One Giant Casino: Investing vs Gambling
The recent rise of prediction markets has been perplexing. The United States government has been risk-adverse when it comes to gambling laws in the past, ensuring proper protections and procedures are in place to protect people from predators and themselves. Gambling is generally considered a harmful activity to society, one that is easily addictive and detrimental to those who partake.
With that background in mind, it's difficult to fathom how people can now place wagers on almost anything, from Federal Reserve interest rate policies to the weather itself. It seems our economy is becoming a giant casino, and it's hard to argue against it.
Capitalism has always required folks to take risks. It’s a natural and healthy part of the business cycle. Some risks do not pay off, and some are not worth the potential benefit. It is up to the investor/owner to decide. However, the line between investing and gambling is becoming more blurred with each passing day, and it's difficult to determine what is a healthy risk to take vs not.
Some argue that everything is gambling, including the stock market. After all, isn’t it essentially a wager on the price going up? In addition, the recent popularity in options trading, where folks have the chance at outsized returns for a fraction of the cost, further pushes forward the casino culture.
The reason for this goes deeper than merely a ‘lost generation’ partaking in debaucherous activity. It has to do with the value of money itself.
As I’ve written previously, along with many others, the transition of the US Dollar off of the Gold Standard in 1971 changed the value of money itself. Fiat currency has no intrinsic value, and with central banks continuing to add to the money supply, thus leading to inflation, money continues to become less and less valuable. How can we ask upcoming generations to value something that is continuing to lose value?
Inflation has continued to outpace wages over the last 50 years. This means that the ‘Real’ earnings of workers is decreasing. The touted ‘Wealth Gap’ is increasing, so less dollars are circulating to LMI households. These households will naturally look for ways to multiply the few funds they have as quickly as possible.
This reality coupled with the legal allowance of prediction markets such as Kalshi and Polymarket is fueling a casino economy that is likely to end in disaster.
So what exactly is the difference between investing and gambling, and what can people do to protect themselves? While both activities require a degree of risk being taken, there are two primary differences: Intrinsic Value and Control. Let’s discuss each of these in their own merit.
Intrinsic Value means the true value of a given asset. There is generally some sort of financial incentive or cash flow tied to the asset that thus gives it value. So when evaluating whether a particular activity is investing or gambling, this is the first question to ask. Is there a series of cash flows associated with the asset? If yes, it's investing. If not, it's gambling. With this framework, we can appreciate that some securities that are generally associated with investing could actually be gambling. For example, buying a stock in a single company that is not paying a dividend would be a gambling activity, although we think of it in a different way then say sports betting or playing blackjack. This is because the stock price must increase for the buyer to make a profit, and the buyer would then need to sell the stock to realize that profit. Conversely, if the company of that stock pays a dividend to its shareholders, then the buyer has a cash flow stream coming to them regardless of the stock price. Of course, no one wants the price of their stock to fall, so there is still an element of risk that the investment could be lost.
The second distinction is control. It’s worth noting that no one has complete control over anything, whether it's investing or gambling. There will always be an element of risk that is outside the control of the person. However, it becomes a question of how much control. A person investing in the stock market doesn’t control the company’s decisions that ultimately lead to its success or failure. However, the person can control how much they invest, where they invest, how diversified they are across different stocks and industries, and how often they invest. If a person starts a business, they have great control over the operations of that company and how it competes in the market. Gambling activities give the person much less control and are completely outcome based. Using sports betting as an example, the only real control a person has is how much to bet. The outcome is completely out of their control, as the players and coaches on the teams ultimately determine the outcome.
So what is to be done about this? How can people forge a fruitful, financially sound foundation in an era of gambling? Assuming the government continues to allow such activities to continue, folks are best suited to turn their efforts to their own behavior and discipline. Starting a business, investing responsibility, crafting and cultivating skillsets for the future and controlling their expenditures so their income can be invested into assets that produce more income. Easier said than done, of course.