Is the Stock Market a Zero Sum Game?

I got this question in the Ask Cullen section over the weekend and I think it’s an important one since I seem to get it quite often.   It’s interesting to note that there doesn’t actually seem to be a very good answer online (at least not as far as my brief search went) so I used a brief (and probably overly simplistic) example to describe why the description of zero sum is incorrect.  This also works into the concept of “moneyness” in Monetary Realism quite nicely as you’ll see that the stock market doesn’t necessarily increase the amount of money in the system, but can increase/decrease our wealth.

“This concept confuses a lot of people, but it’s important because it touches on how stocks are money-like, but not necessarily high on the moneyness chart (because they must be converted into deposits in order to be used for transactions). Let’s work through an example that will help.

Let’s say you have 3 people and 1 corporation. And the 3 people all have $10 for a $30 total. And then the corporation decides to raise capital so it issues 4 shares of stock at $4 or $1 per share. Let’s assume two of our people buy the entire issue and become owners of 2 shares each for a total of $2 each ($1 per share). So our corporation has $4 and our two investors own 2 shares each valued at $1 per share ($4 market cap).

Then, a year later, for whatever reason, investor 1 decides the stock is worth 100% more and tries to sell it on the stock exchange where person 3 purchases the 2 shares for $2 each ($1 higher than the IPO price). Now person 3 owns 2 shares each valued at $2 for a total of $4 and person 1 has $12 TOTAL of which $2 is their capital gains on the stock sale. Person 2 still own his 2 shares that are now worth $4 total ($2 unrealized cap gains).

Is there more money in the system? No. Person 1 has $12 (he had $10, invested $2 and generated a return of $2 for a total of $12 in net worth). Person 2 has $8 and shares of stock that he believes are now worth $4 (ie, he think he’s worth $12). Our corporation has the $4 they raised from investors 1 & 2. Person 3 has $6 plus shares that he thinks are worth $4. But look what’s happened here. Our little economy is actually worth more! Person 1 has $12 where he once had $10. Person 2 has $8, but thinks he’s worth $12. Our corporation still has the cash of $4. And person 3 has $6 plus the shares worth $4. So our corporation can invest the $4 in its operations, person 1 has benefited from his investment by increasing his net worth by 20%, person 2 is worth 20% more (at least on paper) and person 3 is where he started but hopes the corporation will make wise investments so he can benefit like investor 1 did.

I think I got all those numbers right there. So, zero sum isn’t the right description in that a stock market can actually increase the overall wealth of its participants (at least on paper)…Also, I basically just described QE where people bid up stock prices without the underlying corporations actually changing anything. The economy is technically worth more, but that could be a mirage for all we know. This society’s obsession with unrealized stock market wealth is, quite frankly, absurd and misguided. It’s a real-time example of counting your chickens before they hatch.”

For more on MR please see the paper “Understanding the Modern Monetary System”.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.
Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Cullen Roche

    Extra credit if you understand why persons 1 & 2 are true “investors” and person 3 isn’t. :-)

  • dividend

    why didn’t you have the company pay a dividend to make point and assume payout ratio is low? assume $1 dividend and stock goes down just 0.50 on ex-date.

  • rp1

    Speculating on price is a zero sum game. Value investing lifts all boats.

  • Cullen Roche

    Just keeping it simple.

  • Wulfram

    I’m going for the brownie points! Please grade my answer, Professor Roche.

    The reason persons 1 & 2 are true “investors” is because the money they paid for the stock went directly to the corporation as capital to grow or sustain the enterprise. As a result, persons 1 & 2 received partial ownership in exchange for putting up capital.

    For person 3, no such exchange took place between the “investor” and the corporation. His money was not directly transferred to the corporation (although the corporation may indirectly benefit from a slightly higher valuation to its stock). Therefore, we cannot really say an investment in or by the company took place.

  • Cullen Roche

    Nice! A+. Only thing I would add/specify is that person 3 is specifically an allocator of his/her savings and not an investor. For those who don’t think this matters please read “The Investment Myth”:

  • LVG

    Nice. But it won’t seem as intuitive or clear to those who don’t understand MR. FYI.

  • Barak

    Cullen, without dividends or buybacks one can’t understand from the description above why would anyone purchase the shares of the corporation to start with. there is no transfer mechanism between the corporation and its shareholders.

  • Finster

    Mr. Roche, you are confusing wealth and money. Wealth are the real assets and their implied productivity as well as the cash flows derived from them. The stock market is a residual claim on the assets of the corporations after their debt is paid off and as such a share in their future profits delivered to investors after servicing debt and paying taxes.

    There is only more money in the system if one of the participants creates credit with a bank to purchase stocks and use them as collateral (e.g. in acquiring them pays off the previous holder of the stock or leveraging his portfolio). Stocks can create money when used as collateral in lending.

    Stocks can deliver more money to their holders if the companies issue dividends and distribute a share of their profits, thus bringing cash flow to the holders of the stock.

    Any pure trading action on the stock market is just a swap of the cash position of person A for the stock position of person B. The total amount of cash and stock in the system remains constant.

  • Eric Reynolds

    More generally, is trade a zero sum game? This statement seems pretty obviously false, because in any given world state each agent has a different marginal utility function so trade can raise (or decrease) total utility. Is the same not true of the stock market? (Perhaps it’s just harder to grasp intuitively because the utility of holding a stock or cash is more elusive, though I’m sure MMTers get it).

    @Barak: Facebook has declared it has no intention of paying dividends ever, yet people want to buy it. Even BitCoins can be sold for > 0 and they not only have no flows but have absolutely nothing backing them.

  • http://None Pete

    Yes, I agree with that. Stock market is not zero sum, but the short term trading is.

  • Sam A

    Does this “wealth effect”, if you will, create the potential for increased leverage and inflation? If on paper, my asset is worth more than I paid for it, and a bank is willing to lend against it at the market value, doesn’t that create new “inside” money and a conversion of bank reserves from excess to required, thereby increasing the actual amount of money in circulation?

  • Finster

    Sam A: Yes indeed. This is what I referred to in my 2nd paragraph and it’s called “asset price inflation.” Inflation always occurs where excess credit is being created in the good targetted by this newly created money. Housing before 2008, Student loans today, margin lending for stock in 1929.
    See where the credit creation takes place against which collateral and you will see the dynamic of inflation and mispricing. It’s when the assets purchased and used as collateral cannot deliver the cash flows to service the debt that the tipping point is reached. Then liquidity crisis begets insolvency crisis and the “counterfeit” money created against bad collateral is destroyed (an asset was discounted for more liquidity than its inherent value) and the banks providing the credit are potentially insolvent.
    The previous owner of the asset purchased at inflated prices has run away with the money and retains the excess purchasing power (relishing his Porsche 911).

  • jldasch

    Exactly! Even a corporation that never pays a dividend, never does a stock repurchase, and never borrows money, can generate real wealth by increasing it’s stock of both real assets and operational and intellectual assets.

    Money can be created without any borrowing by the company and without any borrowing by purchasers of stock, at any time! In fact, for most corporations that’s generally the case. The economy is a system of interconnected flows, and the activation energy for the interconversion of money to money is 0, so money creation anywhere in the system is the same.

    The idea that there is a difference between between initial investment and a later purchase of a stocks shows a fundamental lack of understanding of economics. The exchange of money for stock at any point is exactly the same, it’s a (subordinated) claim against real and implied assets (which includes future real productivity) of an underlying legal entity.

    Similarly, the idea that there is a difference between investment and speculation is ridiculous. It’s both logically and mathematically exactly the same! To make an arbitrary distinction between the two based upon an arbitrary period of holding is completely wrong. In fact, an efficient market generally requires a high turnover rate (markets with low turnover have very large price variation [ca. houses in the > $5 million range, and cars, art, etc. > $1 million range]).

    This is very basic level stuff. One certainly couldn’t get a bachelors degree in economics from a reputable school and not understand this. And of course if you understand money and MR the idea that there is any confusion on the stock market not being a zero sum game, or that there is no difference between initial investment and later stock purchases, isn’t possible.

  • Cullen Roche

    Money, like stocks (which have a certain moneyness), comprise part of our overall wealth because they give us access to goods and services. A man is a lot of money might call himself wealthy because he has claims on many goods and services. Another man might have money and consider himself poor because he has very little of anything else (friends, family, health, etc). “Wealth” is different things to different people and it’s inappropriate to claim that money is never wealth.

    Credit creation is an entirely separate issue from the one discussed here.

    Dividends and profit payouts don’t create money. They redistribute existing money.

    Your final paragraph says exactly what was explained in the article??

  • Cullen Roche

    Right. Stock market value increases can give the appearance of someone having a higher net worth in the present which might allow them the ability to borrow against that. Loans create deposits and deposits are the ultimate claim on goods and services. So this appreciation process can potentially create money.

  • Andrea Malagoli

    I agree with that too. Also, I have the feeling that adding the temporal aspect to the equation will show that the market is effectively a zero sum game.

    When a “person 3″ purchases the stock at a higher price in the market, there is NO net creation of immediate wealth simply because those capital gains cannot be realized if someone tried: they can only be passed along to a “greater fool”. The extra capital gains represent a claim on “future” profits of a company, and they can only be realized “over time” assuming those future profits come true.

    The stock market is an “expectations time machine”, and as such is some funny sort of zero-sum game.

    The only part which is not a zero-sum game is the initial investment, whereby the company can use the capital to create new profits. How companies turn investments into profits is a separate issue altogether, but has nothing to do with the markets.

    One could argue that the markets have a marginal non-zero-sum component in stimulating investors to provide that initial capital in exchange for the prospect of seeing greater returns later (usually by monetizing from a “greater fool” or reaping dividends).

    The bottom line, one needs to account for the temporal aspect of the mechanics of the markets in order to tackle this issue properly … I think.

  • mutant_dog

    I feel that tax advantages should accrue to primary investors, relative to secondary investors, as the behavior which we wish to foster by these regulations is capital-raising by securities issuers. The distinction is a worthy one. (Implementing this idea as tax policy, otoh, becomes sticky quickly – what is, and is not, a primary, capital-raising funding mechanism can and would be gamed…)

  • Cullen Roche

    “Even a corporation that never pays a dividend, never does a stock repurchase, and never borrows money, can generate real wealth by increasing it’s stock of both real assets and operational and intellectual assets.”

    This has nothing to do with the conversation here.

    “Money can be created without any borrowing by the company and without any borrowing by purchasers of stock, at any time! ”

    Now you are confusing money with wealth. Stocks are a form of money (with low moneyness) which can comprise part of our overall wealth.

    “The idea that there is a difference between between initial investment and a later purchase of a stocks shows a fundamental lack of understanding of economics.”

    It’s actually a mistake made by most economists (one you’re also making) who claim that seeding capital is the same as exchanging money with someone else for something. Investment has a very specific definition. It is purchases not consumed for future production. When you buy a stock on a stock exchange you are simply allocating your savings. This is very different from seeding capital for future production. It’s a basic concept that almost all economists confuse. Real investment (like buying office supplies or obtaining cash from new investors to do so) is completely different from flipping stocks on a stock exchange. In one, the corporation actually sees the cash. In the latter situation the market participants simply exchange claims of ownership and the corporation is only involved to the degree that the owner of its liabilities changes hands (but it sees no cash). If you think you’re seeding capital for the use of future production you are very wrong. That process occurred long ago at IPO (or perhaps during a secondary issue).

    I am afraid you’re the one who hasn’t grasped many of these concepts.

  • Cullen Roche

    If you live in a neighborhood where all the houses are basically the same and your neighbor sells his house for 10% more than what all the other houses are worth then what happens to the value of the houses in the neighborhood? Presumably, an appraisor will value the houses higher because the going market price is that much higher. Whether this is sustainable is not always accounted for by the market. It just simply is. But our house owners are all feeling 10% wealthier after their new appraisals and could potentially refi their home or whatever. It’s zero sum at the transactional level (there’s a buyer for every sell obviously) but there’s also wealth creation in the process in that the net worths of the particpants increase whether they sell or not.

  • Frederick

    The stock market is zero sum at the transactional level and positive (or negative) sum at the wealth level. I don’t see what’s so hard for some people to understand about that. Cullen’s example is pretty clear.

  • Cullen Roche

    Some people seem to think that if their net worth increases because your stocks increase in value then you haven’t accumulated more “wealth”. Of course, as I’ve explained a million times here, this doesn’t increase the amount of money in the system necessarily (neither the quantity of cash nor stocks goes up) and is entirely contingent upon the underlying cash flows of the corporations validating that move in price at a future date (see my work on QE).

    Maybe the people who are confused just don’t understand MR fully or I haven’t explained it very well?

  • jaymaster

    If the corporation in this example was a bank, and it used the $4 as capital on which to base a loan, THAT would be creating money, right?

  • Johnny Evers

    A colleague bought a house four years ago for 300k, and sold it last month for 500k.
    Certainly he now has more money, and more wealth, although on the down side he has not generated any real value to the economy, or created anything of value. The sale benefits no one but him. In fact, you could say it’s a zero sum, because the buyer of the house is expending his income on a bigger mortgage.
    A loan and a deposit was created, so the new homeowner can buy the house, which helps the financial services industry.
    THe same thing is happening in the stock market. That’s the way the game is being played; I don’t know if you’re a fool to play, or a fool not to play. But it’s not raising the standard of living, or rather, it’s temporarily raising the standard of living, with the price to be paid later.

  • Johnny Evers

    If you do a Net Worth statement for a client, how do you put a valuation on their stocks, bonds or real estate holdings?

  • barak

    @Eric: bitcoins have the faith of those businesses that accepts them. that is the source of their value. FB’s “intentions” are not interesting as long as they are governed by the same regulation as any other stock. if they had said “we will never return any form of money to our shareholders”, and also the stock will not have any voting rights, than I would ask what value does the stock have. I’m of course ignoring the fact that never is a relative term in the stock market. after all, who would have thought Berkshire will buy back stocks?

  • Mark Caplan

    In a zero-sum game, every dollar that one person gains somebody else loses. A state lottery, for example, is a zero-sum game. So are options and futures markets. In options and futures, for every long position there must be a corresponding short position. A dollar gained on the long side is a dollar lost on the short side.

    Stocks are different. Ignoring the short sellers, who play a small part of the overall stock market, when a stock in your portfolio gains a dollar, there is nobody who forfeits the same dollar, so stocks are not a zero-sum game.

  • SS

    The word “wealth” is confusing. It’s different to different people even if in an accounting send someone with money (even stocks) has wealth.

  • Ralph Cramdown

    I don’t know where you’ve been the last ten years, but these days, most companies see very little of the cash generated by an IPO — it goes to private equity investors or founders who are cashing out. They wouldn’t have invested in the first place if they didn’t have an exit strategy, so the stock market still serves a vital role, albeit indirectly. But differentiating between an investor who bought his share from the PE firm at the IPO and the one who bought it on the secondary market looks a bit silly.

  • Geoff

    “The sale benefits no one but him”

    JE, the sale benefits other homeowners if it helps to raise the general value of homes in the area. Everyone’s net worth increases.

  • Geoff

    Futures are a zero sum game. The stock market is not.

  • Cullen Roche

    The point of seeding capital is crucial in a consistent definition of “investment”. You’re bringing pre-funding into the picture which changes the story a bit, but not much. The main point is still important. One who seeds capital or makes purchases that are not consumed for future production, is vastly different than someone who just flips stocks on a stock exchange. Sorry, but when you open your ETrade account and exchange Apple for cash with someone you’re not helping the company in any substantive way. In fact, the only person you’re really serving is yourself through the allocation of your savings.

  • Johnny Evers

    But isn’t Cullen telling us that rising asset prices do not equal wealth appreciation.
    Anyway, it’s not until the neighbors sell that they see a benefit, but for every seller who gets a benefit, the buyer has a higher debt load.

  • Cullen Roche

    It’s wealth appreciation. Just not necessarily sustainable wealth.

  • justaluckyfool

    WOW, is the stock market a zero sum game/ a bank loan/a derivative?
    Yes, IF 100% capitalized. Winners get paid and losers pay.
    100% in minus 100% out equals a zero sum game.
    But that is NOT what is being played using modern money IF any of the money going in is not “real currency”, money borrowed from a PFPB (Private For Profit Bank) you could have a systemic failure in that the losers are unable to ‘pay their loses with the ‘good faith and credit guarantee. And then we would score one point for Mises, “*** “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” — Ludwig von Mises .
    However, Justaluckyfool says, “To correct “systemic failure” is to make them true zero sum games.”

  • Jussi

    Lets say person A is an entrepreneur and has a start-up and some cash invested. A gets stocks (claims) against the cash invested. Person B buys a share of that stocks. Now that is a secondary market type of transaction, flipping stocks. But if A knew that she will/might be able to sell a share of the company, she could take that into account and make a bigger investment in the first place. Sometimes B can take a share or promise it almost instantly after initial investment. Time and uncertainty definitely plays a role here. But liquidity offered by secondary market flipping definitely has a value, the moneyness is higher?

    I can see that the process of buying productive capacity is different than flipping stocks but I think those two are interconnected and serves ultimately the same purpose. Thus I’m not really convinced that those two are distinctly separate, there is always a link even though when flipping goes long enough the link is harder to see and it kind of vanishes. It sounds right that buying a piece of Apple doesn’t help the company a lot.

  • Daily Gains Letter


    In my opinion it is a great post about stock market.While following one prediction may be beneficial for your business reading several predictions and making changes accordingly can be harmful or limit your potential to earn larger profits from your investment.