Practical analysis for investment professionals
27 March 2017

Where Markets Fail: Markets Assume Fungibility

Have you ever lent a postage stamp to someone who rather than paying you back with an actual postage stamp, gave you the nominal amount of the stamp, say US 40¢, instead?

This is aggravating because while the transaction is fungible due to the presumed exchangeability of currency, it is not an equal transaction. Why? Because acquiring a postage stamp requires much more than just 40¢. It also means a trip to the post office, waiting in line, transacting, and then returning home.

In the last two articles in the Where Markets Fail series, this fan of capitalism pointed out ways that our main mechanisms — markets — are flawed. First I demonstrated that markets are poor estimators of future states because people are poor predictors of what comes next. Next, I observed that markets assume a context, with deleterious consequences.

A third way that markets fail is that transactions assume fungibility.

Even when a currency is not present, markets involve an assumption of fungibility. Why? Because in a market transaction, both parties are free to either reject or accept the terms of the deal. So a dentist providing dental work to a bricklayer in exchange for repair of a brick wall is a transaction. This does not mean, however, that the transaction is always fungible.

While there is a degree of exchangeability in this example, barter systems fail because of the “double coincidence of wants.” That is, a dentist looking for brickwork must find a brick worker looking for dentistry. Such a search is time-consuming, and therefore inefficient and a drag on capitalist activity. And absent currency, independent and universal prices for these goods and services are difficult to ascertain. Consequently, markets break down.

I know what you are thinking: But we have currency! Currency provides a universal denominator for goods and services so exchanges can occur indirectly in currency rather than directly in goods and services. True. But that does not mean that the fungibility is perfect, as in the postage stamp example.

But who cares about a postage stamp?

What happens when clean air and clean water are exchanged for cash? It may seem that since clean air and clean water can be priced in currency that cash and clean air are fungible. But try making that transaction in outer space on a space station.

Or what about the destruction of an entire ecosystem? Is its elimination fungible for the equivalent value in Kewpie dolls? Or compare the value of your education with the money it cost to attain it. There is a large-sized consumer surplus (your benefit) in those who hold the CFA charter relative to its cost. This is a fungibility mismatch in the opposite direction.

What these two examples illustrate is that the fungibility assumption makes no distinction for uniqueness.

For example, if a hurricane destroys your home and kills your spouse, the cash received from your property and life insurance policies are not replacements, and not fungible with the underwritten.

This is also true for your health. How much money will you accept to saw off your leg? I don’t mean to be garish, I am just pointing out that markets denominated in currency help with the fungibility of commoditized goods, but the same assumption does not apply to more important things.

For that which is irrevocable, fungibility is a poor assumption. Witness: your professional or personal reputation.

Of course, an understanding of supply and demand does not fully describe or rectify the problem. After all, clean air is in vast abundance and demand for it is also universal. But that does not mean that currency in exchange for clean air is fungible.

In investing, a share of stock in two different companies, each share costing £50.00, is not necessarily of equal values over the long term, though the market is accurately discounting the prospects of each business. Clearly, the fungibility assumption fails frequently in capitalism.

I am not saying abandon markets. I am saying know your assumptions so that you can make more fully conscious decisions.

Possible Remedies

  • Pay attention in a transaction and remember: “Just because a thing is priced does not necessarily mean that is its price.”
  • In capitalism, we treat capital as precious, yet the fungibility assumption runs counter to that metaphysical assumption — ¥100 is not the same in every instance. So pay attention to what you value and ask, “What am I trying to maximize/minimize, and is fungibility the correct assumption?” Put another way, “Am I being fairly compensated at this price?”

Here is the future trajectory of this series:

  • Markets are not systemic.
  • Markets have “visible hands.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/erhui1979

About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor and the CEO of Active Investment Management (AIM) Consulting. Voss also sub-contracts for the well known firm, Focus Consulting Group. Previously, he was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. Voss holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: [email protected]

5 thoughts on “Where Markets Fail: Markets Assume Fungibility”

  1. Nana Buanya says:

    Good read. The remedies seem commonsensical but the flawed judgments seem to ensure that this continues.

    1. Hello Nana,

      Thank you for taking the time to comment on the article. Yes, it is probably the case that unless someone changes their mental habits that they will still continue to commit the error that I highlight in the article. To me, this is a strong argument for engaging in a practice that increases both attention and awareness. Hmmm, what could that be? Meditation! See my many pieces on meditation here on The Enterprising Investor:

      Again, thank you for your comment!


  2. Aaron says:

    I appreciate the blog, but I would be hesitant to call these market failures. I believe the term failure is based on an assumption that markets are in equilibrium instead of tending towards equilibrium via coordination. Every realized price is a market-clearing price versus a state of disequilibrium with a supply and demand mismatch. Realized prices, overtime, expose and correct errors via entrepreneurial selection. Therefore, the disequilibrium is a necessary component of a market process and often called “natural rate of profit”.

    This article may be of interest to you. Harold Demsetz, Information and Efficiency, Another Viewpoint in the Journal of Law and Economics, 1969, vol. 12, issue 1, pages 1-22

    1. Hi Aaron,

      Thank you for taking the time to share your thoughts. I will take a look at the paper that you included.

      Separately, I am not sure if you read the first two editions in the series. The second discussed that markets assume a context, most obviously that the activities undertaken by the market are legitimate, at least to two counterparties. Why is this important to this article’s discussion on fungibility? Because markets do not have a particularly good way of logging ‘no’ votes for the activities that are taking place. In the prior post I used the example that there is a market for killing people/for hiring a hitman, for example. In other words, sometimes markets support illegitimate activities. So, too, with fungibility. In the article I give the example of clean air being exchanged for a currency – the right to pollute. This is very similar to my postage stamp example. While the value of a postage stamp may be $0.45, to be paid back in money $0.45 instead of in a postage stamp is a net loss, even though the transaction is technically ‘agreed upon’ and ‘fair’ from the point of markets. But to replace that postage stamp is a harder thing than is compensated by $0.45. I would argue that clean air and clean water are also not fungible with currency. While an exchange may occur between parties, and the price maybe agreed upon, to create clean air and clean water is actually quite expensive. Couple this with my point in the first article in the series, that markets are imperfect discounting mechanisms, then you had better hope that clean air and clean water are being priced well.

      I hope that helps to improve you understanding of my point.

      Yours, in service,


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