Who Cares About Liquidity?

This is the fourth and final entry in the Liquidity miniseries.  Read What is Liquidity?, What Determines Liquidity?, and How is Liquidity Measured? to catch up.

Everyone cares about liquidity.

Clearly, those who invest in the stock market care about liquidity.  If you place an order to buy a stock, you want to be able to get it for close to its current price.  Similarly, when you sell later, you don't want your sale to push the price down significantly.  Liquid stocks are more attractive for this reason.

Liquidity factors into everyday decisions too.  Consider this example I gave to my family last year (yes, my family has social conversations about this sort of thing; we are all nerds):

The bid-ask spread is one measure of liquidity.  For example, I would be willing pay you $1 for four quarters and you would probably be willing to sell them to me for the same price.  So, the bid-ask spread of four quarters is zero, and US currency is very liquid among its denominations.  This also implies that you and I consider quarters and dollar bills to be equal, which we might not in the real world.  Dollar bills suddenly become less liquid when you are trying to buy a candy bar from a vending machine that requires exact change.  In that case, I might pay you a dollar for three quarters just to get the change.  I am paying for liquidity, in that case.

This is an example of how currency isn't always fungible, which is a prerequisite for liquidity.  Two dollar bills are fungible with each other, but dollars and quarters aren't always.  The same is true for your electronic money in your checking account and cash from your checking account.  There are times when you would gladly pay a $3 fee to turn that electronic money into cash at an ATM.

The average person rarely notices liquidity when dealing with liquid goods, which most goods are.  People's decisions in aggregate make changes in the market, but these are hard to perceive at ground level.  One of your best opportunities to experience illiquidity is to do something like bid on a house, sell a used car at an auction, engage in salary negotiations at a new job, or buy a thinly traded stock.