George Soros described his experience during World War II as a Jew as his formative year. In escaping from the Nazis, Soros’ father understood that “there are times when the normal rules don’t apply.” As described in the title of his talk last week, “The New Paradigm for Financial Markets,” the world is entering one of those very times. People haven’t a clue of the value of assets that serve as the foundation of the world economy, our leaders are fumbling their way through the dark, and the world is entering uncharted territory. As a result, the markets yo-yo like a cheap kid’s toy.
Ironically, while Soros was speaking on stage at MIT last week, the Dow Jones index was staging a record rally which produced the second-highest all time point gain. This was in anticipation of a substantial Fed interest rate cut for the next day. What happened the next day when a rate cut actually happened?
Perception is reality. The Dow barely budged.
George Soros is a fan of “reflexivity,” a philosophy that he picked up from his readings of the philosopher Karl Popper. The basic tenet is that the act of comprehending an idea will influence and change the very system that was beheld. Similar to Heisenberg’s Uncertainty Principle in physics — where the act of observation will affect the location wavefunction of a particle — reflexivity naturally extends to financial markets.
Traders are intimately integrated with the financial system; the very actions of buying and selling financial products in the market produce the value of the good. What a buyer perceives to be the price will actually create the price. The failure of the banks caused the limbo the world is currently hanging in, all due to a compounding error of human perception in the valuation of mortgages and their associated securities. Coupled with a system that held up this magnificent and risky Ponzi scheme, we were none the wiser until it came crashing down and the deleveraging began.
There is a logical extension of Soros’ belief in reflexivity — there is no such thing as a completely free market. Soros minted his fortune off those who believed otherwise. Markets are surrounded by very private controls. Governments back the contracts that preside over the transaction. Regulations stipulate what is or isn’t allowed. Officials decide what the market-wide interest rates are. Lately and even more dramatically, regulators have swooped upon the economy like the Grim Reaper, deciding which firms live and which firms die.
The actions of the Bush administration highlight the contrast between Republican dogma and Soros’ philosophy even more sharply. Treasury Secretary Henry Paulson and Fed Chairman Benjamin S. Bernake PhD ’79 stood on the sidelines and looked dumbfounded when the shit hit the fan. Only after Lehman Brothers fell and the rest of the banking system was at risk of cascading into oblivion did the leaders of the US financial system finally toss their free market beliefs out the window. What we’re left with is a thoroughly unfree system and government sticking their nationalization fingers in many pots.
There never was a free market and, as the mortgage debacle demonstrates, there probably should have been less of one given that more stringent regulations were so desperately needed. Libertarians, Chicago-school economists, and Republicans are professing their faith in a false idol. Our government’s leaders spouted out ideology until the circumstances in front of them became so obviously dire, intervention was absolutely necessary.
Soros’ lesson extends to today’s election and the future of our country’s economy. Vote for the candidate and the party that you think understands how markets really work.
If you need a hint to answer that quiz question, here’s one: as Soros proclaimed four years ago during the last election, “I want to shout from the rooftops: ‘Wake up, America! Don’t you realize that we are being misled?’”