The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means
By George Soros
(Public Affairs, 208 pages, $22.95)
“All progress is based upon a universal innate desire on the part of every organism to live beyond its income.” — Samuel Butler
I’m frankly worried not just about the financial meltdown but about how the increasing polarization in this country. It’s not just that the Internet has allowed people to live only within their affinity groups. Even the mainstream media are losing their perspective.
Last week, for example, while every paper in the country had the bailout settlement across its front page, the New York Post, New York’s only conservative newspaper, ran the story on page 5. Apparently it was too embarrassing for President Bush and therefore not worth reporting. Meanwhile, from the Post‘s vice presidential debate coverage, you’d think Sarah Palin walked off with a knockout victory.
Therefore I wasn’t at all disappointed the other day when I was walking out of the library and spotted George Soros’s new book on the “Just Arrived” shelf. Why not give it a try? I grind my teeth over Soros just as much as any other conservative. After all, he’s the man who helped pass McCain-Feingold to “take the money out of politics” and then turned around and spent $25 million to defeat George Bush in 2004. It turned out he only wanted everybody else’s money out of politics. Still, Soros has made billions playing the international currency markets. He must know something.
Soros, it turns out, has a very good perspective on the current meltdown. He says it’s a system-wide overextension of credit, mainly through novel financial instruments and the housing market. Conservatives may fret that it all comes down to Fannie Mae and Freddie Mac and their subprime mortgages for low-income minorities, but it was a universal phenomenon.
Martin Feldstein, a former chairman of the Council of Economic Advisors [under Ronald Reagan], estimated that from 1997 to 2006, consumers drew more than $9 trillion in cash out of their home equity. A 2005 study led by Alan Greenspan estimated that in the 2000s, home equity withdrawals were financing 3 percent of all personal consumption. By the first quarter of 2006, home equity extraction made up nearly 10 percent of disposal personal income.
Obviously vast numbers of people were shoehorning money out of their home values and into present consumption. Something had to implode somewhere. Sure, Congress might have regulated more. And sure, Republicans should have steamrolled Barney Frank and borne down harder on Fannie Mae and Freddie Mac. But basically everyone took part. I still owe quite a bit on my home equity loan. So now we’re suffering the consequences.
The problem for Republicans is that George W. Bush was in charge when all this was happening and now the blame is also shifting to John McCain. Barack Obama, who doesn’t know anything more about finance than you or I, will be the beneficiary. Who knows, he may even choose George Soros as chairman of his Council of Economic Advisers.
SO WHAT WILL Soros advise? His criticism of Bush is more political than economic. We never should have gone into Iraq — it’s costing too much and the War on Terror is a phony. Of course all that is a little outdated. With Iraq stabilizing and the Taliban renouncing al Qaeda in Afghanistan, it appears George Bush may have drawn a winning hand after all.
Soros’s overall view of America’s situation in the world, however, extends far beyond Iraq and is not so easily dismissed. Like many other market watchers (James Grant of Grant’s Interest Rate Observer, for instance), Soros believes America is essentially living off the reputation of the dollar and is headed for a fall. The only reason the U.S. Treasury will be able to come up with $700 billion to bail out the banks is that China will lend us the money. But countries are getting tired of accepting a currency that is worth less and less. At some point there is going to be a run on the dollar and every American could lose a significant portions of his wealth overnight. George Soros, on the other hand, will do well. He’s shorting the dollar.
Much of this book is spent explaining Soros’s idea of “reflexivity.” This is one of those “theories of everything” that your grandfather forces on you at Thanksgiving. Like every liberal who ever breathed, Soros disputes Adam Smith’s economics. Markets do not tend toward equilibrium, he says. Instead they tend toward disequilibrium and can fall apart altogether. The reason, says Soros, is that while information is imperfect, people often act on this wrong information, making the situation worse.
The idea that classical economics depends on perfect information was discredited long ago by Ludwig von Mises, Friedrich Hayek, and the Austrian school. They argued that markets are a system for distributing information, with prices a search process by which players use their imperfect knowledge to discover true value. Liberal critics, on the other hand, want to short-circuit the process, saying that since markets are imperfect, governments must intervene to set them right.
Soros is at least modest honest enough to admit that government regulators don’t have perfect knowledge either. Still, he somehow works around this, saying it’s important to have them in the mix anyway.
[C]ontrary to market fundamentalist beliefs, the stability of financial markets is not assured; it has to be actively maintained by the authorities.
Soros’s countertheory — “reflexivity” — actually seems to be based more on his own experience than objective reality. Reflexivity says that classical theory doesn’t work because the players themselves can change reality, even while they are relying on imperfect information. This only makes things more unstable. Soros speaks from experience. In the early 1990s, he single-handedly destroyed the Thai baht, bringing down the governments of Prime Minister General Chavalit Yongchaiyudh and President Suharto of Indonesia. The result was rising anti-Western sentiment and the strengthening of Islamic separatist groups. Whereas the Austrian School posits there is economic reality, reflexivity ends up saying that economics is just history and nothing can be predicted with certainty. Those most experienced in reading the animal entrails, however, can still make a lot of money. (Soros’s son, who has also written his own book, reports that the real way his father judges investments is by how much pain they create in his back.)
Right now Soros recommends going short on the American dollar and long on China, India, and the Persian Gulf oil sheikdoms. “Saturday Night Live” satirized him for this vulture position last week but it probably isn’t a bad bet. Americans must recognize we are going through our inheritance by ignoring technologies such as nuclear energy and living off foreign oil.
On the other hand, just think, this guy could end up chief financial officer of a Barack Obama administration. Imagine that, the Secretary of the Treasury trying to reduce the deficit by speculating against the U.S. dollar. That should be interesting.
