Dow 20,000 and Donald Trump as the embodiment of animal spirits: Don Pittis

Even as stock markets climb higher and the Dow Jones industrialaverage flirts with the 20,000 mark, some of our wisest critics havecontinued to doubt the substance of the Donald Trump rally.

Rational analystsassumed that last week's hike in interest rates from the U.S. Federal Reserve, with hints of more to come, would knock the stuffing out of the market surge.

But in a world where rationality has repeatedly failed to guide us, maybe it's time to revisit the idea that irrationality namely president-elect Donald Trump as the embodiment of animal spirits has a far greater effect on markets than rational analysts might have us think.

The fact is, economics contains morevoodoo than many of itsexponentsadmit.

The most traditional economic point of view tells us thatwhen we buy and sell and earn and spend we operate like perfect calculatingmachines.

Epitomized by suchprinciplesasoptimizationand rationalexpectations, market traders are supposed to be guided by something called market fundamentals, whichin theory arebased on a pure scientific analysis not unlike physics.

When rationality fails

The theory is seductive. It may also be true in some kind of absolute sense.

If we knew every potential influence and if we knew how each of those influences reacted together, it is possible to imagine some omniscientbeing or super intelligentcomputer constructinga sound predictive model.

But there are flaws in that idea, even from the point of view of mathematics. Adding infinite variables to an equation also adds infinite error and uncertainty.

It is also not what experience tells us. Rationality has been devalued.

In Canada, years of rational analysispointingto an overheated property market has done little to cool it.

It is not necessarily the wise stock portfolio managers who pick the best group of stocks. In fact, rationality appears to add a bias toward failure, since most such funds are repeatedly outpaced by random collections of stocks.

In politics, we know rational expectations are repeatedly blown out of the water.

Rationally speaking, a return to economic growth and a surge in jobs under President Barack Obamapointed to victory by the Democrats.

Limits of reason

And widespread predictions of a market crash in the event of a Trump winproved to be just plain wrong.

Political philosopher Michael Sandel, author of the book What Money Can't Buy: The Moral Limits of Markets, has disparaged "the prestige of economic reasoning, market thinking and market talk," part of what helabels "technocratic liberalism."

"Politics is about more thanjust economic self-interest," Sandel told Michael Enright on CBC Radio's Sunday Edition this weekend.

And just as many people who benefit from Obamacarevoted for politicians who vow to destroy it, many of our market choicesare not rational at all and instead aredeeply embedded in human psychology, something behavioural economists have repeatedly demonstrated.

Long before the current behavioural economics revolution, one of the most anti-rationalexamples of the principle was the idea of animal spirits as proposed by economist John Maynard Keynes.

"Mostof our decisions to do something positive 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," Keyneswrote in 1936 in his magnum opus The General Theory of Employment Interest and Money.

If rational market analysis is seductive, the idea that economies are stimulated by popular will through a spontaneous, though possibly irrational, popular urge, is even more so.

The idea has a certain internal logic.

If you are gloomy and think things are going to turn worse, you'reunlikely be as enthusiastic orhard working as when you are optimistic and are convincedthings are getting better.

So imagine if you had an orchestra leader or coach to get everyone enthusiastic and optimistic together.

If we wanted to imagine theTrump rally as something real that will keep working on markets and, eventually, the real economy, then this is it.

Sour notes?

Trump's role is as cheerleader, appointing cabinet members who seem to favour business success, promoting policy that seems tosupportnew investment and growth.

Research conductedforthe Globe and Mail's Report on Business shows that even in Canada Trump is spurring executive optimism. Studiesin the U.S. also show business leadershave been energized by the election results.

For many critics, economic optimism requires a certain amount of nose-holding and ear plugging.

Trump's outrageous stance on many issues, such as yesterday's comment about"Islamistswho slaughter
Christians,"could lead to outcomes disruptive to the economy.

And the rationalists could be right. An overpriced dollar could kill off U.S. exports. A shortage of labour could block growth. Trouble in Europe or Japan could be contagious. Growing inequality or environmental outrage could lead to a political backlash.

But if the new U.S. president can concentrate on being the economic orchestra leader, convincing Americans that now is the time to succeedand invest, urging on the sections at the back and getting everyone to play in concert, maybe the great performer will have found his best role.

Follow Don on Twitter @don_pittis

More analysis by Don Pittis