Gambling vs Investing
© 18 Oct 2012 Luther Tychonievich
Licensed under Creative Commons: CC BY-NC-ND 3.0
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Thoughts on global wealth, financial markets, and investing.

 

Matt Levine recently posted a surprisingly clear (and lengthy) discussion of derivatives and, in the process, financial markets in general. For those not inclined to read it all, a summary:

Stock

Partial ownership of a company

Bond

A loan: I pay the company now, it promises to pay me more later. Or I buy that promise off of whoever the company first made it to.

Derivative

A bet: we agree to exchange money in the future based on some aspect of the world at that time.

Levine goes into some detail about how all three of these, as well as physical assets and operations, alter how a company’s profits depend on myriad future uncertainties. He also points out that these can be used for insurance (if my crops fail, I get some money anyway) or to magnify potential losses and rewards (I bet you a thousand dollars I sell more than you do).

I have no argument with Levine’s summary of these topics. But I do find the view he presents leaves out something important. Buying wheat and betting on wheat prices both impact a risk portfolio in similar ways, but buying wheat also encourages wheat production.

The world is wealthier than it has ever been before. There are more people with a higher standard of living. There is more food, more entertainment, more shelter, more of virtually every measure of wealth I can think of except, perhaps, happiness—but that’s a subject for another day.

The world is increasingly wealthy because people can (and do) generate wealth. Any honest work increases the net wealth of the world. This is true, too, of banking. Moving assets and risk around can improve the productivity of other workers much as making tools can improve the productivity of craftsmen.

But at some point this honest work of bankers breaks down into simple gambling. There’s some invisible line, on one side of which we are moving assets to those who need them and risk to those who can handle it, and on the other side of which we are playing dice with thousands of people’s lives.

Is that line clearly visible to anyone? Are day traders the leaches they look like to me, or do they see themselves as providing some actual service?

More practically, how do I invest my own money (hedging against my expected future loss of productivity) in a way that builds global wealth instead of merely tilting the tables towards me?




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