There's a war going on among music critics of a certain age. A few months ago, San Francisco Chronicle critic Joel Selvin mourned the loss of concern for sound quality in the MP3 era. Since then, writers for the Wall Street Journal and New York Times have thrown down the gauntlet for the other side, arguing not only that MP3s and other forms of compressed digital music are sufficient, but that audiophiles are delusional--especially older audiophiles, whose hearing has probably decayed to the point where they couldn't even hear all the things that MP3s take out. Slate columnist Fred Kaplan responded this week with an impassioned defense for the audiophile team, arguing that you need to the gear in order to hear the subtle beauties that make music musical ("the silky sheen of massed violins; the steely whoosh of brushes on a snare...").
There's an element of truth to both sides. Nobody's arguing that MP3s sound as good as a CD or LP on a proper stereo system. But in listening to audiophiles rave about their gear, I've often found that they show a strong bias toward big, expensive speakers. Same with many studio engineers. To me, that sounds a lot like conspicuous consumption masquerading as knowledge.
Personally, I agree with the kind folks at my local audiophile store, Hawthorne Stereo, who argue that speakers are chronically overmarketed, overadvertised, and overpriced. Yes, bad speakers can absolutely ruin sound, usually by trying to add color that shouldn't be there, or sometimes by having obvious gaps in their frequency response. (There's a story about the Beatles recording "Hey Jude" at a different studio than usual. It sounded great on that studio's speakers, but horrific at Abbey Road, where they usually recorded. Turned out that the other studio's speakers were set to artificially boost the treble.) But source is king--if your system can't convert your source material to electrical signals accurately, the best speakers in the world cannot help you. They cannot add to sound, only subtract from it!
So, if your budget's limited, you'll do far better to spend about 40% on an audiophile turntable or CD player, and split the rest between amplifier and speakers. This holds true in amplified live music as well--the most important component is the source (the player), followed by the construction of the instrument, followed by the electronics on the instrument, followed by the amplifier, with the speaker serving as a mere transducer to transfer electrical into acoustic energy. It's not unimportant, but it's the least important component in the chain.
All of this is a roundabout way of saying that there's an element of chicanery in a lot of audiophile marketing and self-congratulatory backslapping. As I've said before, if you want convenience and portability--background music for working out at the gym or driving--MP3s on an iPod are adequate. The convenience more than outweighs the lack of sound quality. Compressed AAC or WMA files generally sound better for the same bitrate, and lossless files are the best but take up lots of space. But if you are the type of person who really sits and listens to music, invest in the best turntable or CD player you can afford, make sure your amplifier and speakers don't suck, place yourself in the center of the stereo field, and allow yourself to be carried away.