Is the Stock Market a Casino?
by Sheldon Richman, Editor, Ideas on Liberty
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When former U.S. drug czar William Bennett acknowledged being a high-stakes gambler (the estimated ten-year loss at the slots and video poker is over $8 million), some of his supporters tried to dilute the impact of the revelation by claiming that millions of Americans gamble regularly in the largest casino of all: the stock market.
Is the stock market just a big casino? No, it isn't.
Admittedly, the stock market is risky; you can lose money there. But the difference between the market and a casino is dramatic. This is indicated by the words we use. You win money in a casino, but make money in the stock market. The language points to the distinction between gambling and investing. The word "gambling" comes from Middle and Old English words relating to play and fun. The word's kinship to "game" is obvious. A game is defined by its rules; its activities and results have no meaning outside those rules. A royal flush has value only by virtue of the rules of poker. You have no reason to strive for a royal flush unless you're playing the game.
Another feature of gambling is that the winnings are provided by the losers. It's a straight transfer. There's nowhere else for the money to come from.
The Stock Market
In both respects, the stock market is different. To be sure, stock markets have rules--about membership, trading hours, and so on. More fundamental rules underlie trading activities, the most important being property rights. But the rules do not define the activities or their purposes. Those activities, or something much like them, would occur even if no stock market existed.
When people invest in the market-that is, buy and sell shares in corporations-they participate in a process that directs capital to productive enterprises. (This is not to say that corporations receive the proceeds from secondary stock trades. But the secondary market makes initial stock offerings more valuable to investors.) Those enterprises produce either consumer goods or things that will help produce them. Companies do this because consumers want products in order to live and enjoy life. Those objectives are important independent of the rules of the stock market; indeed, they predate the stock market. As Frédéric Bastiat pointed out, rules ("the law") emerge because people need to engage in production and trade in order to survive and flourish.
Share prices reflect investors' estimates of how well enterprises will perform in the future. Thus the stock market's foundation is the productive enterprises striving to make things that will immediately or eventually satisfy consumers.
Profits from investing are not the flipside of other people's losses, as gambling winnings are. When someone buys low and sells high, both he and the new buyer come out ahead at the moment of the exchange. Each person profits by gaining something he prefers to what he gives up. If later, investors lower their estimate of the company and the stock price falls, the new shareholder's losses do not correspond to the former's profits. This is simply a case of entrepreneurial risk in a world of uncertainty.
Profits represent something new-the creation of value. In a free market, a firm's profits are what's left over after it pays all its expenses. They are the result of an entrepreneur's correct hunch that certain inputs are undervalued in the market; for example, land, labor, machines, and raw materials can be acquired at a unit cost of $5 and used to make a product for which consumers will pay $10. The profit represents no one's loss. New value is created. Consumers would not pay $10 if the product wasn't more valuable to them than anything else they could have spent their money on.
A given person might approach the stock market as though he were gambling; he might rely entirely on luck rather than skill in picking his investments. But the fact remains that the underlying process is not a game and the "winnings" are not merely transferred from losers, but, rather, are signs that real value has been created.
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