John Maynard Keynes, the eminent economist who is back in style, described the stock market as a beauty contest. He asked the readers of his General Theory of Employment, Interest, and Money to imagine a newspaper contest featuring six photos, with everyone who picked the most beautiful being eligible for a prize. The prize winners would be rewarded not for picking the person they thought was the best looking, but rather the person that everyone else thought was best-looking. When it comes to stocks, therefore, the key is to pick the companies that you think everyone else will want to buy, because when they buy the shares, they will bid up the price. It doesn’t matter what you think will be the best investment. Instead, you have to guess what everyone else will choose.
Keynes was trying to simplify his explanation of how the market works, but his example turned out to be strangely convoluted. What kind of contest would this be?
But this week, we have a great example of what kind of contest it is: an American Idol pool. Wherever people gather in this great land of ours, they’ll be betting on which person ridiculed by Simon tonight will end up going all the way.
The winner of American Idol is rarely the best singer or performer; consider that the biggest star to come from the show is probably Jennifer Hudson, who was eliminated before the semi-final vote in the third season of the show, brought back as a wild card, and then eliminated again to finish in seventh place. Fantasia Barrino won that year. Fantasia has had an okay career since winning, but she’s the lesser of the two stars. Kelly Clarkson and Carrie Underwood have had much success, but Taylor Hicks and Ruben Stoddard have not.
If you bet on the American Idol winner, you are not betting on the singer you like best, or even the singer who is the most talented. Instead, you need to bet on the singer that ”America” will like best when Ryan Seacrest urges ”America” to vote. Thus it is someone talented enough to stay on the show when Simon/Randy/Paula/Ellen have their say, charismatic enough to garner a following from those viewers who are committed enough to voting (and voting and voting), and bland enough to appeal to many while offending very few. Carly Smithson’s tattoos alone would have kept her from winning Season 7, especially with David Archuleta capturing the hearts of Tweens who Text and David Cook getting the votes of their mothers.
Now, apply that to the stock market: you aren’t looking for the stock with the best balance sheet, or the best prospects, or the most responsible governance. Instead, you are looking for the stock that other people will get excited about. The result? The Internet bubble of the 1990s. Keynes’ concept applies to other markets, too, like that for luxury condominiums in Las Vegas.
Regardless of what the teabaggaz think, Keynes is back in fashion because his work in the General Theory applied to the Depression and has lessons for the current era; hardly anyone has done as much thinking on the problem of deflation. His work on the stock market was a bit of a throwaway; Keynes enjoyed speculating in the stock market and made good money at it, too, but it was not his primary area of research. In fact, the stock market didn’t receive a lot of serious academic attention until the 1950s and 1960s, when the Modern Portfolio Theory was developed. It’s based on the idea that markets are rational and efficient, which is questionable. That’s sending many researchers back to their computers to try to determine a new theory for how markets work.
But maybe it’s time to think about Keynes, especially as the new season of American Idol begins. Is the market for American Idols efficient? Probably not. Any evaluation of the contestants will be subjective, and the winner will still have to appeal to the people who watch American Idol and participate in the voting.
And even if you do not watch the show, you know have enough insight to win your office Idol pool.