My Interview with George Soros: End of Financial Crisis Could Be in Sight
George Soros, the financier and philanthropist, is author most recently of The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means. He spoke with me in Washington, D.C., where the IMF and World Bank are meeting, on Sunday.
Nathan Gardels: Let's talk first about the nature of the crisis. Thanks to low interest rates, global liquidity and deregulation, we have had a 25-year, self-reinforcing credit expansion bubble, leading to "irrational exuberance," as it was once said, in financial markets. Now we have the self-reinforcing crash of the stock and credit markets --"irrational despair" -- not justified by the economic fundamentals in the real economy.
How does this pattern fit your theory of reflexivity and your new paradigm for understanding finance?
George Soros: The key to understanding this crisis -- the worst since the 1930s -- is to see that it was generated within the financial system itself. What we are witnessing is not the result of some exogenous shock that knocked things off balance, as the prevailing paradigm, which believes markets are self-correcting, would suggest. The reality is that financial markets are self-destabilizing; occasionally they tend toward disequilibrium, not equilibrium.
The paradigm I'm proposing differs from the conventional wisdom in two respects. First, financial markets don't reflect the actual economic fundamentals. Expectations by traders and investors are always distorting them. Second, these distortions in the financial markets can affect the fundamentals -- as we see in both bubbles and crashes. Euphoria can lift housing and dot.com prices; panic can send sound banks tumbling.
That two-way connection -- that you affect what you reflect -- is what I call "reflexivity." That is how financial markets really work. Their instability is now spreading to the real economy, not the other way around. In short, the boom-bust sequences, the bubbles, are endemic to the financial system.
The current situation is not just about the housing bubble. The housing bubble was merely the trigger that detonated a much larger bubble. That super-bubble, created by the ever-increasing use of credit and debt leverage, combined with the conviction that markets are self-correcting, took more than 25 years to grow. Now it is exploding.
Gardels: What ought to be the "circuit breaker" that short-circuits the distortions that inevitably destabilize financial markets?
Soros: If bubbles are endemic in the system, then government regulators have to intervene to prevent bubbles from getting too big. Governments have to recognize that markets are not self-correcting. It is not enough to pick up the pieces after the crisis.
Gardels: Does the presence of the 24-hour global financial news cycle amplify and exaggerate distortions in the financial markets?
Soros: Without question, they accelerate the process. At the same time, I wouldn't overstate it. At the end of the 19th century, you didn't have 24-hour cable, but nevertheless you had the same kind of bubbles. Throughout the 19th century, when there was a laissez-faire mentality and insufficient regulation, you had one crisis after another. Each crisis brought about some reform. That is how central banking developed.
Gardels: How come all the efforts of the U.S. government so far -- the $700 billion rescue package, low Federal interest rates, backstopping deposits and commercial paper -- have not stemmed the crisis?
Soros: The U.S. authorities bought into market fundamentalist ideology. They thought that the markets would ultimately correct themselves. U.S. Treasury Secretary Henry Paulson epitomized this. He thought that six months after the Bear Stearns crisis the market would have adjusted and, "Well, if Lehman (Brothers) goes bust, the system can take it." Instead, everything fell apart.
Since they did not understand the nature of the problem -- that the market would not correct itself -- they did not see the need for government intervention. They did not prepare a Plan B.
As the shock of the Lehman failure set in, he had to change his mind and rescue AIG. The next day there was a run on the money markets and commercial paper markets, so he turned around again and said we need a $700 billion bailout. But he wanted to put the money in the wrong place -- taking the toxic securities out of the hands of the banks.
They have finally now come around -- with the government buying equity in banks -- because they see the financial system is on the verge of collapse.
Gardels: Now that the U.S. authorities are at last on the right track, what are the key components of resolving the crisis?
Soros: The outlines are clear. There are five major elements.
-- First, the government needs to recapitalize the banking system by buying equity stakes in banks.
-- Second, interbank lending needs to be restarted with guarantees and bringing LIBOR (London Interbank Offered Rate) in line with Fed funds. This is in the works. It is going to happen.
-- Third, we must reform the mortgage system in the U.S., minimizing foreclosures and renegotiating loans so that mortgages are not worth more than houses. Stemming foreclosures will cushion the fall of housing prices.
-- Fourth, Europe has to fix a weakness of the Euro by creating a safety net for its banks. While initially resisting this, they have now found religion and done it at their meeting in Paris on Sunday.
-- Fifth, the IMF must deal with the vulnerability of countries at the periphery of the global financial system by providing a financial safety net. This is also in the works. The Japanese have already offered $200 billion for this purpose.
These five steps will start the healing process. If we implement these measures effectively, we will have passed through the worst of the financial crisis.
But then, I'm afraid, there is the fallout in the real economy, which is now gathering momentum. At this point, repairing the financial system will not stop a severe worldwide recession. Since, under this circumstance the U.S. consumer can no longer serve as the motor of the world economy, the U.S. government must stimulate demand. Because we face the menacing challenges of global warming and energy dependence, the next administration should direct any stimulus plan toward energy savings, developing alternative energy sources and building green infrastructure. This stimulus can be the new motor for the world economy.
Gardels: At the end of the day, won't we be looking at a vastly different global financial landscape? The U.S. will decline as the top power. It will have, along with parts of Europe, socialized banks and loads of debt. Communist China will be the new financial power globally, flush with capital and a major investor in the West.
Soros: U.S. influence will wane. It has already declined. For the past 25 years, we have been running a constant current account deficit. The Chinese and the oil-producing countries have been running a surplus. We have consumed more than we produced. While we have run up debt, they have acquired wealth with their savings. Increasingly, the Chinese will own a lot more of the world because they will be converting their dollar reserves and U.S. government bonds into real assets.
That changes the power relations. The powershift toward Asia is a consequence of the sins of the last 25 years on the part of the United States.
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It's not going to work. The credit based economy has been over extended. When the government gives money to the banks and the banks loan the money to businesses, who are the businesses going to sell their products to?
The population no longer has money or credit. The government continues to move jobs off shore and clamor for H-1B visas for cheap labor, not to mention the 20 million illegals many of whom send the money they make back to their own countries. The population has to have money, not credit, in order for the economy to work.
Mortgages will continue to fail and we will be right back here in a few months with the government wanting to once again bailout the banks.
Congress and the Senate will continue to go along and pass out money to the wrong people unless you take action this election. http://ewe
Technical pressure (ie. margin calls) on the market may be ending ... for now. Fundamentals are going to start kicking in. When people realize the E portion of the PE is much smaller than originally estimated, stocks will head lower again. Lower prices will bring more margin calls.
This is a death spiral. Propping up the pigmen banks does nothing for Joe 6Pac. Bank bailouts and stimulus packages don't create jobs (they do buy votes though).
Bailouts won't work. Stimulus packages won't work. More DEBT won't work.
What we need: Transparency. Reform. Efficient allocation of capital. Positive real interest rates. And most of all free of government intervention and midnight rule changes.
Right now, 'the people' think socialism is a pretty reasonable option, and are opting for bailouts and stimulus packages.
Finally someone who "gets it". Dean, you get the gold star. This nation has exsited not only on "smoke and mirrors" in the economy for far too long, but remains in "suspended disbelief" at he hands of the politicians for who the system has been designed. The Republicans have by in large been the biggest winners, but Demorcrats have been complicit.
I will find it so ironic that it will take the first black President to rearrange the new world order.
I'm betting that our future will be brighter after President Obama levels with the people on the sacrifices that lie ahead.
Capitalism only works when it provides what is necessary to the largest of the populus. That is the essence of efficent allocation of capital.
The Andromeda Galaxy is within sight too...
"US influence will wane", yep that's what history tells us. The writing is on the wall......
I went into China 27 years ago for the first time. I came home and commented to my new bride that, "I hope our countries can be friends, we'll be working for the Chinese in 50 years." My time frame was a bit too long, but I think you get the picture.
sonoffestus,
There is only one reason why China is doing so well at this point and that is because our Great Patriotic Wealthy Class have shipped all of their industries and our jobs there. With it went the wealth. These Patriots have screwed America and Americans for their own benefit. If anyone is responsible for the turnaround it is them.
Generally like Soros, but not when he spouts nonsense like this:
"Each crisis brought about some reform. That is how central banking developed.
The European nations have had central banks since before our Revolutionary war. They are mechanism for establishing and controlling power in the hands of the moneyed class--that's all. They are certainly not ambassadors of positive reform. The banks have engineered booms and busts in this country IN ORDER to have a central bank be established. How's that worked for us so far?
First thing we got was the income tax to help the government (us again) pay for the interest on Our money, which before the central bank was interest free. Then in real short order we got WW1, an amazing amount of new debt that the income tax was used to pay, and then The Depression! Then another war with even more national debt and bigger interest levied against Americans, and then another war, Korea, and another war, Viet Nam, and a recession, and another recession and another war and now this Depression.
Anyone see a pattern here? Does anyone know the history of banking, and Central Banks in particular: how they have been behind most wars since the middle of the 16th century, often arming and financing both sides in a conflict in order to maximize their profits?
Sorry George, but you've dropped the ball on this one, and caused me to reconsider a lot of what you've said in the past.
Perhaps you missed the word 'developed' in the sentence, "That is how central banking developed.
The problem of the last 25 years in the U.S. banking system is that, as in all other aspects of the American economic system and, in fact, in popular American opinion generally, deregulation (i.e., we should all do whatever happens to cross our minds because government is evil) has produced two disastrous mindsets:
1.) No matter how massive the risks we're willing to take, everything will work out to our benefit.
2.) If a market is booming, we don't have to worry about the risk of the bubble bursting (and therefore, the risk of borrowing money to invest in it), because the market will just keep going up.
Central banks originally did nothing to engineer economic success or failure, beyond providing a very, very loose framework for a system which could provide banking stability; something which private banks did not provide at all, since they were entirely unregulated in most instances. Before the genesis of the central banking system, a bank was nothing more than a for-profit company in which you would invest your money in the hope that the bank's investment decisions weren't so risky that it lost all of the money which was invested.
Central banks provided the means with which banks could eventually be rescued when too many of them were about to fail. This is what was done in the U.S. during the Roosevelt administration and was, yes, the result of the DEVELOPMENT and REFORM of the central banking system. Central banks also provide the means, once Nixon tied the money supply to the international money market instead of to some commodity (like gold or silver), to grossly inflate the currency; which can have both positive and very negative consequences depending upon the situation.
Banks did not create the wars of the 16th, 17th, 18th, 19th or 20th centuries. Some banks profited handsomely from such wars. Other banks completely collapsed because of those wars. In all cases, war was, for them, like tossing a coin...no better than a 50/50 bet. Bankers, in essence, don't want any major war at all because it's a terrifically bad investment bet.
As long as the Capitalists are powerful enough to use the words "capitalism" or "free market system" as labels for their control of resources, we will continue to be mired in what is essentially a modern version of Feudalism. Ultimately, we all share only one Earth, and we must demand a more equitable distribution and allocation of resources, or these "financial crises" will continue until the whole system collapses under its own fraudulence. Right now, the battle for Energy is the looming issue, and the development and global distribution of publicly-owned "Green Energy", most likely Solar, is the key to Humanity's peaceful survival. Conversely, the continued diversion of attention and resources toward the maintenance and expansion of a privately-owned, fossil-fuel based infrastructure will prove disasterous and un-sustainable.
The end of the financial crisis is in sight? So McCain is right when he says the fundamentals are sound?
He said the Financial crisis may be ending. The Real crisis - in jobs, incomes, housing, manufacturing, will worsen. It's a hysteresis loop. The financial sector blew up first but wounded the real sector, which, being real, will take longer to recover. Real manufacturing plants would have to be built, for instance, unless we plan to cede All manufacturing to China, and that takes time. Right now, all America makes is "exotic financial instruments," war, and pornos. I think we need to do better ;') We used to be the industrial powerhouse of the world.
So jobs, incomes, housing, and manufacturing have nothing to do with the financial crisis? Really?????
The US leads the world in medical innovations and computers (even if Bill Gates lost $1.5 billion in this fall). Both grow without government interference or the hindrance of labor unions. Both also pay well and offer competitive benefits.
If America is going to compete in a commodity market (steel) is either has to invest billions in inovation or pay dirt cheap labor. Labor unions have prevented this and steel decines.
America can compete in the auto industry. When Detroit automakers try to cut costs and add inovations to manufacturing they have to fight not only the union but also inaccurate leftist propaganda from the likes of Michael Moore. Automobiles can be manufactured well and profitably here in America (ask Honda...) if labor and management work together. New plants have been opened by Honda, Nissan, BMW, and Toyota and employ many skilled laborers here in the US. Those companies decided NOT to locate in Detroit partially because of the labor climate. If reasonable cooperation between labor & management can be arranged we can continue to have good jobs here.
Typical. Here's the gap in your logic, in order to reach your preferred conclusion: No, the fundamentals are NOT sound. If they were, would they require all this government intervention?
Why do people keep saying that the market isn't self correcting? That's exactly what is happening. The correction might be a depression, but it's still a correction. Now that the government is stepping in and preventing the correction, we'll have the seeds planted for the next iteration because of the artificial propping of institutions that should die. In fact, now we see even greater consolidation by financial entities so that in the future, everyone will be too big to fail, and the government will have to own the means of production. And that is a very, very bad thing. Much better to crash occasionally.
Ya mon. Sign me up for that bread line!
"Why do people keep saying that the market isn't self correcting?" Because it isn't. The depression is not a correction, the correction is the massive, coordinated response by governments toprevent the depression from completely destroying civilization as we know it. It's not just that they are stepping in, it's what they're doing (see the post). The US government stepped in initially with a stupid plan that did nothing.
You absolutely don't get it. It's easy for you to cling to laissez faire ideology because you're not running a government or a bank. The guys who actually have the responsibilitiy were forced to deal with reality and forget the ideology, which just is not true, and Soros explains here why. Markets are self-destabilizing. But you don't have to understand it, you already know the answer -- the answer that just failed. If these guys hadn't stepped in, the depression you're talking about would have made the 1930s look like a walk in the park.
"That changes the power relations. The powershift toward Asia is a consequence of the sins of the last 25 years on the part of the United States. "
Probably the scariest thing I have read during this entire election season.
It leaves me wondering why America has been so dumb for those 25 years. Why have we turned to Democrats only as a last resort, to fix what we feel is "wrong" with the system? Why do we turn over our economy to Republican rule when it so obviously results in blatantly un-American activity? How long with the myth of "Republican fiscal conservatism" last?
Funny how people believe there are two parties still.
Not at all what mredder4 said!
So, are you saying that it is wrong to elect those that hate government into government positions? What a concept! :>)
Fascinating. The "sins" of America are causing a shift towards communist regimes, as if that is a beacon of light for humanity. Good lord, the nonsense that passes as wisdom around here.
I read Soros' "New Paradigm" earlier this year and in it he warned of the possibility of the crisis that we are in now. Soros issues a disclaimer in the book that he has predicted disaster before, but the disaster has never materialized. Well, in this case the disaster has arrived and I am glad that you're discussing his ideas on how to resolve the crisis.
Too often, conservatives use Soros' name as a code word for evil and thus makes it difficult to discuss his ideas in a forum outside this one.
The financial crisis has provided an opportunity to reexamine his ideas on reflexivity (for which he has been mercilessly criticized in an epistemological context). But within the scope of the crisis, his idea that financial markets tend towards disequilibrium is relevant because it undermines the Republican embrace of laissez faire as the solution to prosperity. Instead it supports the idea of the need for a wise regulatory hand to prevent disasters like the one we are seeing now, while allowing for the normal course of economic growth.
As much as I hate agreeing with conservatives, they are right about Soros.
Every major power since the dawn of civilization has had it's guns or butter moment. We spend ourselves into irrelevancy to raise more armies to protect the assets of rich. Now the rich scream about paying taxes for armies that only they require. The religious right jumps in to champion a theocracy (the Easter Island syndrome). Chile looks better to me every day, but keep it to yourself.
You are absolutely right! The rich start the wars, everybody else fights and dies to win them, and th rich then profit from it. Nothing has changed in milennia! Will anyone ever learn? Certainly not those who have brought us to the brink-why should they? Everything is working in their favor.
As I predicted (really I did) the Chinese are moving towards increasing domestic consumption by doubling rural income by 2015 and eliminating rural poverty by 2020. This should offset the loss of demand from the declining US market. The Chinese insulated themselves from the financial meltdown in the West by forbidding trade in derivatives. With their 2 trillion in US dollar reserves they will be able to soak up our new debt requirements. We are in hock to China Inc. Market socialism to the rescue, or in other words we better get on board or else we'll drown. Democratic market socialism is 21st century Americanism.
You are so right! Deriviativesare the source of the problem!
At times like these it's a good idea to turn the the teachings of the elders.
Hyman Minsky (Financial Instability Hypothesis) and Irving Fisher (Debt Deflation Theory of Depresssions).
Nathan, please next time could you speak to him a bit earlier - before the crisis hits with full force.
My children's college fund will be highly appreciative.
Our economy is based on the servicing of DEBT.
We need to return to making things.
Economies are driven by the middle class.
No, economies are driven by computers!!!!
(See NYT op-ed Sunday.)
In the same sense that mules drive wagon trains. Don't glorify mediocrity.
Debt is the worst mediocrity of all.
And it's high interest debt. Isn't it odd that the same fundamentalists who put Bush into office ignore their own biblical teachings about Usury? You hear a lot of hatred for homosexuals from pulpits but nothing about the Real sin of our age - staggeringly usurious credit. These morons cherry pick so they can find things to hate, and ignore true virtue. Lending at high interest actually is sinful. It destroys people. It always has.
cybervigilante,
Great point. Touché!
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