 Hi, this is Gerald Friedman, professor of economics at the University of Massachusetts at Amherst. And we're here today to talk about investment demand and animal spirits. The phrase comes from Keynes. He talks about people's decision to invest in some future product or future activity as driven by phases of the moon, irrational exuberance, animal spirits. And where does this come from? Well, first of all, think about it. What are you doing when you buy an investment? When you put your money into something that's going to pay off in the future? Well, you hope it will pay off in the future. Think of all the things that can happen between now and then. You build a factory planning to make iPad covers, seems like a great idea. You think it will really work out well, OK? You may die. And then your investment is wasted as far as you're concerned. The factory may burn down. There may be an earthquake. There may be new technology. Somebody else may build a factory making the same thing, just doing it better than you. Or maybe somebody will do it in some place where it's cheaper than you. All these things can happen. Apple may go bankrupt. Not likely, but it may happen. The iPad may become unpopular. Yes. The electric grid may fail. Global warming may happen. And the world may be flooded by the melting ice caps. I mean, all sorts of things can happen. So how do you decide whether your project is worth investing, tying up your money? You make a guess. Investments are all about guesses about the unknown and the unknowable. Or we can pretend that we're making careful assessments. We're serious risk analysts. And we make our investments based on a real understanding of the future. Well, nah. You don't understand the future. A year ago, that is in March, April 2011, sports illustrated and everybody else predicted the Red Sox would win the World Series. Well, guess what? They didn't even make it to the playoffs. What happened? On September 1, 2011, the Sox were, what, seven games ahead of the next place team in the wild card? They managed to lose it. It happens. It's unpredictable. Life is like that. So first thing to know about investment is it's based on an assessment about the unknowable. You can never know the future. What an investment decision depends on making a bet about the future. It gets worse than that because not only is the future unknowable, but you're actually not guessing about the future. You're in some sort of platonic cave. Remember in the Republic, Plato talks about what we see of the world isn't the world. We see the shadows of things, lit backlit from the other side of the cave and all we see are the shadows. Well, your investment decision is like that because you're not really interested in whether your iPad cover factory is going to work. What you're interested in is are other people going to be willing to pay for your investment in the future? Will other people like what you're buying? If they will, then you'll be able to sell it to them and you don't care whether the factory works or whether the covers are popular. If you can sell your investment off to somebody else at a nice return, then your investment is paid off. This goes back to Tulips. In the 17th century, West Europeans discovered the tulip bulb. The Dutch imported some tulip bulbs from the Ottoman Empire and they were all excited about them. They were pretty, they were beautiful. Tulips, they're great. Dutch tulips, wonderful. The Dutch started to buy more tulips, cultivate them, and a futures market developed because farmers would plant their tulips and they needed cash. They would sell the futures of their tulips. From this futures market developed the whole market in tulips and one day the tulip prices started to go up and then they went up higher and they went up higher and people were pouring money into tulips until tulips were selling at the price of a house $200, $300,000 for a tulip bulb. Well, one day people realized that this was completely absurd and they started dumping their tulips, selling them, cashing out, and prices plummeted all the way back down to $10 a bulb or so. That's investment life. Was it irrational to buy tulips at a $100,000 bulb? Well, if you bought a tulip at $100,000 and sold at $200,000, you're rich. That was a great investment. What makes it a good investment is not whether there's any rationality about it, anything, any reason to think that these bulbs are going to produce such beautiful flowers that they'll be worth $200,000. That doesn't matter. What makes it a great investment is if you guess correctly about what other people are going to want to buy in the future. If you guess correctly that these tulips are going to sell for a high price, then that's a good investment. What shapes your decision here? How do you decide that some investment project, a tunnel under the Mississippi River, a power plant, a factory, an office building, a house, how do you decide that this is going to be something that other people are going to want to buy in the future? You're guessing. You just wake up one morning and you feel really good. Maybe you took too much Prozac. Maybe you just had a really nice time with your spouse or significant other or whatever and you just get out of bed just feeling all alive and tingly and ready to go out and so you go out and you buy stuff. You invest. Because you invested, other people look around and say, hey, wait, Dan's investing. Beowulf is buying stuff. Time to get in on it because if they're buying, then prices are going to be going up and we'll be able to buy and sell and make profits. Every other people start to get excited. This is an animal spirits episode. People feeling good, they're getting all excited. They're buying, they're buying, they're buying and prices go up because they're buying. Until at some point after a while you get up and you say, you had a fight with your significant other. Your Prozac was replaced with sugar pills and maybe the placebo effect wore off. Whatever it is, you get up one morning. You're still angry that the Red Sox lost and you say to hell with it, I'm just going to cash out and you sell. All of a sudden, those investments don't look so good to everybody else and they start to sell. What happens to the economy? When your animal spirits are good, it's booming. Investments lead to more output, more employment, justifying the investments. Everybody's buying stuff. It's all good. And then the Prozac war is off. You stop investing and it all comes tumbling down and the whole economy is bad. Everybody's out of work, nobody's producing anything. It's all very sad. That's animal spirits. That's investment. That is the Keynesian interpretation of the capitalist business cycle. Okay. We'll talk some more next time about the United States and what we've been doing since World War II. Thank you. Have a good day. Bye-bye.