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Confessions of an Economic Lit-Man

By Gene Mirabelli

The New Paradigm for Financial Markets: The Credit Crises of 2008 and What It Means By George Soros

PublicAffairs, $22.95

George Soros is a billionaire, former hedge fund manager, and philanthropist. When it comes to giving away his money, he’s right up there with Bill Gates and Warren Buffett. Soros was born in Hungary where the family changed its name from Schwartz to evade anti-Semitic persecution. They endured the Nazi occupation, then the Soviet occupation, while George escaped to England to attend the London School of Economics. Upon graduating, he moved to the United States and eventually became a very rich man with progressive views. More recently, he contributed several million dollars in an attempt to prevent the reelection of President George W. Bush.

As a young man, Soros hoped to be known as a philosopher, and over his lifetime he created a philosophical framework for economic theory. His most recent publication, The New Paradigm for Financial Markets, is the 10th book in which he presents these ideas. Though his work is read attentively by financiers and stock traders for its immediate practical insight, his theories have not attracted a following. Soros, who regards himself with detachment and self-deprecating humor, will be the first to admit this.

Soros says that the old paradigm for financial markets is radically wrong. It assumes that markets are self-correcting and tend toward equilibrium. If the price of something rises too high then people will recognize that it’s overpriced and refuse to buy it, so the price will, resultantly, fall to where it should be.

Under the assumption that markets are self-correcting, we shouldn’t need to regulate them. Moreover, regulation will interfere with the market’s self-correcting mechanisms. An example would be Russia and China, which used to regulate their markets, control what and how much was produced and how it was priced. The result was miserable poverty for everyone.

George Soros’ new paradigm says that markets don’t always tend toward equilibrium. To the contrary, prices can deviate farther and farther from the norm, and produce buying manias and financial bubbles. In the end, unregulated financial markets go bust and people wind up selling good securities as if they were worthless.

The old paradigm assumed that market participants had perfect understanding of what was going on and rational expectations about what was going to follow. However, Soros reminds us that humans are imperfect and they enter the market with biases, hopes and fears; they misperceive what they see, and their expectations are often not rational at all.

Furthermore—and this is extremely important, in Soros’ view—by participating in the market, people change it, and those changes can alter the market’s fundamentals. Soros has dubbed this interaction between the market and its participants “reflexivity.”

The book’s subtitle is The Credit Crises of 2008 and What It Means, and the later pages focus on the extraordinary economic firestorm we are going through today. Soros’ writing is remarkably contrite; he records not only his view of the crises but also the financial choices he made in light of what he saw. He handed this manuscript to the publisher around April of this year, so we’re in a position to ascertain how well he foretold the future and how well he made his financial decisions.

As for the latter, he didn’t do so well. Like just about everyone else, he underestimated the horrific dimensions of the crises. He was right about the dangers of the global credit bubble and the strange toxic assets held by the banking system, but he didn’t foresee the credit drought, the evisceration of global financial institutions, the falling price of oil or the plunge in commodity prices. He also believed that China and India had such dynamic economies that they wouldn’t be much effected by what was happening in Europe or the United States.

By the time Soros finished writing the book, his investments had merely broken even, and by midsummer they must have lost ground. In an unfortunate way, his recent losses validate one of the crucial points in his theory: You never have perfect knowledge of what’s going on in the market and you can rarely foretell its future direction.

Soros notes with wistful regret that people read his books hoping to find a way to make money, whereas he writes them as a philosopher hoping to gain converts. His writing is concise but occasionally opaque. It’s not always clear when he uses the word “market” whether he’s referring to the buying and selling of products and services, or to the exchange of financial instruments such as stocks. It’s not the same kind of market. He leads the reader on with abstractions, but, after being teased for several pages with disembodied observations, we lust for corporeal examples.

Soros’ paradigm for the way financial markets work will strike many readers as common sense. Most who think this will be politically progressive, will have voted for Obama, and will regard George W. Bush and his economic ideology with disdain. We wouldn’t be able to make such assumptions about supporters of a theory on earthquakes or molecular interaction, but economics is not a natural science; it’s a human construction full of human engagements. Economic “laws” are not natural laws, but the operations of human society. George Soros knows this in his bones, and has for many years been preaching his analytical system. Though it isn’t scientific, it is certainly philosophical.


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