06/24/2010 11:12 am ET Updated May 25, 2011

The Wants and Fears of George Soros

George Soros has demonstrated to the world that he has one of the brightest financial minds of our era. He articulated a framework that he dubbed "reflexivity," which inconveniently argued that forces in the financial system could periodically become unstable rather than always tending towards equilibrium. His famous winning bets such as against the British or Thai currencies made his opinions not only respected by money managers such as myself; they instilled fear within powerful politicians and central bankers. Those on the wrong side of Soro's wagers are not only speculators, they can be simple businessmen and their employees who pursue trade using the only thing available: government fiat currency. Yesterday, I had lunch with a businessman, who in the Asian contagion of 1998, lost his 125 year old company when a major contract for sale of equipment into Thailand failed because letters of credit were not available. Fortunately, after a modified bankruptcy he recovered from the experience many painful years later.

Yesterday Mr. Soros delivered a speech in Berlin in which he lambasted the Germans for wishing to operate a sound currency and refrain from racking up an oversized government budget deficit. He advocates temporarily application of massive establishment of credit, the "recapitalization" of banks with freshly printed reserves, and dramatic fiscal stimulus. In a clever analogy, he likens the world's situation to that of an automobile speeding out of control around a curve, which would be corrected by a delicate two-phase maneuver: "just as when a car is skidding, first you have to turn the car into the direction of the skid and only when you have regained control can you correct course." Later, like a self-styled Einstein, he proposes a "thought experiment" proving that if Germany were to continue its monetary and fiscal disciplines, it would suffer tremendous lack of industrial competitiveness and the whole of Europe would collapse around it.

To understand the speech, one must know what the wants and fears of George Soros are. In my book, Endless Money (John Wiley & Sons 2010), I develop a unique perspective on the topic of liberal billionaires such as Soros and Buffett. Specifically, I argue that their vested interest in maintaining the trend towards socialism and feeding its insatiable appetite with voluminous money creation through bank lending preserves a tax structure that imperils the middle class and results in unprecedented accumulation of wealth among the super-rich. Billionaires love a system in which banks double the money supply every seven years through issuing credit-backed currency , because it sets asset prices on an upward trajectory. More than half of wealth accumulation of the super-rich comes from this rather than accumulated net income or the earning of ordinary income, and this rise in net worth is generally untaxed since it is unrealized. And not to worry - it can be monetized free of taxation through manageable amounts of borrowing at government suppressed interest rates and even hedged out with derivatives.

It is no wonder that liberal billionaires ask that we solve the deficit problem by lifting the combined total of state and federal income taxation over 50%, because unlike small entrepreneurs and highly productive laborers, they are mostly untouched by the tax on income. So, what is Soros's greatest fear? It is the end of such a system, and its replacement with the only unencumbered currency known to man for thousands of years: gold. This would end the politically convenient bread and circuses promulgated by socialists and Keynesians that deflect public attention from the glaring injustice and looming disaster of it all, much less the chronic unemployment of Europe and the emergence of the "new normal" impoverished and governmentally dependent underclass in the United States.

Yesterday Mr. Soros warned the Germans that their prudence will bring down Europe and that they will not be spared, even if they might enjoy the pleasures of buying Spanish vacation villas or Greek islands at fire sale prices. He criticizes the inadequacy of the $1 trillion euro "shock and awe" solution enacted a month ago, chiding, "Even more troubling is the fact that Germany is not only insisting on strict fiscal discipline for weaker countries but is also reducing its own fiscal deficit. When all countries are reducing deficits at a time of high unemployment they set in motion a downward spiral. Reductions in employment, tax receipts, and exports reinforce each other, ensuring that the targets will not be met and further reductions will be required."

Taking it further, he engages us in a thought experiment of what would happen if Germany were to withdraw and leave the rest of Europe on the euro: "The Deutschmark would go thru the roof and the euro would fall thru the floor. This would indeed help the adjustment process but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain."

But why engage in thought experiments when history has been a guide? In the aftermath of the first world war most of the countries of Europe were mired in unemployment and relied upon the printing of currencies to monetize their war obligations and feed government budgets hell-bent on kick-starting their economies. This included Germany, which unfortunately through the Versailles treaty could not escape liabilities owed in strong currencies. We know in hindsight that despite the incredible currency tumult witnessed in the depression of 1920-1921, the world economy recovered so quickly that there was scarcely time for Warren Harding to be pressured into enacting legislation to end the downturn, even though the U.S. operated the strongest currency at that time. Only beginning in 1930 with the overdose of intervention begun by Hoover, who was wrongly accused of doing nothing, did we see the damage that reflexivity could exacerbate.

This interwar period is complex, and in Endless Money I devote many pages to it in order to lend insight to what happened in the Great Depression. And accordingly, our present situation cannot be understood unless an emphasis is placed upon the post-1971 buildup of credit, which went into orbit in recent years. The media and investors continually are looking for the next bubble that might follow the internet blowoff, the subprime disaster, and the 2008 meltdown. But these are merely small manifestations of the larger, multi-decade or even multi-century bubbles of fiat currency and big government intrusion into the economy that cannot be made to disappear through the adroit turn of the driver's wrist when he loses control of his vehicle.

Up to this point, Soros has advocated that sovereign gold is of little use and should be redirected to developing nations through IMF lending. Around year-end 2009 he began accumulating the yellow metal and miners of it, probably in anticipation of inflation that would be caused by monetary and fiscal stimulus. But he warned the economic brains at Davos in January 2010 that gold was a bubble while doubling his holdings, a deceptive ploy which for any garden variety investment advisor might attract the scrutiny of the SEC. Like BP might have thought before the unimaginable disaster of the Gulf occurred, he need not fear the jack boot of the regulators, since they both have in common heavy political donations to liberal politicians and causes. But that protection racket may not save him from an angry mob should his fears of driving over the edge materialize.

The great investment question of our time is the inevitability of deflation or inflation, and this subject is investigated in detail in Endless Money and my other writings such as For Whom the Gold Bell Tolls (February 2010). Predicting the financial markets might be easier if the wild card of government intervention were not poised to be dealt. Operating a fiat currency completely severed from gold in 1971 (continuing a trend of precious metals demonetization begun in the early nineteenth century) has built a veritable mountain of debt. And Mr. Soros's hypothetical car might have swerved off the curve on the financial road that was constructed upon this mountain many times if it were not for Greenspan or Bernanke executing the delicate two-stage maneuver several times already: in 1987, 1991, 1998, 2001-2, and most recently 2008-present. These incidents have lulled the car's driver into thinking that excessive speed in the creation of money and governmental budgeting can be managed by dexterous maneuvering. The better he got at it, the more systemic moral hazard was assumed. Unless Mr. Soros is the penultimate deceiver of financial markets, governmental leaders, and men generally, he still has not learned what a strong and growing minority of gold investors know, which is that they no longer wish to be passengers in that car.

Disclosures: Long and short equities. Long gold, gold derivatives, and gold equities.