If it was the spirit of Chicago economist Milton Friedman that dominated the ethos of mainstream economic thinking during the last 30 years, today it's the ghost of English economist John Maynard Keynes that is making a comeback. That's because Keynes' name is inevitably associated with big fiscal stimulus packages contemplated by the new Obama administration in the United States and other governments around the world. Yet, Keynes' mostly forgotten notion of "animal spirits" is an equally important concept. It's "animal spirits" -- in the form of "irrational exuberance" -- that got the financial world into its current economic parlous state. And it will be its emergence from an equally "irrational depression" that will be its savior.

The term "animal spirits" was first popularized by Keynes in his 1936 magnum opus, "The General Theory of Employment, Interest and Money." There, Keynes defined "animal spirits" as "a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." When "animal spirits" are low, consumers do not want to spend and businesses do not want to hire people or make investments. Although the phrase "animal spirits" is unique to Keynes, other observers such as Gustav Le Bon -- in his book "The Crowd" -- had discussed similar concepts decades earlier. Warren Buffett identified the same thing when he used the metaphor of "Mr. Market" and his manic depression as a way to describe mood swings in the financial markets.

With the Dow Jones Industrial Average and S&P 500 coming off their worst January since the Great Depression, and consumer confidence at or near record lows, you don't need a complex equation to tell you that "animal spirits" are low. And that's precisely what's so slippery about "animal spirits" -- a notion that could not be farther from the mathematically exacting discipline of economics and its assumptions about the ultimate rational actor, homo economicus. For a mainstream economist in 2009, if you can't put a number on it, it might as well not exist.

Yet the elephant in the room is that few would deny that "animal spirits" exist -- and that they have nothing to do with the hyper-rational actors found only in economics textbooks. And as Berkeley's Nobel Prize-winning economist George Akerlof and Yale's Robert Shiller point out in their upcoming book: Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, swings in "animal spirits" and confidence are anything but rational. The "irrational depression" that can follow the "irrational exuberance" of any financial bubble can get economies into big trouble. In that sense, every government stimulus package is an attempt to reverse the downward spiral in "animal spirits." If banks aren't lending to each other, and consumers aren't buying houses, "animal spirits" must change first, for banks and consumers to change their minds.

"Animal Spirits": Cassandras' Ball at Davos

The downward spiral of the world's "animal spirits" today was on full display at last week's World Economic Forum at Davos, Switzerland, an annual meeting of the world's economic elite. The feel-good factor and politesse of previous meetings was absent -- a stark change for, as one journalist observed, "a Davos Man (who) is an optimist by nature and profession." Instead of self-congratulatory panels dedicated to the success of globalization, it was the Cassandras of the world, the "doom and gloom" types, who took the center stage in 2009. One dinner boasted an all star-cast of New York University professor Nouriel Roubini, aka Dr. Doom; Nassim Taleb, author of "The Black Swan"; Daniel Kahneman, the economics Nobel Prize-winning Princeton psychologist, and Niall Ferguson, the history professor and author of "The Ascent of Money." It was a sign of the times when Nassim Taleb drew an exuberant cheer as he exclaimed, "I was happy when Lehman went bust," boasting he had shorted the company and literally danced when he heard the news.

Not to be outdone, Russia's Vladimir Putin's speech openly mocked the U.S. delegates who spoke at Davos last year and boasted about "the U.S. economy's fundamental stability and its cloudless prospects." As Putin sardonically pointed out: "Today, investment banks, the pride of Wall Street, have virtually ceased to exist. In just 12 months, they have posted losses exceeding the profits they made in the last 25 years." Putin's chutzpah is breathtaking. After all, last year, it was Russia that was touted as "an island of stability." This year, Russia's stock market is down over 70% from its highs; its Central Bank has spent over $200 billion to defend its collapsing currency; and the government will spend another $200 billion of its rainy day fund to plug the gaps in its budget. That's big bucks for an economy the size of Texas.

"Animal Spirits": An Absence of "The Audacity of Hope"

The role of "animal spirits" in the world's collective psychology may be the most underrated idea around. After all, it was "animal spirits" -- let's call it "irrational exuberance" in politics -- that lifted Barack Obama into the White House. Ironically, the Davos gathering was marked by the almost complete absence of representatives from the Obama Administration. Playing foil to the self-delusional fits of Vladimir Putin was White House advisor Valerie Jarrett, whose speech on "a new era" was predictably short on detail. In a testament to the fickleness of animal spirits, the purple haze of Europe's infatuation with Obama may already be lifting. European "Obamaniacs" of all stripes squirmed when, in his inaugural speech, their favorite son failed to mention the Old Continent a single time.

But here's what you need to know about "animal spirits." First, "animal spirits" is not a number. The real success of any government's stimulus package is whether it is able to shift public confidence. And that's not a figure you can pry out of a spreadsheet. Second, "animal spirits" are neither rational nor permanent. And as much as the overwhelming consensus at Davos was that things were really bad and getting worse, that in itself could be good news. As one of India's wealthiest men noted at Davos: "the consensus at Davos has been over the last many years, never right." And that fickleness of "animal spirits" may be the best news yet.

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