Understanding Globalization - Soros

This is an excellent summary of George Soros' views of the world - what it is and what it can be. Since George's Quantum Fund made over a billion dollars on one trade in 1992 against sterling, it is appropriate to respect his opinions, or at least give them forbearance. I, myself, have a great deal of admiration for his market savy and monetary system knowledge. He also has an excellent interview at: ...{Soros Link}

Patricia A. Alvarez | Understanding Globalization

....When Soros first addressed the public in 1987 with The Alchemy of Finance: Reading the Mind of the Market, he chose a title highlighting the ability of his superbly successful Quantum Fund to transform investor dollars into gold. That work centered on the strategy his hedge fund had employed to extract rewards by assuming risk. Experience as a trader had taught him that classical equilibrium theory, the idea that perfect competition guides prices to correct valuations, ignored important features of a market's operations. Confident that his financial wizardry conferred the credentials of a social scientist and intent on remedying this flaw in the mechanism, Soros posited instead a Theory of Reflexivity to explain price gyrations. Simply stated, reflexivity refers to a feedback process that distorts natural swings in the market. Rather than the passive indifference assumed in equilibrium theory, market participants all exhibit a bias, and their collective bias creates a trend that exaggerates prices and leads to instability.

Using his theory, Soros handily demystified the boom-bust cycle. He explained that the problem of distortion is especially acute in the credit markets that underpin domestic and world economies. There, a boom results when bias for a certain market's prospects leads to a trend of extending credit, stimulating its economy while artificially inflating the collateral behind loans. As expansion continues, valuations increase to a point where credit is insufficient to induce further growth. The failure to provide additional financing reduces asset valuations, depresses economic activity, causes fear, and ends in a panic. While ascent in the boom phase is gradual, a bust in the credit market is severe and more compressed than in other arenas because investors quickly liquidate loans just at the point where asset values are lowest. Order could be restored, Soros said, by empowering an international bank similar to the U.S. Federal Reserve to minimize troughs and peaks in the world's capital markets.

At the time he published Alchemy, Soros' main concern was the international debt crisis that had resulted from an unparalleled trend of lending to the less-developed nations. Although the situation cried out for a correction to remove its destabilizing bias, Soros ominously noted, "We continually go to the brink and then recoil when we see the abyss opening up at our feet." The real U.S. economy, he warned, was becoming progressively more unsound, with an artificially high-priced dollar, propped up by the financial authorities of "Reagan's Imperial Circle" in a way that guaranteed a future calamity. In the meantime, the nation's industrial producers were losing market share to cheap imports. The danger in the situation, for Soros, was its potential to jeopardize the international free market in goods and services that was steadily making headway against protectionism.

Feeling vindicated by the 1987 crash on Wall Street and by his own successful challenge to fixed currency exchange rates in Europe, yet humbled by the failure of "reflexivity" to become a household word, Soros felt compelled to reissue Alchemy in 1994. His revised edition modified his claim, admitting his theory governed special cases more than normal conditions, yet refusing to concede its irrelevance. He marveled that U.S. government actions had averted a recession, but noted that its policies brought temporary relief at the cost of long-term damage, especially to the dollar. No less disturbing to him, however, was the emergence of Japan as the world's financial strongman. He argued that a society such as Japan's, so "fundamentally different" from those in the West because "the interests of the individual are subordinated to the interests of the social whole," could not be trusted to lead a system premised on democratic equality. Soros flailed about here for a comprehensive solution to the woes he had successfully documented and set the stage for a further installment.

The Asian Crisis of 1997, a quintessential bust, spurred the analyst's comments the following year. In The Crisis of Global Capitalism [Open Society Endangered], Soros shifted his attention from the center of the financial system to its periphery. Having lifted their long-held prohibitions on repatriation of capital, that acted as stop signs on the financial highway, the liberalizing governments of Korea, Thailand, and Indonesia found themselves happily awash in short-term "hot money" that poured in from investors responding to the new opportunity for a high return. Not surprisingly, the financier found reflexivity at work, with the bias of market participants distorting the prices of collateral in these economies beyond their real worth and fueling a trend guaranteeing that money invested there would reap far less than originally projected. The lack of transparency in Asian economic institutions misled investors until it was too late to avoid a market collapse. Once the trend had turned from a positive to a negative bias, hot money fled faster than it had entered, leaving those nations with deflated currencies, high rates of corporate insolvency, and explosive social problems. ...{article continued}