The Competition of Bad News: Financial Instability & the Animal Spirits

Financial instability is often either ascribed to rationality itself coping with a looming future or to an irrational exuberance, a faulty thinking. The former is known as the efficient market theory in the mainstream literature. The latter, which has some conventional wisdom flavor, stems from the analysis of certain mainstream mavericks, such as Akerlof and Schiller. The purpose of this paper is twofold. On the basis of Keynes's seminal intuition of animal spirits, it strives to stimulate theoretical discussion on investors' behavior in the stock markets out of a survey of alternative analysis. By the same token, it aims at providing a consistent analysis of the current financial crisis in the light of this notion. Actually, two rationales do coincide at any time in the stock exchange, two rationales that pertain to two different kinds of buyers and sellers. One is rather a long-term rationality, for the goal of the investor is to forebode the inner value of the company he (or she) is investing in so that he (or she) may reap dividends. The other requires a short-term rationality, since the aim of the investor is to forecast and, consequently, forestall the psychology of the market in order to make a capital gain. The kind of rationality involved is different; it has to do with Keynes's metaphor of a beauty contest. In the twelfth chapter of his General Theory, Keynes referred to the animal spirits of the investors in a somewhat elusive manner. Our attempt at deepening this notion will hinge around three headings. First, we will examine the breakthroughs in the fields of behavioral economics (prospect theory, norm theory, heuristics and biases…). There are patterns in speculators' behaviors such as overconfidence, a narrative bias, a propensity to rely on the strength of an argument rather than on its weight, and anchors. Second, the acclaimed work of René Girard enables us to analyze the momentum of desires, which lie at the very gist of the speculative process. Desire is not what binds a man with an object but two men together, via this object. Thus, unconscious imitation emerges as a major pattern of speculation. Third, the recent watersheds in the fields of the neurosciences shed new light on the affective frame of one's decisions. By summoning the outstanding works of Damasio, Libet and Berthoz (to mention but a few), we will try to make some important points: the intelligence of our emotions, the fact that rational choices need to be buttressed by emotions, action lies at the heart of perception (giving a new impetus to Husserl's phenomenology), short-term and long-term anticipations use different cognitive processes… As Turgot pointed out a long time ago, there is no such thing as a "natural pricing" in the stock market. Indexes can skyrocket or plummet at an appalling pace, due to these cognitive patterns. But it appears that, when Price-Earning-Ratios are too high, the market wax jittery. As the general mood dampens, each new information tends to be interpreted as part of a narrative: the "good news" are discounted or discarded. Symmetrically, when optimism is high, the same information is perceived in a very different manner and the "bad news" are disregarded.