Is the price always right?

Stop me if you’ve heard this one: a couple of economists are walking along a quiet avenue; one of them stops to pick up a $20 bill just sitting on the sidewalk. “Don’t bother picking it up,” one says. “It has to be counterfeit.” “How can you tell?” the friend asks. “If it had been a real 20,” the first replies, “someone would have picked it up already.”

This, in a nutshell, is the theory of efficient markets.

The notion is that there are no bargains out there, there are no $20 bills lying around, the only real opportunities involve taking risk of one sort or another.

And if those two economists were walking along in pre-pandemic downtown Chicago, with thousands of pedestrians strolling up and down the streets, the story makes some sense. Spare change doesn’t lie around on the street very long. The same thing happens in busy markets. When a market gets crowded, information gets incorporated into prices pretty quickly.

But there are lots of times when these circumstances don’t apply. I remember a story my pastor told me when I was in graduate school – and living on spare $20 bills. He spoke of one New Year’s Day when he and his wife went out for a walk early in the cold, cold morning. They were students at the time, struggling to make ends meet. He asked, “Well, would you like to go out to breakfast?” “With what?” she responded. “Maybe with … THIS. AND THIS. AND THIS!” Along the deserted street where they were walking blew five $100 bills. Clearly, someone had had a good time the night before and perhaps tossed some bills in the air. Not another soul was in sight, early on New Year’s Day.

My pastor told it as a story of unexpected providence. But I now see it as an example of inefficient markets. When no one is around, sometimes you can find something special just lying around. Sometimes it’s enough for breakfast, sometimes more.

There’s a lot that the efficient market theory doesn’t say. It doesn’t say that the market is always right. It doesn’t say that you can’t make money i. It doesn’t say that everything is just an elaborate scam. It simply says that in a market with millions of participants all applying their own calculations to their own circumstances, that there aren’t many $20 bills lying around.

What can we learn from this?

Photo: Roland Adriano

If you go everywhere everyone else goes, the $20 bills get picked up. That doesn’t mean don’t ever walk down a crowded avenue. There are lots of reasons to invest in what others also invest in. For one thing, it’s probably legal. For another, if you need your money back, there’s likely to be someone else who will buy what you’re selling.

But it also means, if you want results that differ from the crowd, you have to go somewhere different than the crowd. That doesn’t necessarily mean that you need to take more risk. You just have to be different in some way. And you have to be right.

Sometimes, those lonely trades get a little uncomfortable. Which means, you might want someone to help.