Game Theory: The Most Important Thing They Never Teach Us in School

There are plenty of things they should teach us in school and don’t. How to navigate and have a successful relationship. How to achieve lasting happiness and fulfillment. How to find and carve out your niche. How to invest in and lean into your skills. How to invest, period.

But one of the perhaps easiest things they could teach us, and simply don’t touch upon at all, is called Game Theory. Sales people learn this without knowing exactly what it's called. People studying econ may touch upon this in college. And many women make an Olympic sport out of it without ever knowing what they are actually doing.

Game theory is essentially the practice of being able to make decisions and implement plans, while accounting for basic human thought processes. Its being able think abstractly and projecting into the future what will most likely happen if you behave a certain way. And if you do it right, you can even manipulate the outcomes to suit your purposes.

Here are two historical examples:

Hernan Cortez arrives in the new world and the first order he gives is to burn the ships he came in on. This serves a few purposes.

One, his enemies now know that he believes himself so confident of victory as to burn his only way home. Two, they are concerned his troops are better equipped, better trained and deadlier than them because of his confidence and bravado. And three, Cortez’ troops now know there is no going home. There is no way out. They have to fight as well as they can, or they risk death. There is no surrender.

Game Theory is being able to add a layer of abstraction to your thinking. A recent example is Elon Musk saying publicly that Twitter must disclose data proving the amount of bot accounts in their system is less than 5%, otherwise he deserves a better deal to buy it.

But by casting doubt on them and saying this, the stock price drops, because either Twitter has a higher number of bot accounts, which means its less valuable, or there is a possibility that Elon walks away from the deal.

So either way, the Board is going to lose and Elon is going to win. Either he will be able to buy it at a lower price, or he will walk away, keep his money, and the board and shareholders of Twitter will lose money anyway.

This is Game Theory in action. Higher level abstract thinking. Of course now they are suing each other and it will probably devolve into who has the better lawyer, but in the meantime, Twitter’s share price continues to plummet and all Twitter can really do at this point is throw paper at Elon.

But Game Theory isn’t only used in the most extreme and cut throat of situations. It actually underpins much of our modern society. We all work together to cooperate to create projects that would be impossible for any individual acting alone.

Say I agree to build your house and you agree to build mine. But once we are done building your house, you don’t agree to help me build my house. My labor is now free as you reneged on your promise.

But you see, now your action has given me an incentive to take your house by force, both because I am in need of a house, and perhaps because I feel justified as I helped to build it. So you either must spend valuable time and resources guarding yourself against me, or you have to give up the house that I helped you build.

In the end, you conclude that it would be a better bargain to actually just follow through on helping me to build my house, because any benefit you might have gotten by reneging on your promise, would be outweighed by the amount of time and resources you would have to expend protecting yourself from my wrath.

This understanding is what underpins modern society. In the words of Adam Smith, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from regard to their own interest.”

This simple line boils down much of why Capitalism works and Communism does not. Capitalism relies on self interested parties buying, selling and trading things of value. Should it be regulated? Yes. Does it work? Yes.

There’s a famous story about the Soviet Minister of Labor visiting the UK, that I believe is from Noah Yuval Harari’s book Homo Deus, that goes something like this. The Minister arrives in London and sees no breadlines and no shortages of anything in shop windows.

He remarks to his handler, “This is amazing, who is responsible for producing all the bread for your country? Who is responsible for producing all the cloth for your country?” The handler thinks about it and says, “I don’t know. No one.”

And that’s the point. No one person is responsible for making bread in a capitalist society. A baker who wants to make a living makes bread because he knows someone will pay for it. And a person who wants to make sandwiches that week buys the bread because he wants to feed his family with money he’s made from selling a good or service that someone else wanted. And the world goes round. Why?

Because these men did some quick Game Theory analysis and concluded that it was better business to create a product, set a price and sell that product. Competition keeps things fair, as the best loaf wins, and if you lie about your product, word will get around and people will stop buying from you, thereby putting you out of business and on the street.

While I digress a bit, this system is what underpins all of modern society, and is based in Game Theory. But quite frankly, the system only works because people believe it works.

Currency only works because people believe it has value. Globalization only works because nations believe they can trust their economic partners to continue to trade with them. Military agreements only work because organizations expect their allies to come to their aid in times of crisis.

Why? Because the consequences of not adhering to the system are worse than the benefits given when we adhere to the system. Everyone agreed on that, at least until recently.

It is my firm belief that Russia, in this current moment, is attempting to reshape the current geopolitical atmosphere because Vladimir Putin is unhappy with where his country exists in the global ecosystem and where it is set to go in the future.

Anyone could tell you that the Russian people, and the world, would have been better off had an invasion of Ukraine not happened. But by doing so, he has done what I believe he wanted to do all along: destabilize the current system, create chaos in the hope that the system would fray and collapse.

Do I think he failed? Yes. But he’s also single handedly made life worse for most of the world’s inhabitants, and murdered God knows how many.

And what’s worse is he’s shifted the balance of Game Theory in the other direction and set the world back for who knows how many years.

Let’s go back to our house building example. If I expect you and I will cooperate in good faith to achieve a goal, and you do, we probably will achieve mutual sum goals together.

But if there is a shred of doubt one of us might renege on our deal, then logically, it follows, I should anticipate you betraying me, and you should anticipate me betraying you. And in that case, the only thing that makes sense is striking first, taking your resources for my own, and building my own house.

This is the bloody cycle that perpetuated throughout most of human history, something that made Thomas Hobbes refer to human existence as “nasty brutish and short.” It's only been recently that it has become more profitable to cooperate, than it has been to invade another country to steal its resources.

At least, until now. The Nordstream Pipeline was supposed to provide Europe with the gas it needed to supply their electricity and heat, so that they could achieve their climate goals and invest their money in other areas of their infrastructure.

In a Game Theory world where both parties are working in good faith, Europe gets gas for their populace and can invest the money they would have otherwise spent in this sector into other areas, allowing them to increase their specialization and have a healthier economy.

Russia meanwhile would become rich from their oil and rare earth mineral exports and use the money to fix their ailing infrastructure and provide better education and human services to their people so they can grow into a thriving member of the world economy.

But of course it didn’t happen this way. Because of one bad actor who controls the resources of a nation with existential nuclear weapons, we now have a shattered world.

There is or will be a migrant crisis in Europe. The Ukrainian economy will not recover for at least 20 years after the fighting has stopped. Russia is now a global pariah and cannot trade on the US stock exchange, has been banned from the SWIFT network, and cannot conduct business in US dollars, which is the world’s exchange currency.

The Russian people have seen their life savings crushed in a matter of days, while the rest of the world deals with the fallout of increased energy costs throughout the world. To put it in perspective, the latest report put out by WorldWide Exchange is that France is set to see energy costs of up to the equivalent of $400 per megawatt hour. The average Boston resident pays about $40 per megawatt hour.

We are now about to enter a tremendous game of chicken, with Game Theory at the center. Full sanctions on Russian goods go into effect on December 7, 2022. And I’m sure I don’t have to tell you winter will have set in by then in Europe.

If there is no relief from the US or other OPEC states, it will be a choice in Europe between keeping the lights on, or keeping the heat on. And meanwhile in Russia, there will continue to be widespread panic as their economy continues to crumble, their currency continues to free fall, and their citizens wonder aloud who is responsible for keeping the shelves stocked when their bread lines return.

So how can you apply Game Theory to your own life? Use it to think two steps ahead. Now is the perfect time to invest in the market. When everyone is running for the hills, that's when you want to pony up your cash and find good companies with strong balance sheets and good outlooks for the future.

People will often throw platitudes at you. “Don’t try to catch falling knives.” “Don’t fight the trend.” “Buy at the bottom.” Which is all well and good but the definition of the bottom is the highest proportion of sellers to buyers in the market. And by definition, there is no way to know when that will be because it is a statistic that can only be measured by comparison.

So here’s the key. If you have a couple grand lying (and that's the key ALWAYS invest with disposable income), find a couple good companies that you think have bright futures and invest in them. Don’t worry if the market is going to fall or if we are at the bottom yet. Invest in companies you believe in and ride the trend through its natural conclusion and back to a bull market.

The economy will recover, the world will re-balance itself, and nations will begin to specialize and engage in further global trade again. You just have to be able to use Game Theory to think three steps ahead and position yourself to be in the right place when that happens.