(SOUNDBITE OF YOUTUBE VIDEO "SUPRISED KITTY (ORIGINAL)")
UNIDENTIFIED PERSON: (Laughter) Oh, you look like a little monkey.
(SOUNDBITE OF ONE ESKIMO SONG "AMAZING")
DAVID KESTENBAUM, HOST:
Hello. And welcome to PLANET MONEY. I'm David Kestenbaum.
ADAM DAVIDSON, HOST:
And I'm Adam Davidson. Today is Tuesday, January 11. That's 1-11-11. That was the sound of someone tickling a kitten you heard at the top.
KESTEBAUM: That's part of our very first economics experiment that 12,000 of you participated in. We will have the results and analysis for you shortly. But first - the PLANET MONEY Indicator from Jacob.
JACOB GOLDSTEIN, BYLINE: Today's PLANET MONEY Indicator is about 7 percent. That's the rate on Portuguese 10-year bonds. And it's really, really high. It means that people around the world basically are getting nervous that Portugal won't be able to pay back its debts. And they're thinking, you know, if I'm going to lend money to Portugal, I better get a lot of interest. So if we just, for the sake of comparison, look at bonds from Germany - say, a country investors really trust - those bonds are paying less than 3 percent interest.
KESTEBAUM: Compared to 7 percent - Jacob, I feel like I hear this from you all the time. We heard this very same story for Greece. We heard it for Ireland. And both of those countries wound up getting bailouts.
GOLDSTEIN: Yeah, it really seems like this sort of Europe-bailout script has developed by now. I was actually thinking about this this morning when I was putting together the indicator. I read this quote in a Bloomberg story. I'll read it to you. I have it here. Quote, "Portuguese Prime Minister Jose Socrates said today his government will not ask for aid and that talk of a bailout is only helping speculators. He also said last year's budget deficit will be lower than the government had forecast."
KESTEBAUM: That's the first sign you're headed for a bailout - the denial of the bailout.
GOLDSTEIN: Right, the denial of the bailout - I mean, it's almost like he's going down this checklist now. It's like the same list we heard in Greece and in Ireland. It's like deny that you're going to need a bailout - check. Say something about speculators - check. Say things aren't as bad as everybody thinks - check.
DAVIDSON: And another check - the prime minister of the country is the only person in the world who seems to think these things - who seem to think their economy...
GOLDSTEIN: Right. I guess that's job one if you're the prime minister of a country like that.
DAVIDSON: Don't say, our country's about to go bankrupt.
GOLDSTEIN: Yeah, exactly. Do not say that. Now, of course, Portugal has been on this sort of bailout watchlist for a while now. But this is a particularly big week. The country is selling new bonds tomorrow. And everybody is very anxious to see how that goes.
KESTEBAUM: All right, Jacob, thank you very much.
GOLDSTEIN: Thanks, guys.
KESTEBAUM: Now onto our economics experiment - so we set up this special webpage. And for those of you who tried it, you know that we forced you to watch three cute animal videos. And some of you wrote to us saying that was fun. But what is this all about? Now, we can tell you what the heck all this was about. We can reveal this was actually not about cute animals at all. No, it was a test of an idea written in 1935.
DAVIDSON: It was written specifically by John Maynard Keynes. Now, many of you know, John Maynard Keynes was the British economist who just towers over economics for this entire century. I mean, to this very day, some of the most contentious battles in economics are over ideas that John Maynard Keynes introduced in the '30s. Now Keynes said that a way to think about how the stock market works is to think of it like an unusual beauty contest. Now, people who've read the masterful biography of Keynes, by Robert Skidelsky, know that Keynes' romantic interests were generally directed at men. But in this case, he imagined a beauty contest of women.
KESTEBAUM: So the contest he imagined would work like this. It would be in a newspaper where you put six photos of different women. And then you ask the newspaper readers to write in with their vote. And this is the important part. You get a prize if you pick the most popular face.
DAVIDSON: And the reason this is a good proxy for the stock market is - think how the stock market works. So you might go around and look at different companies and say, boy, I think Coca-Cola really should be worth $50. And, boy, I really like the chances of GE growing in the future. I think they're going to be worth more in the future. But the rational, logical investor thinks about something else as well. They think, well, I have my view of how healthy these companies are. But if the rest of the world has a more optimistic view - they think these companies are going to do even better than I do - that is sort of a self-fulfilling prophecy. I should invest not based on what I myself think but what everyone else thinks. And this issue of people casting their vote effectively - spending their money in a market based not on what they themselves think is right but based on what they think other people think is right - is what some people thought could lead to bubbles and manias and many of the distortions that we've seen in the markets lately.
KESTEBAUM: And not just the stock market, right?
DAVIDSON: Not just - obviously the housing market. I know you and Jacob are looking into the gold market, which has some hints that it might be a similarly frothy market - where people aren't so much thinking gold is worth more. But I think everyone else thinks gold is worth more, so I'm going to keep investing in it even if I think it's overpriced.
KESTEBAUM: So Keynes was thinking about this in terms of a beauty contest, where he was pointing out that the rational, logical thing to do is to try to pick the woman that you think everyone else is going to pick - not necessarily the person you think is the prettiest. In fact, the person who's the prettiest might not actually win. Here, I'll read from what he wrote. Quote, "it is not a case of choosing faces that, to the best of one's judgment, are really the prettiest nor even those that average opinion genuinely thinks the prettiest. We we've reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees."
PIETRA RIVOLI: He's just talking about sort of some kind of strange exponential psychological process.
KESTEBAUM: This is Pietra Rivoli, who gave us the idea to test this out. She's a professor at the McDonough School of Business at Georgetown University.
RIVOLI: I'm trying to figure out what you think, and you're trying to think figure out what the next guy thinks. And that guy's trying to figure out what the other guy thinks and so forth and so on. So you know, I guess theoretically we could go around the world doing this with nobody really thinking for themselves.
KESTEBAUM: So instead of deciding what I think the stock should actually be worth, I'm thinking what does Pietra think. Or I'm thinking what does Pietra think that Adam thinks that Caitlin thinks.
RIVOLI: Exactly, exactly. And, you know, again, the key danger is that nobody's really thinking.
DAVIDSON: So we decided to do our own beauty contest. We wanted to test this idea that if people are voting based not on what they personally think is beautiful and valuable but based on what they think other people will think is beautiful - how does that change the dynamic? How does that change how things are valued? And we decided not to use the beauty of human beings. David, I'm just going to say this because I think it's part of the experimental study - what our thinking was or at least my thinking was. I'm clearly the most beautiful member of the PLANET MONEY team. And my feeling was I would just get 100 percent of the vote. It wouldn't be statistically significant, and it might hurt morale.
KESTEBAUM: (Laughter) Yeah.
DAVIDSON: So David, you had the brilliant idea of us focusing not on human beings but on animals and not focusing on beauty but cuteness. Pietra Rivoli helped us design the experiment. She explains.
RIVOLI: So we have three animals. We have a kitten who's very cute. We have some baby polar bears - or a mama and a baby maybe - also very cute. And we have something called a loris, which is an animal I wasn't familiar with. And the loris is a - surprise - also cute.
KESTEBAUM: So the loris - can I just speak up for the loris here? I think I'm a loris guy. I don't know if every one out there has seen a loris. It's like a slow-moving monkey-type thing.
DAVIDSON: I think of it more like a sloth.
KESTEBAUM: No, no, no. It's like - it's definitely primate with huge, huge innocent eyes. And in this video it is being scratched under its arm. So it's got its arms straight up above its head to sort of facilitate the scratching. It is dangerously cute.
DAVIDSON: But David, you have revealed your bias. And to avoid the bias of the test designer - the pro-loris bias - we actually constructed a much more rigorous system. People who engaged in this experiment went to a website. And they were put into two experimental groups randomly. Now, the first group was group A. Now, if you were in group A, you were asked to pick the animal that you think is cutest - kitten, the polar bear or the loris - simple enough. People in the second group though, group B - the people in group B were asked to pick the animal that they thought everyone else thought was the cutest - not their own desires, their own view but what they think the broader view is.
KESTEBAUM: So we're going to hear from someone in each group. First, for group A, we'll just use Pietra.
RIVOLI: I was in the first group - group A. Which one do I think is cutest?
KESTEBAUM: And what did you pick?
RIVOLI: Oh, I have to tell you?
RIVOLI: Oh, really? OK.
KESTEBAUM: Is it embarrassing?
RIVOLI: I picked the polar bear. I liked the white fur. And I also thought that the whole skating on your belly on the ice thing was adorable.
KESTEBAUM: And, Adam, here is a listener from group B who got in touch with us.
MARLA WOOD: Hi, how are you.
KESTEBAUM: Good. This is Marla Wood (ph).
WOOD: I actually had a hard time finding any of them particularly cute, honestly.
RIVOLI: (Laughter) So she keeps her money in the bank. She doesn't put her money in the market.
WOOD: Am I supposed to tell you what I chose?
KESTEBAUM: What did you think was the cutest first?
WOOD: OK, I guess the loris was the cutest.
KESTEBAUM: But you were asked to pick the animal you thought everyone else would pick as the cutest.
WOOD: Yes, correct.
KESTEBAUM: So what did you pick?
WOOD: I chose the cat - the kitten, I should say - for two reasons. One was it was least appealing to me, which I find is generally the case with my experience in life. I'm always on the outside in my opinion. And then also I thought it was the most sort of understandable, accessible, predictable - you know, sort of my experience of others is the thing that they know best. So I figured most people would pick that.
KESTEBAUM: Even though you personally would have picked the loris?
KESTEBAUM: That's pretty strategic thinking.
WOOD: Yeah, that sounds like me (laughter).
DAVIDSON: So even though she thinks the kitten is the least appealing - her fundamental valuation of the kitten is extremely low - she's voting for the kitten because she thinks every one else is going to like it. All right, so David, I have to say it was all very exciting because you were sort of in charge of this experiment. So all of us found out the results before you did.
KESTEBAUM: I didn't know that.
DAVIDSON: Yeah. And you went into the studio to learn the results so that we can have your response on tape. But all of us were outside of the studio going, oh, wow, he doesn't know.
KESTEBAUM: All right, so Caitlin has the results. And she's going to come in here and tell us what they are.
RIVOLI: Ok, I'm ready.
KESTEBAUM: I'm nervous.
RIVOLI: I'm nervous.
KESTEBAUM: You have them in an envelope labeled official results.
CAITLIN KENNEY, BYLINE: (Laughter).
KESTEBAUM: Handwritten in pen - not looking super official actually.
KENNEY: This is a serious economics experiment, David. OK, so here we have the envelope - opening it up. You guys nervous?
RIVOLI: I'm nervous.
KENNEY: First, I'll read you the results of group A.
KESTEBAUM: How many people responded?
KENNEY: So in group A, we have 5,934 votes.
KENNEY: And taking the lion's share of the votes, we have the kitten. The kitten in group A received 2,983 votes, which is about 50 percent. And hold on. I did this math earlier.
KESTEBAUM: Adam, I'll just summarize for you here. The people from group A - asked which animal do you think is the cutest - about half of them went for the kitten. And the other half are pretty evenly split between the loris and the baby polar bear. That's group A.
KENNEY: Now for group B - vote for the animal you think is most likely to be voted the cutest by the other participants. The kitten has 4,516 votes.
KENNEY: So the kitten is 76 percent.
KESTEBAUM: Adam, so the kitten is 76 percent. The loris got 15 percent. And the baby polar bear got 9 percent.
DAVIDSON: All right, so let's just recap. So we have two groups. Just to remember - group A, the people who are asked to pick. What do you think, for yourself, is the cutest? Half of them - 50 percent say kitten. The other half's split between loris and baby polar bear.
KESTEBAUM: But in group B - the more sort of strategic investors who are asked to pick what they think everyone else will pick - 76 percent of them correctly identify that the kitten will win. But you've got 15 percent thinking it's going to be the loris and 9 percent thinking the polar bear.
DAVIDSON: And I feel like from the standpoint of wanting the world to function in a rational way, where markets work efficiently and reasonably, there's sort of good news and bad news in this story, I think, right? I mean, so some good news is - well, 76 percent of group B was right. They were correct that people voted the kitten the cutest. Now 24 percent of group B were wrong. They voted - they thought everyone was going to like the loris or the polar bear. So you can imagine. If there was a cute animal stock market, which, David, we are going to keep working on until it exists, you might get very different prices for the different animal stocks depending on how investors are making their decisions. Are they making fundamental analysis - just looking at what they truly believe is the cutest? Or are they being strategic? Are they trying to guess what everyone else is thinking?
KESTEBAUM: Yeah, I thought of a particularly extreme scenario where this all went very, very wrong. What if the market was entirely filled with Marlas, right? Then basically, you know, there's a huge kitten bubble. And no one actually thinks kittens are cute.
RIVOLI: And there we have the subprime, right?
KESTEBAUM: So the subprime housing bubble, right - obviously, the housing bubble had many, many causes. But this is at least a story you can tell about some of the psychology that was probably going on.
RIVOLI: You know, you have all of these people kind of doing the fundamental analysis of all of these borrowers. And they're saying, you know, we're giving mortgages to all of these people who might not be able to repay - or maybe even probably can't repay. But we're going to invest in those mortgages anyway even though we know fundamentally they're not worth very much because we think that, you know, we'll be able to sell them easily to the next guy, right? We think the next guy will pay some high price for it. So you know, that's a scenario where fundamentally, you know, we all know that something isn't worth very much. But since we believe that other people believe that other people believe they are worth a lot, you know, there's the conditions set for the formation of this bubble.
KESTEBAUM: That's the danger.
RIVOLI: That's the danger.
KESTEBAUM: A market full of Marlas.
WOOD: Oh, no. Oh, no.
KESTEBAUM: But this is the other thing, right? It's not irrational. Marla is behaving completely rationally, right? You're trying to pick the stock you think is going to go up.
RIVOLI: We also have to put a time frame on this, you know. So I think even Keynes would say that, in the long run, the prettiest beauty contestant will win. It's just that in the short-term, there's a lot of noise, a lot of distortions, a lot of psychological second guessing and so forth.
KESTEBAUM: So let's just explain what Pietra is saying there because it's a crucial point. The idea is that eventually, after a few years, all bubbles pop, right? That's the nature of bubbles. In fact, that's what's so bad about them. Eventually, you find out that there's not an infinite number of people who want to buy homes. And, therefore, you can't constantly just rollover homes and rollover homes at ever increasing prices. There's not an infinite number of Internet companies that are just going to make more and more and more money forever and ever and ever.
Eventually, over the long term - you know, four years, five years, 10 years - people find out what the real value is - you know, in our analogy, what the cutest animal truly is. But in the short-term, which can last a long time as we've seen, all sorts of things are happening that are not - that are totally unmoored because if everyone's choosing based on their true fundamental sense, that seems like a more grounded market. But if everyone's just guessing what everyone else is guessing that everyone else is guessing, then you can see how it can become kind of frothy and insane every once in a while.
DAVIDSON: We've been talking a lot in the office - imagining a bunch of competing cute animal shops selling - you know, one shop is selling kitten posters and kitten plush toys and. The other one is selling loris toys and loris backpacks. And you can quickly imagine that if people are sort of constantly investing based on what they think other people think lorises are worth or kittens are worth, that you could very quickly have all sorts of distortions. You could have millions and millions of kitten posters that nobody wants and far too few loris posters that are really demanded for.
KESTEBAUM: There are far too few loris posters.
DAVIDSON: I think we can all establish that, yes.
KESTEBAUM: It's sometimes said that in the short-run the stock market is really - it's like a voting mechanism. It's like - you know, it's like a popularity contest. But in the long-term, it really is a weighing mechanism. It actually weighs the worth of a company. Pietra says it is hard to get a real bubble for, you know, some blue chip company, like General Electric, because we have a pretty good idea of the weight of that company. We know what the company does, you know. The danger, she says, is really in situations where you don't have good information to go on.
RIVOLI: The Chinese IPO market comes to mind, you know, where...
KESTEBAUM: Like when a new stock comes out in China.
RIVOLI: A new stock comes out in China. And people buy these stocks. And there's quite a bubble now going on. People buy these stocks without even knowing, you know, what the company makes because they just buy it because, oh, you know, it's an IPO. And so it's going to go up, and somebody else will buy it. And, you know, so those markets are really dominated by this psychology.
KESTEBAUM: So you're saying, like, when there's a new company listed stock in China, basically a lot of people have to be in group B. There aren't - you can't be in group A and think, well, I think that company is going to do well or not very well or very well because you don't have information. So you're basically sitting there saying, well, I think everyone else will like a slow loris. Or, you know, you're just guessing at what everyone else is going to do.
RIVOLI: That's exactly right. And that's why it's so important. And that's why we have so much regulation, you know, in the U.S. You know, that's why we have rules about, you know, how you have to publish your financial statements. That's why we have rules about how market, you know, prices have to be transparent to everybody. You know, we have a lot of regulations out there to try to put information in front of the investors, with the idea that that will help the market to perform better for the economy. But you're right. And in some examples, you know, where there is no information, we have no choice but to kind of rely on what Keynes would call our animal spirits.
KESTEBAUM: I'm sure Keynes meant to write cute animal spirits. But, Adam, this is why I think the new Congress should require all animals file quarterly cuteness reports - specifying eye size to head size ratio, tail furriness measurements.
DAVIDSON: Yeah, you remember the big paw scandal of 1986.
(SOUNDBITE OF SONG, "AMAZING")
ONE ESKIMO: (Singing) Now there is no sin in anything. And it's amazing.
DAVIDSON: Please us know what you think of today's show or what you think other people think of today's show. Send us an email to firstname.lastname@example.org. Or you can find us through our Facebook page. Thank you very much to the 12,000 of you who took part in our Keynesian cuteness contest. We're very grateful.
KESTEBAUM: We've got links to Keynes' writing about the beauty contest from his "General Theory" on our blog npr.org/money. And we have links to those cute animal videos. And for those of you who picked the slow loris, we're going to put up a link to another video I found which might change your mind. It turns out slow lorises love to eat maggots.
DAVIDSON: Ew. I'm Adam Davidson.
KESTEBAUM: And I'm David Kestenbaum. Thank you for listening.
ONE ESKIMO: (Singing) It's glorious. It's life-changing - this feeling, this feeling.
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