By Greg Ip, WSJ | 30 June 2008
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Mr. Soros, the chairman of Soros Fund Management, is best-known as a speculator, philanthropist and political activist. He made a fortune by doing things such as betting against Britain's currency in 1992 and Thailand's in 1997. A Hungarian refugee, he has spent millions to promote democracy and learning in post-Soviet nations. He also has spent heavily to promote liberal causes and has been an ardent critic of President Bush.
But Mr. Soros, 77 years old, wants to be remembered most as a philosopher. Since he was a student in 1952, he has been promoting his economic theory, which he calls "reflexivity." In essence, he argues that markets don't simply reflect fundamental determinants but can change those determinants in a way that causes asset prices to go to extremes. In his latest book, "The New Paradigm for Financial Markets," he argues a "superbubble" has developed in the past 25 years and it is now collapsing.
Mr. Soros's predictions in his books have fallen far short of his track record as a hedge-fund operator. In 1987 he wrote that the world had to ditch the dollar in favor of a new international currency system or risk "financial turmoil, beggar-thy-neighbor policies leading to world-wide depression and perhaps even war." His 1998 book said, "The global capitalist system ... is coming apart at the seams." In recent interviews in Washington and New York, The Wall Street Journal asked him about his forecast— why he succeeds financially when his world view has been so wrong— and about his aspirations to be a philosopher. Excerpts:
WSJ: You've said this is the worst financial crisis since the Great Depression. Yet at its worst, the stock market was only down 18%. That doesn't seem Depression-like. Is this as bad as it gets?
Mr. Soros: I think that the decline in housing prices is going to be more precipitous and go further than people currently expect. To expect [to come] out of the recession by the end of the year, I find that inconceivable. But I can envisage a very broad range of scenarios. One would be a very prolonged world-wide recession.
I cannot imagine a replay of the '30s. But you can have a 'muddle-through' replay of the Japanese scenario— 10 years of stagnation. The employment figures are still very, very satisfactory. Part of this is due to the impact of the lower dollar in stimulating exports and partly to the very strong position of the corporate sector. The economy turned out to be structurally in very good shape.
WSJ: You argue that the crises we've experienced in the past 25 years have been, in retrospect, "testing events" that convince us the system is stable, encourage us to take even bigger risks, leading to one, cataclysmic collapse. Could this be just another testing event?
Mr. Soros: Each time the authorities saved us, that reinforced the belief that markets are self-correcting. Each time when you bail out the economy, you need to find a new motor, a new source of credit and a new instrument that allows for the credit expansion. [It's] difficult to imagine what [more] you can do when you are already lending effectively 100% on inflated house prices.
I have a record of crying wolf at these times. I did it first in "The Alchemy of Finance" [in 1987], then in "The Crisis of Global Capitalism" [in 1998] and now in this book. So it's three books predicting disaster. [But, after] the boy cried wolf three times ... the wolf really came. If we can sail through this without a recession, then the 'superbubble story' is seriously impacted ... I [will] have cried wolf again. Unfortunately, if you go into a recession, [it is not] proof of reflexivity, or vice versa.
WSJ: How is that you are rich despite your world view having been wrong so far?
Mr. Soros: I'm only rich because I know when I'm wrong.
WSJ: How do you stay levelheaded in the middle of a bubble?
Mr. Soros: I don't. I panic. The same thing applies to me as to everybody else, so I'm given to euphoria and despair. And I would say that I basically have survived by recognizing my mistakes. I very often used to get backaches due to the fact that I was wrong. Whenever you are wrong you have to fight or [take] flight. When [I] make the decision, the backache goes away. I don't always make the right decision. I sometimes cut my losses when I shouldn't.
WSJ: Is reflexivity really behind your success, or are you just a good trader?
Mr. Soros: My performance currently is not that good, but taking the longer [view] it is kind of outstanding. There are two possible explanations. One is the theory [of reflexivity] and the other is the backache. And I think it's really the combination of both because recognizing reflexivity drives you to this constant re-examination.
WSJ: Would you prefer to be remembered as a philosopher than as a successful speculator or philanthropist?
Mr. Soros: Much more. You know, people have hang-ups and that's my hang-up. The most popular reaction to my philosophy is ... success has gone to his head and he wants to be more than what he is. That's obviously a very plausible theory. Certainly being a successful fund manager gave me a platform. But I would like the ideas to be judged on their own merit. I think I'm on the verge. For the first time, this book [his 10th] is a best seller. I was asked to testify [before the Senate Commerce Committee] because a staff member read the book.
WSJ: Are you getting recognition from heavyweights in academia or policy making?
Mr. Soros: It has certainly not penetrated academia, and not policy makers either. There was an article in The Wall Street Journal about people doing research on bubbles at Princeton, so I'm going to meet with one of them. I wish I could engage in a discussion with [the Federal Reserve]. I'm waiting for a phone call. I'm [meeting with] Alan Greenspan.
WSJ: But you are quite critical of Greenspan.
Mr. Soros: Greenspan is one of the great manipulators of financial markets. I mean it in a good way. He managed [in 2001] to forestall a more serious recession. He kept interest rates [low] too long. And he did not heed the warnings that lending standards were being lowered, that deceptive practices were being used. He was too much of a market fundamentalist. He believed that if you leave it to markets, everything will be all right. That's initially self-reinforcing, but eventually self-defeating.
WSJ: Greenspan argues that the benefits of innovation are worth the occasional bubble.
Mr. Soros: This is, of course, [Joseph] Schumpeter's creative destruction idea. However ... going overboard in generating change is not necessarily a good thing. Financial innovation may not be an unmixed blessing because it really prevents proper regulation [[resulting in severe financial dislocations: normxxx]].
If you look at the 19th century, you had creative destruction going on, one financial crisis after another. But each time you had a crisis, you had an examination of what went wrong, and you put in some instrument or some institution to prevent it from happening [again]. I'm not advocating ... central planning because that's worse than [free] markets. But the regulators need to learn from the mistakes that they have made. I think it's pretty clear that you've got to accept responsibility for moderating asset bubbles. ... That involves regulating credit as well as [interest rates].
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Normxxx
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