Thoughts on <Animal Spirits>

Opening

Honestly, I learned about this book as a recommended read back in 2013 and it kept nagging at me for a full ten years before I finally read it — a somewhat embarrassing but personally historic book. One reason I finally picked it up after a decade is that I've been spending more and more time on crypto and stock investing over the past year or two. The more I watch what people commonly call "the market," the more I feel that the human cultural and psychological elements that can't be explained by simple numbers and theories are at the very core. Hoping to ease some of that confusion, I thought it was finally time to really read this book.

The title "Animal Spirits" uses words that are somewhat unfamiliar in Korean, which may have made it feel unapproachable. But as the subtitle — "How Human Psychology Drives the Economy and Why It Matters for Global Capitalism" — suggests, what this book is trying to say is actually quite simple. Reading it, you start to feel that where conventional economics used to talk about rigid numbers, formulas, and laws, this book reads so much like a psychology book that you might wonder if you're reading economics at all.

About the Book

Before reading this book, I honestly didn't know what Keynesianism was. I had only a faint memory of briefly seeing it in <Mankiw's Economics> in an introductory economics class in college. Having finished it, I now understand that this book argues that Keynes's original concept of "animal spirits" deserves our serious attention — and that forgetting what we learned after the Great Depression of the 1930s was the root cause of the financial crisis. So the very first page of the book opens with this passage from Keynes's The General Theory of Employment, Interest and Money:

Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits — a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

The book is divided into two main parts. Part 1 explains the five irrational human psychological forces that make up the "animal spirits" theory. Part 2 answers 8 common questions about the economy to show how greatly animal spirits influence it. The book's Korean editor suggests that reading Part 2 first might be better for general readers, since it poses questions anyone has probably wondered about. However, since Part 1 concepts are repeatedly referenced throughout Part 2 with examples, if you do choose to read it, I'd recommend reading in order — with a bit of tolerance for the slower pace.

Here I'll summarize the core of each part. Part 1 identifies five aspects of animal spirits that influence the economy:

1. Confidence
   1. People buy assets when confidence is high and sell when confidence is low.
   2. Standard economic theory says people consider the outcomes, value, and probabilities of all possible options before making decisions — but if you ask people around you why they bought a major asset like real estate, you can easily see a strong correlation with the prevailing mood and the level of confidence it creates.
2. Fairness
   1. Motivations based on fairness tend to overpower purely rational economic motivations.
   2. (One of the questions answered in Part 2) Wages tend to rise across many years but almost never fall. Research has consistently shown that employers always pay more than the minimum amount workers would accept — and the difference between this higher wage and the "clean" supply-demand wage is exactly enough to generate a sense of "gratitude" for the job and a "motivation" to honor its fairness. Without this motivation, an employer simply cannot extract the work output they want from workers just by paying the supply-demand wage.
3. Corruption and Bad Faith
   1. Some economic fluctuations are influenced by social attitudes toward corruption and how widespread it is. More importantly, the spread of bad faith — economic activity driven by bad motives that isn't illegal but is still destructive — is a serious problem.
   2. This bad-faith economic activity is also another face of capitalism. Capitalism is commonly said to generate wealth by producing what people truly need — but wealth can also be generated by making people believe they want things they don't.
   3. Economic crisis cases that can be explained by corruption and bad faith include: corruption scandals, accounting fraud, savings and loan fraud, the Enron scandal, and the subprime mortgage crisis.
   4. When major events like these explode, regulations and systems are improved — but new financial services and more complex instruments emerge to exploit the gaps. Regulations must keep pace, but they always lag, which is why financial crises recur periodically.
4. Money Illusion
   1. Money illusion is the common mistake people make when they fail to account for inflation.
   2. In the 1960s, despite a lack of clear evidence, economists argued that economic decisions are based on rational behavior — a view that left no room for money illusion.
   3. One important assumption of modern macroeconomics is that people can see through the veil of inflation. But in everyday wage contracts and bond contracts, neither party actually indexes to inflation — and this itself is a clear example of money illusion in action.
5. Stories
   1. The confidence of a nation or any large group is influenced by stories. The story of the invention and adoption of the internet — available to the public from 1994 — sustained itself from the mid-1990s through 2000 and had a core role in driving the economic boom of that period.

Part 2 covers how these five animal spirits can explain major questions about the economy. The 8 questions are:

1. Why do economies fall into recession?
2. Why do central banks have control over the economy?
3. Why are there people who can't find jobs?
4. Why do inflation and unemployment move inversely in the long run?
5. Why do people save for the future in an unplanned way?
6. Why are financial markets and corporate investment so volatile?
7. Why does the real estate market go through periodic booms and busts?
8. Why does poverty among minorities continue to be inherited across generations?

I'd encourage you to read the book to savor the authors' detailed answers. A few messages I took from Part 2: the authors argue that what was needed during moments like the 2008 financial crisis was the more active, appropriate government intervention that we had learned and practiced following the Great Depression. They re-emphasize that the original purpose of the Federal Reserve — born from many historical experiences of psychological panic causing bank runs and financial crises — was to act as a stopper that keeps the first domino from toppling the others. And above all, they argue that too many macroeconomists and finance professionals have become so captivated by "rational expectations" and "efficient markets" that they are missing the most important dynamic at the base of economic crises.

Traditional economic theory has no room for the principles of animal spirits. It excludes the fundamental dynamics that cause change and crisis. It does not account for the loss of confidence and trust, the perception of fairness that suppresses wage and price flexibility, the effect of bad financial products during boom times and the corruption that enables it, the effect of the exposure of that corruption when bubbles burst, or the influence of the stories through which we interpret the economy.

Closing

Reading this book, I often felt that the authors' arguments and evidence didn't feel logical or scientific — probably because the approach was so different from economics books that typically express things in equations and graphs. It felt more like reading a psychology book, with many social experiment examples — similar to <Influence: The Psychology of Persuasion>. Holding onto this skepticism as I read, I eventually reached the "conclusion" section, where the authors themselves acknowledge that this book does not offer specific answers to all the questions it raises; its purpose was to suggest a direction of thinking — that how economies work and the role government plays within them cannot be explained by economic incentives alone. Having read that admission, the parts I'd found insufficient throughout suddenly made sense as being intentional.

Having finished the book, I'm still personally left with one question: why did the authors choose these particular five animal spirits from among the many irrational human emotions? For example, just as Charlie Munger said "the most dangerous psychology to guard against is not greed but envy," envy also strongly influences human decision-making and thus must have a significant economic impact. I think the book would feel even more complete with an explanation of why these five are especially important.

What I took away from this book is a firm awareness that human psychological, social, and cultural factors cannot be ignored when interpreting investment markets. I'll likely pay more attention to behavioral economics and try to understand it better going forward. And Charlie Munger's statement — "The core content of psychology, which I call 'The Psychology of Human Misjudgment,' is enormously important and must be learned" — is something I now find a little more relatable and comprehensible.

Investing, markets, and the future still feel vague and difficult. But through this book, I was able to recognize a version of myself that had been relying too heavily on "efficiency" and "rationality" to explain phenomena. For the aspects that can't be explained by efficiency and reason, I now have more diverse perspectives to consider — rather than feeling frustrated or dismissing them — and that's where I find the meaning of this reading.