by
Peter
C. Earle

Recently
by Peter C. Earle: Of
Krugman and Diocletian

I. Introduction

Nearly a decade
ago, poker exploded in popularity. Between television programming,
media coverage, and pop culture references to it – in particular,
the Texas Hold ‘Em variant – the game became virtually unavoidable.
The American Gaming Association estimates that nearly 1 in 5 Americans
played poker in 2004, up 50 percent from 2003; also, that nearly
20 percent of those new players had begun to play within the previous
two years.[1]

The creation
myth associated with the poker boom credits the improbable victory
of a prophetically-named Tennessee accountant, Chris Moneymaker,
in the 2003 World Series of Poker (WSOP). Other accounts source
James McManus’s 2003 book Positively
Fifth Street and the 1998 poker film Rounders.
Still other, more mystical explanations refer to the game’s sudden
“cultural resonance.”[2]

But fads and
surges of popularity come and go; these explanations hardly account
for why, in a short amount of time, tens of millions of people suddenly
flooded into a familiar – indeed, 150 year old – American
card game, frenetically expending tens of billions of dollars on
it. Nor do they explain why between 2007 and 2008 poker television
programs were suddenly cancelled, tournaments saw a drop in participation,
and many poker-related businesses scaled back or failed.

Austrian business
cycle theory (ABCT) can, however, explain the origins and outcome
of the poker bubble as well as its simultaneity with the housing
boom, which, as will be demonstrated, are by no means coincidental.

II. Austrian
Business Cycle Theory

In unfettered
markets, firms coordinate production in response to profit and loss
and prices are formed through the interaction of supply and demand.
Interest rates, the price paid to rent money in the present, are
derived in part from interaction of the supply of money deposited
at banks (depositors’ savings, to be lent) with loan demand.

A market-determined
interest rate is, therefore, a snapshot measure of the naturally
prevailing time preference characteristics in an economy, which
is to say, a rough quantitative assessment of economic actors’ preference
for current consumption over future consumption. Because of that,
interest rates are watched by producers for cues as to the consumptive
propensity of consumers.

When bank
credit expands owing to the machinations of central banking, it
in turn causes an artificial lowering of interest rates; consequently,
the savings rate appears to be higher than it actually is. This
distorts the business community’s perception of consumer time preference,
leading them to begin new projects and invest in longer-term factors
of production. An artificial boom begins.

For a time,
there is the appearance of prosperity. But when the credit expansion
ends, the business expansion undertaken during the boom is revealed
as malinvestment, and the bust ensues. Businesses must then liquidate
assets, exit lines of business or fold entirely, turning their assets
over to creditors, better run or more fortuitous firms. For consumers,
the end of the expansion typically involves cutting back on spending,
increasing rates of saving, and paying down (or defaulting upon)
debt.

III. Credit
Expansion and Bubble Inflation: 2003–2004

While ABCT
tends to focus on the business effects of central-bank-interest-rate
manipulation, the same illusory monetary effects influence consumers;
in this case, would-be poker players. As economist Dr. Joseph Salerno
explains:

[W]hile the
artificially-depressed loan rate encourages business firms to
overestimate the present and future availability of investible
resources … at the same time it misleads households into a falsely
optimistic appraisal of their real income and net worth that stimulates
consumption and depresses saving. Although overconsumption is
caused directly by what may be called the “wealth” or “net worth”
effect, it is financed by the increase in money supply.[3]

Between January
2001 and June 2003, the Federal Reserve Bank lowered the Federal
Funds Rate from 6.5 percent to 1 percent: first in response to the
dot-com collapse, then to forestall potential interruptions of the
financial system in the wake of the 9/11 attacks. As early as January
2003, the housing bubble was already expanding. CNN/Money reported
that

[n]ew home
construction starts rose … to an annual pace of 1.85 million units,
the fastest pace in 16 years, according to a Commerce Department
report, confounding economists’ expectations.[4]

Consumers were
also finding their way back to gambling, a sector which had been
depressed throughout the 2000–2002 recession. In January of 2003,
casino and gambling stocks began to rise noticeably. IGT, a casino
service firm, reported that sales rose 70 percent over the same
period last year on higher sales to casinos.[5]
By March 2003 – even facing the uncertain prospects of an impending
US invasion of Iraq – at least one firm was bullish on casino
and hotel stocks.[6]

Disproving
the “Moneymaker Theory” behind the start of the poker boom, registration
for the 2003 WSOP was 33 percent higher than in 2002, and three
times the 12-percent average year-over-year increase experienced
over the previous 10 years.[7]
Clearly, by the time the first hand was dealt in the 2003 World
Series of Poker – weeks before Moneymaker’s victory and fame
– Fed policies resulting in the ready availability of money
were already creating armies of newly-minted poker players.

By August
2003, poker clubs in Miami had increased their hours, and the Atlantic
City Sands reopened its shuttered poker room.[8]
Throughout the gaming community there were comments about “lots
of new faces” appearing around poker tables.[9]
By the end of the year, it was reported that in 2003

[t]he U.S.
economy … expanded … at the fastest pace in nearly two decades,
even as it was losing jobs [emphasis added]. The Commerce
Department reported yesterday that the economy grew at a roaring
7.2 percent annual rate in the July–September period. … It was
the highest growth rate since the first quarter of 1984.[10]

IV. Cashing
In: 2004–2005

Owing to the
popularity of the Texas Hold ‘Em variant of the game, the term “all-in”
soon became painfully ubiquitous in all walks of life.[11]
Increased popularity brought legitimization and a scientific patina
to a game that had spent most of its life played in the back of
saloons and around kitchen tables. Registration for the “Main Event”
of the 2004 World Series of Poker exploded to 207 percent over the
previous year, with a $5 million first place prize – twice
that of the year before.

New magazines
specifically devoted to poker suddenly appeared on newsstands. Publishers
specializing in gambling books found themselves having to expand
warehousing and printing facilities:

Poker’s upsurge
in popularity has been a jackpot for the publishing industry.
New York City-based Cardoza Publishing is reporting a tenfold
increase in sales for its poker-related titles and USA Today
estimates that 60 poker books will make print this year. … [Another
poker firm] sold 45,000 books [in 2002], most of which retailed
for $30 apiece. “We think we’ll hit 500,000 this year.”[12]

The longstanding
“Bible of Poker,” Doyle Brunson’s 1979 book Super System,
saw a second edition arrive in 2004. In August of 2004, World Poker
Tour Entertainment (WPTE) went public at $8/share, raising $34 million.[13]
The 2004 holiday season became known as “The Poker Christmas” as
“Official World Poker Tour” sets became the top gift in America:

You might
find one if you just happen to be there when the merchandizers
bring out a new palette. … “Sam’s cannot keep the Official WPT
product in stock. The minute the stores put it out, it’s gone,”
said Scott King, Vice President of Sales and Marketing for U.S.
Playing Card Company. … From Hawaii to Florida, Sam’s Clubs are
reporting the same phenomena.[14]

Retailers
dutifully responded to the explosion of interest, with poker chips
and related products being carried in chains as diverse as Academy
Sports and Outdoors, Albertson’s, Associated Grocers, Costco, CVS/Pharmacy,
Discovery Stores, Hallmark Stores, Kroger, Lewis Drug, Nordstrom,
Rite Aid, Shoprite, and Wal-Mart.[15]

After holding
the Fed Funds rate at 1.00 percent for one year, in June of 2004
the Fed embarked upon a slow tightening campaign, first raising
the Fed Funds rate from 1.00 percent to 1.25 percent. After a series
of quarter-point raises over the rest of the year, the rate stood
at 2.25 percent; twice the low of June 2003, but still far below
historical averages going back several decades.

~

Fed Funds (avg)

Real personal Consumption
(chg prev yr)

Subprime (per new mortgages)

WSOP entrants

WSOP prize pool

WPT entrants

WPT prize pool

2001

3.89%

$205B

8.5%

613

$1.5M

111

$2.69M

2002

1.67%

$208B

8.0%

631

$2.0M

343

$8.34M

2003

1.13%

$226B

8.5%

839

$2.5M

451

$10.9M

2004

1.35%

$271B

18.5%

2,576

$5.0M

605

$14.6M

V. Feeding
Frenzy: 2005–2006

By 2005, the
poker boom took on characteristics of a speculative bubble: in the
World Series of Poker, the avalanche of entrants outstripped the
capacity of the traditional venue, requiring expanded facilities.[16]
Although not the subject of this analysis, the online poker market
also exhibited sympathetically explosive growth with total revenues
reaching $2.4B, up from $1B the previous year and $365M two years
earlier.

PartyPoker.com,
a leading Web site, is host for about 32 hands of poker play per
second, according to a British securities filing by its parent
company, PartyGaming. In 2005, that amounted to about $1,454 wagered
per second, or $45 billion for the year.[17]

To determinedly
acquisitive poker fans, endless peripherals were marketed, ranging
from poker-themed clothing and “Bobbleheads” of famous professional
card players to “poker vitamins.”[18]
A debate arose: first over whether poker is a “sport,” and then
– with some evidently deciding that it is – whether and
in what form it might be featured in the Olympics. The “Poker Dome”
was invented, offering more fast-paced action and promising a twist
of the familiar game “on triple espresso.”[19]

The 2006 WSOP
appears to mark the peak of the poker craze, with a 56 percent increase
in players over the previous year (8,773 – a tenfold jump since
Moneymaker’s win three years earlier) and a main event prize totaling
$12 million. A familiar shibboleth of late boom phases
was trotted out: “it’s different this time.” One poker business
owner commented, “I don’t know why the boom would die out … you’ve
got a million 20-year-olds sitting there watching and waiting to
come to Vegas.”[20]

VI. The Bubble
Bursts: 2006–2007

Why do tighter
money policies ultimately cause apparent booms to go bust? Because
business activities which are created out of money supply growth
– which is to say, not out of savings generated from productive
commercial undertakings – are exposed as unsustainable when
the flow of created money disappears. A cluster of error ensues.

From June of
2004 through June of 2006, the Federal Reserve raised the Fed Funds
rate from 1 percent to 5.25 percent. By December 2006, media outlets
began reporting that mortgage delinquency and foreclosure rates
were increasing markedly, and that “early signs of credit distress”
in subprime securities were evident.[21]
By general consensus, the housing bubble appears to have burst in
2007. When in that year, as Dr. Salerno continues,

housing prices,
corporate profits, and the stock market plunged. … The capital
gains accumulated since the mid-1990s were revealed to be an illusion
… [and] household net worth declined by $13 trillion, or 20 percent,
… a figure exceeding the sum of the combined annual GDP of Germany,
Japan, and the U.K. … This brought the overconsumption frenzy
… to a screeching halt.[22]

Industry onlookers
sensed a decline in poker’s popularity in late 2006, but the change
in sentiment was made clear when registrations for the 2007 World
Series of Poker were revealed:

This year’s
WSOP Main Event received 6,358 entrants, a 40 percent decrease
since 2006. As such, the prize will be respectively small as well,
now estimated between $8.25 and $8.75 million – more than
$3 million lower than last year.[23]

Later that
summer, the trend continued with a gaming analyst commenting that
poker “figures (for July and August) [were] nowhere near the double-digit
increases … in recent years.”[24]
No less than five poker television series stopped broadcasting in
the 2006–2008 time period.

And, the most
conspicuous publicly traded symbol of poker’s fortunes began to
bear hallmarks of a classic “bubble stock”:

[I]nvestors
do not appear convinced that the World Poker Tour’s owner is telling
a growth story. Even though WPT’s revenue grew to $18 million
last year from about $4.3 million in 2003, the company is unprofitable
and its stock price closed at $6.86 yesterday, exactly where it
was shortly after the company went public in the summer of 2004.[25]

~

Fed Funds (avg)

Real personal Consumption
(chg prev yr)

Subprime (per new mortgages)

WSOP entrants

WSOP prize pool

WPT entrants

WPT prize pool

2005

3.21%

$287B

20.0%

5,619

$7.5M

639

$15.5M

2006

4.96%

$251B

20.1%

8,773

$12.0M

545

$13.2M

2007

5.02%

$208B

3.1%

6,358

$8.2M

338

$8.1M

VII. Liquidation
of Malinvestment: 2007–2009

When a boom
is revealed to have been illusory, as Rothbard wrote in America’s
Great Depression,

[w]asteful
projects … must either be abandoned or used as best they can be.
Inefficient firms, buoyed up by the artificial boom, must be liquidated
or have their debts scaled down or be turned over to their creditors.[26]

Casinos and
poker rooms are businesses like any other, allocating resources
in anticipation of customer preferences and measuring their success
in profit and loss. For a brick-and-mortar gaming enterprise, usage
of floor space is a key factor in determining profit since profitability
comes from allocating space to the most popular, profitable games.
For this reason, the business side of the poker bubble fulfills
the Austrian prediction. Rothbard continued:

Prices …
must fall, particularly in the higher orders of production –
this includes capital goods, land, and wage rates. … Not only
prices of particular machines must fall, but also the prices of
whole aggregates of capital, e.g., stock market and real estate
values.[27]

In spite of
this principle, the actual liquidation process of the poker bubble
is difficult to spot; as opposed to common manifestations of that
process – selling equipment and bankruptcies – in casinos
it can be as simple as removing poker tables, changing hours of
operation, and reconfiguring bonuses/playing options:

[A]t least
one local resort has quit trying to offer the game. Earlier this
month, the Las Vegas Hilton closed its 2-year-old 11-table poker
room. Spokesman Ira David Sternberg said casino executives who
had anticipated more play on a daily basis plan for “a better
use of the room.” In other words: mostly likely slot machines.[28]

Another casino,
Excalibur,

shut down
its poker room Sunday night at midnight and is in the process
of installing … electronic poker tables … in an effort to provide
a jolt to a poker room that has been “on the decline from a customer
base (standpoint)” for the last three years. “In 2005, poker was
going gangbusters and everybody added rooms,” [a manager] explained
… The staff at the Excalibur before Sunday’s shutdown was around
50 people – 40 of them dealers. The new electronic poker
room will be staffed by just 18 “poker hosts.”[29]

But perhaps
the best example of the liquidation of nonproductive poker gaming
assets was when, in April 2008, an exasperated financial media finally
asked,

Can anything
resuscitate the rapidly withering stock of the World Poker Tour?
The stock, WPTE (listed on the Nasdaq), is currently trading at
just $1.53. This gives the entire company a valuation of $31.35
million dollars. Just three years ago, the stock was trading north
of $20 and had a valuation in excess of $400 million dollars.[30]

By the fall
of 2008 the stock had fallen to $0.56/share before recovering, and
in late summer 2009 it was announced that

WPT Enterprises,
otherwise known as World Poker Tour … plans to sell its assets
to British online-gaming group PartyGaming for $12.3 million …
well below [a] $29.50-a-share offer [valuing the company at nearly
$700 million] … in July 2005.[31]

The cessation
of projects in Atlantic City, N.J., took on both physical and financial
market dimensions:

Casino construction
has been shelved. Bonds of Trump Entertainment Resorts Inc., which
owns three Atlantic City casinos, trade at as little as 12.25
cents on the dollar on concern the company can’t make interest
payments. … Three signs pitch a $2.5 billion Pinnacle
Entertainment Inc. casino-hotel project, which the Las Vegas-based
company put on hold earlier this year. Another planned $5 billion
Atlantic City resort was canceled in October by MGM Mirage, the
Las Vegas-based casino company.[32]

VIII. Summary

The 2003 to
2007 poker boom is deftly explained by application of the Austrian
business cycle theory, displaying all the hallmarks of a central-banking-induced
boom and bust cycle. And far less romantically than Horatio Alger
tales of novice gamblers breaking big in Vegas, the ultimate responsibility
for the poker boom lies with the Federal Reserve System.

Notes

[1]
Experts,
Educators Wary of Poker

[2]
Ole Bjerg, Poker:
The Parody of Capitalism (Ann Arbor: University of Michigan
Press, 2011), p. 1.

[3]
Joseph T. Salerno, “A
Reformulation of Austrian Business Cycle Theory in Light of the
Financial Crisis,” Quarterly Journal of Austrian Economics,
Vol. 15, No. 1 (2012): 9.

[4]
No
Housing Bubble Trouble

[5]
Earnings
Up Sharply for IGT

[6]
Investors
Bet on US Consumer Looking Past War

[7]
Average increase from 1992 to 2002: 1993(9.45%) + 1994(21.82%)
+ 1995(1.87%) + 1996(8.06%) + 1997(5.76%) + 1998(12.18%) + 1999(12.29%)
+ 2000(30.28%) + 2001(19.73%) + 2002(2.94%)/10 = 12.4%. Increase
from 2002 to 2003: 32.9%.

[8]
Atlantic
City Roundup

[9]
“Texas Hold-‘em Card Game is All the Rage,” Yakuma Herald-Republic,
Nov. 16, 2003.

[10]
“Economy Growth Rate Biggest Since 1984,” Pittsburgh Post-Gazette,
Oct. 31, 2003.

[11]
A partial list of the adopted uses of the phrase “all in” during
this time period includes but is not limited to the titles of
several books, adopted mottos of several sports teams, two films,
half a dozen television episodes, several musical endeavors, and
the rallying cry of at least one insufferable motivational speaker.

[12]
Poker
Craze Sparks Book Publishing Explosion

[13]
World
Poker Tour Raises 32 Million With IPO

[14]
Official World Poker Tourâ„¢ Poker Paraphernalia Leaps Off Store
Shelves

[15]Ibid.

[16]
In a brief scene wrought with several layers of synchronicity,
the main event of the 2005 World Series of Poker ended with heads
up play between Joe Hachem (the ultimate victor) and Steve Dannenmann,
both involved in mortgage lending in their lives outside of poker.

[17]
Is
Poker Losing Its First Flush?

[18]
“Interview
with Daniel Negreanu,” AskMen, 2006

[19]
Is
Poker Losing Its First Flush?

[20]
Wikipedia,
Home Ownership and Subprime Origination Share

[20]
Everyone
Getting In On Poker Craze

[21]
Rates of Mortgage
Defaults Increase

[22]
Salerno, pp. 32–33.

[23]
Decrease
in WSOP Entrants Largely Effects Prize

[24]
Flush
Times for Poker Fading

[25]
Is
Poker Losing Its First Flush?

[26]
Murray N. Rothbard, America’s
Great Depression (Auburn, Ala.: Ludwig von Mises Institute,
2000), p 13.

[27]
Ibid.

[28]
Flush
Times for Poker Fading

[29]
Excalibur
Makes the Move to Electronic Poker Tables

[30]
World
Poker Tour’s Stock (WPTE) Dying a Slow and Painful Death

[31]
5
Dumbest Things on Wall Street

[32]
Atlantic
City Bleeds as Would-Be Gamblers Pay Bills

February
21, 2013

Peter
C. Earle’s [send
him mail] website can be found at: PeterCEarle.com.
Follow him on Twitter.

Copyright
© 2013 by the Ludwig von Mises Institute.
Permission to reprint in whole or in part is hereby granted, provided
full credit is given.