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Political and economic views

Reflexivity, financial markets, and economic theory

External video

George Soros - Festival Economia 2012 02.JPG George Soros

video icon The Lecture Series: Introduction, 2:56

video icon General Theory of Reflexivity, 52:00

video icon Financial Markets, 43:59

video icon Open Society, 43:39

video icon Capitalism vs. Open Society, 47:38 all by the Open Society Foundations

Soros's writings focus heavily on the concept of reflexivity, where the biases of individuals enter into market transactions, potentially changing the fundamentals of the economy. Soros argues that different principles apply in markets depending on whether they are in a "near to equilibrium" or a "far from equilibrium" state. He argues that, when markets are rising or falling rapidly, they are typically marked by disequilibrium rather than equilibrium, and that the conventional economic theory of the market (the "efficient market hypothesis") does not apply in these situations. Soros has popularized the concepts of dynamic disequilibrium, static disequilibrium, and near-equilibrium conditions.[60] He has stated that his own financial success has been attributable to the edge accorded by his understanding of the action of the reflexive effect. Reflexivity is based on three main ideas:[60]

Reflexivity is best observed under special conditions where investor bias grows and spreads throughout the investment arena. Examples of factors that may give rise to this bias include (a) equity leveraging or (b) the trend-following habits of speculators.

Reflexivity appears intermittently since it is most likely to be revealed under certain conditions; i.e., the character of the equilibrium process is best considered in terms of probabilities.

Investors' observation of and participation in the capital markets may at times influence valuations and fundamental conditions or outcomes.

A recent example of reflexivity in modern financial markets is that of the debt and equity of housing markets.[60] Lenders began to make more money available to more people in the 1990s to buy houses. More people bought houses with this larger amount of money, thus increasing the prices of these houses. Lenders looked at their balance sheets, which not only showed that they had made more loans, but that the collaterals backing the loans – the value of the houses – had gone up (because more money was chasing the same amount of housing, relatively). Thus they lent out more money because their balance sheets looked good, and prices rose higher still.

This was further amplified by public policy. In the US, home loans were guaranteed by the Federal government. Many national governments saw home ownership as a positive outcome and so introduced grants for first-time home buyers and other financial subsidies, such as the exemption of a primary residence from capital gains taxation. These further encouraged house purchases, leading to further price rises and further relaxation of lending standards.

The concept of reflexivity attempts to explain why markets moving from one equilibrium state to another tend to overshoot or undershoot. Soros's theories were originally dismissed by economists,[149] but have received more attention after the 2008 crash including becoming the focus of an issue of the Journal of Economic Methodology.[150]

The notion of reflexivity provides an explanation of the theories of complexity economics, as developed at the Santa Fe Institute, although Soros had not publicized his views at the time the discipline was originally developed there in the 1980s.[151][152][153][154]

Reflexivity in politics

Although the primary manifestation of the reflexive process that Soros discusses is its effects in the financial markets, he has also explored its effects in politics. He has stated that whereas the greatest threats to the "open society" in the past were from communism and fascism (as discussed in The Open Society and Its Enemies by his mentor Karl Popper), the largest current threat is from market fundamentalism.

He has suggested that the contemporary domination of world politics and world trade by the United States is a reflexive phenomenon, insofar as the success of military and financial coercion feeds back to encourage increasingly intense applications of the same policies to the point where they will eventually become unsustainable.[155]

View of problems in the free market system

Soros argues that the current system of financial speculation undermines healthy economic development in many underdeveloped countries. He blames many of the world's problems on the failures inherent in what he characterizes as market fundamentalism.[156]

Market predictions

Soros's book The New Paradigm for Financial Markets (May 2008), described a "superbubble" that had built up over the past 25 years and was ready to collapse. This was the third in a series of books he has written that have predicted disaster. As he states:

I have a record of crying wolf ... 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. [After] the boy cried wolf three times ... the wolf really came.[157]

He ascribes his own success to being able to recognize when his predictions are wrong.

I'm only rich because I know when I'm wrong ... 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.[157]

In February 2009, Soros said the world financial system had in effect disintegrated, adding that there was no prospect of a near-term resolution to the crisis.[158] "We witnessed the collapse of the financial system ... It was placed on life support, and it's still on life support. There's no sign that we are anywhere near a bottom."

In January 2016, at an economic forum in Sri Lanka, Soros predicted a financial crisis akin to 2008 based on the state of the global currency, stock and commodity markets as well as the sinking Chinese yuan.[159][160]