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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"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."
So if this is true & our assets(market cap) are real cheap right now, and 'somebody' starts quietly buying stocks, companies, mortgages, houses & everybody cheers while most Americans still huddle on the sidelines with their suddenly important & 'safe' cash, should I worry? And that cash is slowly dissolved by inflation, while new asset owners heave sigh of relief(cue villian music).
Paranoia, the new 'Politically active'. tallllama4Obama08
Corporate interests will come up with new lines of lies to justify their existence. Nothing will change until Americans understand that the "free enterprise" is supposed to work for us and not the other way around. As a result of this financial and economic crisis we will end up even with greater concentration of ownership. We will have fewer banks that are even larger than "too large fail". Americans must realign the force diagram in such a way that the system works for the $95% of the people and not the 5% that currently benefits. To what degree we succeed will determine how fast this country rises from the ashes brought to you by decades of false "market knows best" philosophy.
"Free enterprise" isn't supposed to "work for" anyone. "Free enterprise" permits you to compete, that is all. It doesn't guarantee the result of the competition.
The free enterprise system is not an inevitability - it is our creature. It is a system we choose because we believe it best serves our nation. The fact some benefit more than others under capitalism should not lead you to your conclusion. The inequality is sanctioned by us because we believe that despite of that it still serves the rest of us better than alternatives. Once it ceases to deliver value to the rest of us, we have the right, as free people, to regulate it, mold it, modify it, or replace it. Your position is utterly undemocratic and invariably leads to tyranny.
"US influence will wane" - and yet our amateur politicians continue to saber rattle.
Hey if we're going to be a third world country, we have to act like one.
Our politicians are already standing up.
What are you doing?
Politicians are just realizing all the underemployment and unemployment that exists - here and in all advanced western countries. IT is the crisis that keeps on crisising. When they get out from beneath all those trapping of Gulfstream jets, etc. they are beginning to realize that the lies they've been told are untrue.
People talk about revitalizing the banks but they are not addressing the base problem - economic destruction of many people in their countries, for the sake of supporting an autocratic, antithetical regime.
The natural consequence of the development of huge areas of the world previously living in savagery. Perhaps we long for the good old days when we could just colonize them and live comfortably turning bolts for $40/hour while they supplied raw materials at 2 cents a day.
Great article. Thank you. I love hearing from Mr. Soros.
Whatever the solution to this crisis that the politicians and business leaders, who caused most of the problem. come up with will probably set up the next crisis. Congress loaded up the bailout with pork, AIG went to the spa, and the stock market kept dropping day after day. Nothing has changed.
Forget the crimes and the fraud. The CEOs should be sent to prison for being so darn ugly. Have you ever seen a bunch like these guys. Corruption sure gets revealed in one's face.
We face an interesting problem: how to stimulate the global economy via U.S. government spending on renewable energy sources and an upgraded electrical grid (etc) when the policies of the Bush administration have left our country with such a staggering debt load. Bush didn't just break Iraq, he broke America. I say to hell with missile defense - energy independence is more important from a national security perspective. I have no desire to go toe-to-toe with China over oil in Africa in the decades ahead. That said, I wonder just how far we can push government spending given the economic realities - can we really just pretend we aren't in so much debt already? And an aside: I'd like to hear a new vision for American manufacturing. Something will have to replace the slack left by the shrinking financial services industry...
I totally agree. The awful truth, which no politician dare speak out loud, is:
1. By far our largest and least productive expense is our military. In 2008, we budgeted $479 B on base discretionary spending, $87 B from congressional supplementals, and $102 B for the "war on terror" (not part of the base budget that the DOD asks for). At $669 B, we spent more on our military than the entire rest of the planet combined. http://www.gpoaccess.gov/usbudget/fy09/pdf/budget/defense.pdff) We have to leave Iraq and greatly slash our military spending. Our military is going to have to be purely for defense, not for trying to control the world or the internal politics of other countries.
And don't forget the Pentagon just announced today they "need" another few hundred billion budget increase over the next few years! With half the amount they are getting now used just for defense, along with repealing the Bush tax cuts for the top 5%, that would free up over half a trillion dollars annually.
Our military spending is low for wartime (historically), and pretty average for peacetime (as a % of GDP).
Second awful truth:
2. We have to greatly increase taxes on the wealthy and cut taxes on the middle class and poor, and invest that money in infrastructure, alternative energy, education, and health care. From 1986 to 2006 the percent of total income earned by the top 1% rose from 11% to 22%. (A 100% increase.) Yet the share of the total tax burden they pay only rose from 26% to 40% (A 54% increase.) Thus, in 1986, for the top 1%, 33% of their income went for taxes; by 2006, that percent dropped to 23%. (Taxes on the median income only dropped from 16% to 14%.) In constant dollars, the income of the guy at the boundary between the top 1% and the bottom 99% increased 78%, while Americans earning the median income have experienced virtually no increase in income or standard of living, even though they are far more productive now than 22 years ago. (All these tax stats are found at the IRS site http://www.irs.gov/pub/irs-soi/06in01etr.xls) The only time in U.S. history that there has been such a divide in wealth and income between rich and poor is 1929. The next president will have to increase taxes on income, corporate taxes, AND CAPITAL GAINS back to Clinton levels, or we will go bankrupt.
Democratic market socialism is the answer. Protect small business and incentivize venture capital by subsidizing new start ups with government grants. Spin off new enterprises from the universities and public and private institutes (like the Chinese do). Eliminate taxes on small businesses employing less than 100 people. Nqationalize large corporations, but preserve the market economy. Make big corporations truly public by putting all stakeholders on the boards of directors including government, relevant NGOs (consumer groups) and workers. so that they have a determining voice on corporate policy. Free higher education, national single payer health care. Come on people get with it. Political democracy + social democracy + economic democracy = 21st century Americanism = democratic market socialism.
That's good. Have politicians decide what businesses are worth funding. Good grief. How anyone thinks a politician has a clue about anything is beyond me.
That is one problem. Stockholders have No voice. Try going to a stockholder meeting to raise a fuss about egregious executive pay for a failing company - or to fight a bad decision. You'll be smothered or ignored or ejected. The executives are supposed to work for the stockholders but they really don't. They work for themselves. And they have bribed the politicians to make stockholder suits against them much harder.
Forget to mention: Confiscate all personal wealth above 100 million dollars. Could be lower. Who needs that much money?
It's hardly any of your business how much money somebody else has. Nor is it your money to steal. "Need" is irrelevant.
Heheh, this will drive the conservatives crazy.
China ascendant. Deregulation shown to be a major cause of financial crisis. Dealing with debt rather than deficit spending.
It's almost like an utter repudiation of everything Republican; not just Bush, but all the way back to Reagan.
I should be more sympathetic, and I am nervous about my own role in this brave new world, but I can't completely hide my gleeful grin at the thought of all the preachy "tax cuts and deregulation" conservatives finally eating humble pie.
Just like the Soviets were ascendant in the 60s. I wouldn't be so gleeful about a setback for freedom vs the nominal successes of a tyranny.
Neocons will not like America's new position in the world.
We must take on a partnership role with the other powers in the world, not unlike Europe.
Right on George! In the 1970s, theorists drew almost entirely negative conclusions about both the uniqueness and the stability of general equilibrium (= the market correcting "invisible hand" a term coined by Adam Smith). It wasn't stable or self-correcting. Well, we just found that out. In other words, there is no financial God. Economies are deadly serious games that require rigid rules and almost draconian penalties for those who cheat.
But I think the U.S. economy can be easily turned around by the rebirth of a productive economy (making goods) together with the gradual elimination of free-trade which is nothing more than outsourcing (shipping jobs and factories to third world countries). I have studied enough economic history to know that the wealth of a nation is based on manufacture - not financial markets which have, historically, made bubbles (remember the South Sea Bubble of 1720?).
We can't make goods cheaper than Chinese slave labor but we can sure make them Better, and let people know they are better. When I go to the store now, I often have no choice but to buy chinese-made. The stuff often doesn't work, or doesn't last, or breaks easily. (or it's poisonous, like their milk and toothpaste.) People think they're saving by buying at Wal-China, but you have to spend time and gas to replace the defective stuff, or buy another when it wears out instantly or is so worthless you throw it in a closet. You really don't save that way - plus, it's just aggravating. And of course, when you buy from Wal-China, more jobs are shipped overseas, which lowers wages, so you think you can only afford Chinese crap. It's a vicious circle. It's not the fault of the Chinese, of course - we sowed the seeds of our own destruction.
Long term, the views expressed about how the U.S. will be positioned financially for the long term reflect where the U.S. is headed - toward a Europeanization of America. See Writing Frontier's piece on this at
http://writingfrontier.com/2008/07/27/the-europeanization-of-america/
Check Urban Dictionary for alternate meanings of IMF. There are times when the dudes at the IMF are really IMFs as when Paul Wolfowitz was associated with the IMF.
Leveraged consolidation of business ALWAYS leads down the same primrose path.
http://www.mindfully.org/Industry/2003/Wal-Mart-Economy3feb03.htm
It's NOT about "what's in your wallet?", it's more about "who MADE your wallet, and why is it empty?".
I'm not saying a word. Do some research people.
Mr Soros is an optimist who wants to revitalize globalism. He wants people to believe that the credit problems is due to bad mortgages. Actually half the bad assets are loans to China related activities.
Half of this problem is due to globalism, unfettered and extremely risky. He wants you to ignore this part.
To cure this economic strife we must contend with this also.
"Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability."
So, freinds ... to save yourselves, get off your lipitor (causes laxity of muscles), beta blockers, get help with therapists for excess stress, and .. take your 401K out of China, and place it into anything else.
Where is the evidence that you understand the global economy better than George Soros?
any links to back up your comments on China?
if half is china and half is globalism, the other half must be housing
It's all derivatives and leverage. Mortgages are just the "chip" they play with.
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