance is a finite resource. Wall Street is not Lake Wobegon, and not all investors can outperform. If one outperforms, another underperforms.

Consider for example real estate price movements: it is a clear zero-sum-game, in that any gains by home owners are paid for by non-home-owners. This has large implications for investment, because it affects the overall level of economic activity, as well as price pressure on various asset classes, and the distribution of spending power between asset holders and non asset holders, and between older and younger investors and consumers.

Similarly for transfers of large chunks of GDP from the bottom 99% of earners to the top 1%, as they have happened in the past 15-20 years: when investing what matters to many is outperformance, and that comes from investing in companies growing faster than GDP. Which suggests that companies whose customers are the middle and lower classes are poor investment targets, as the share of GDP going to their customers is shrinking, and companies whose customers are in the top 1% are a better investment target.

Buffett has made a lot of money by investing in companies whose fortunes were tied, via the sale of branded, aspirational, goods and services to those of the rising middle class, and right now that looks like not such a good strategy, except in India and China of course.

Similarly for natural resources: at least in the short and medium term extraction capacity is fixed (never mind that the overall total is finite, peak oil or not), and allocations of that fixed and thus finite capacity are entirely zero sum games. If China is getting more oil, then the rest of the world is getting less, and prices change to reflect that, and so do the prices of oil company shares.

Posted by: Blissex | Oct 11, 2006 9:05:45 AM

Markets don't create wealth, they put a value on an asset. Saying that people collectively deciding something is worth more than it was before 'creates wealth' doesn't really make sense. Do bubbles create wealth? That's a bunch of people deciding things like tulips are worth more than any concrete value they provide, but are the tulips really worth any more in a realistic long term sense?

At the same time, aren't most transactions non-zero sum? If I buy a cup of coffee for $5 I may think its expensive, but I value the coffee more than the money. At the same time the coffee shop values the money more than the coffee. From a strictly financial point of view it may be zero sum, but not all transactions are taken for strictly financial reasons.

Anyway, interesting topic.

Posted by: crack | Oct 11, 2006 9:06:09 AM

I agree that the markets are not zero-sum, however, perhaps Barry was thinking in the back of his mind that they are becoming MORE zero-sum like with the crowding of hedge funds -- there seems to be a record level of shorting -- although it is only about 6 or 7% of all available shares, last I checked.

The real dilemma, as I see it -- is that the markets do rely on FAITH. Wealth is certainly created but no matter how liquid the markets may seem, it is critical that the majority do NOT cash out or wealth will be destroyed instantaneously.

Hedge funds introduce this very, very dangerous risk. When / if they hit the sell button for short-term gain -- they risk setting off a tsunami of selling. When the shorts who have probably finished covering no longer provide any upside fuel, the major indexes could drop rapidly.

The only problem with non-zero sum is this: Yes, everyone may have millions more than they had in, say, 1980. But as we all know, inflation and taxes tends to reduce those holdings significantly. It's like what Barry was saying about everyone enjoying a higher quality of life because everyone has a VCR -- but the actual cost of a house is now 3 or 4 times the average person's salary, as opposed to 1 year. -- Or maybe I read that in Newsweek.

Posted by: ari5000 | Oct 11, 2006 9:08:31 AM

Lotta Truthiness in some of the comments.

The term is Zero Sum Game, not Zero Sum.

It is an analysis technique, not a stated fact.

I personally believe in innovation, productivity increases, automation and so on, all of which expand the "pie". Oops, a pie is a zero sum game...isn't it...

Sounds like a lot of posters would want to ban the use of the Pie Chart, as being anti-growth.

Posted by: wnsrfr | Oct 11, 2006 9:16:58 AM

From a trader's perspective, markets are a zero-sum game. But equity markets exist not for traders, but to match ventures would not exist without financing with investors willing to finance them, This is a positive sum game. Traders are a zero-sum means to a positive sum end.

[My original comment was longer, but TypePad considers it comment spam. For a detailed account of how markets can be positive sum, read the rest here.]

Posted by: Steve Waldman | Oct 11, 2006 9:34:43 AM

Well, since everyone else is piling on Barry, I guess I will too : )

While we are discussing "markets", let's remember that they are just a reflection of the overall economy. And a Capitalist economy is definitely NOT a zero sum game. That is why Capitalism has succeeded to the degree it has such that it has no serious competition around the world.

Capitalism has succeeded because it creates wealth better than any competing system, even while it distributes that wealth unevenly. Reasonable people can reasonably agree about what steps should be taken to reduce that inequality (possibly at the expense of growth), but that doesn't diminsh the fact of the remarkable wealth creation.

Since the stock market, in the long term, is the summation of the values of all publicly traded companies, and these companies share in the newly created wealth over time, then the stock market as a whole is obviously not a zero sum game, although some trades (buy long/sell short, option put/call, etc.) certainly are.

Posted by: cornerkick | Oct 11, 2006 9:35:31 AM

There is an old saying, for every person that makes a buck, someone lost a buck. I have never heard what you people are saying, that for every person that makes a buck, another person makes a buck.

it is really easy to leave out transaction costs and inflation. Did I create wealth selling my house, or do I just have to go out an pay an inflated price for the next one?

400 engineers at IBM in Austin just lost their jobs. We all know those jobs are going to India. Jobs are a negative sum in this country.

Posted by: me | Oct 11, 2006 9:39:33 AM

Trading is a zero sum game. One winner, one loser. The stock goes up or it goes down. One buyer, one seller.

Investing is not a zero sum game. The value of a stock is the value of future discounted cash flows. Buy stock, reveive cash flows over time.

Currently, most market participants are traders. The value of future discounted cash flows is too low right now (high valuations), so don't invest in stocks!!

Posted by: Mike M | Oct 11, 2006 9:40:38 AM

A company goes IPO. Investors buy the shares. The company uses that money for growth. 1 year later, the company double in revenue, size, profits, etc. Who loses?

Posted by: Jonathan | Oct 11, 2006 10:08:24 AM

Didn't Thomas Malthus try to define the world in zero sum terms in the early 1800s when he predicted the world would soon not be able to produce enough food to feed its population? Malthus fell into the trap of thinking about the world in static terms, not considering technological innovation, ingenuity, etc.

Posted by: S | Oct 11, 2006 10:18:03 AM

or say productivity of people or land etc..sure the quack greenspan exaggerated it..but 1 man hour / 1 acre of land's productivity today is worth lots more than 50 yrs ago

Posted by: ss23 | Oct 11, 2006 11:01:33 AM

I'm really surprised.

Barry is usually a very insightful guy, fighting against the forces of half-baked thought and sloppy intuitions. But here he starts off trying to defend a strong (but wrong) statement and eventually falls back to a useless tautology--"in any system, all the percents add up to 100%'--which is not, fortunately, anything like what economists or complexity theorists (or even the wonkier traders) mean by 'zero sum'. It's a game theory term, and Barry has just outreached his competence.

If Barry really believes that zero sum can be applied to percentages, and thus to everything ever created, doesn't he wonder why the term was invented in the first place? How fantastically useless and redundant! One might as well say 'all groups are 100% of themselves'. How revelatory and inspiring! Why not call it 100%-sum instead of zero sum? Is the farce becoming clear?

Why did this happen? Because most transactions in the stock market, where Barry begins, are indeed zero sum (or slightly negative sum, due to friction and comissions, unless you include the brokers/exchanges in the 'sum', in which case order is restored). But that's a fairly uncontroversial application of zero sum. Barry, being something of a bright but sloppy dilettante (no slur; many of us fall in the same category), extends it past its definition. He's a busy guy, posting several times a day. He didn't actually look up what the term meant. If he had, he might have wondered why those pesky game theorists kept claiming that there were non-zero-sum games like the prisoner's dilemma and such. "What could they be talking about?" he might ask.

Barry, please, we love ya--stop embarrassing yourself and look up the term. Don't distort the intelligence to suit your preconceived (and incorrect) notions, my fellow Dem.

Posted by: CG | Oct 11, 2006 11:09:26 AM