The principal of fallibility: People base their decisions not on actual reality but on what they perceive to be reality. The extent of the divergence varies from time to time and from person to person.
The principle of reflexivity: Market participants' misconceptions as reflected in market prices affect the so-called fundamentals.
"The extent and degree of uncertainty is itself uncertain and variable."
Soros states that he believes that the market trends towards near-equilibrium or far from equilibrium rather than hovering around some mean.
Most Succinct History of European Sovereign Debt Crisis I've Seen:
"The euro was an incomplete currency to start with. The Maastricht Treaty established a monetary union without a political union. The euro boasted a common central bank but it lacked a common treasury.
"So even though member countries share a common currency, when it comes to sovereign credit they are on their own. Unfortunately, this fact was obscured until recently by the willingness of the European Central Bank to accept the sovereign debt of all member countries on equal terms at its discount window. This allowed the member countries to borrow at practically the same interest rate as Germany and the banks were happy to earn a few extra pennies on supposedly risk-free assets by loading up their balance sheets with the government debt of the weaker countries. For instance, European banks hold more than a trillion euro’s of Spanish debt of which more than half is held by German and French banks. The large positions came to endanger the creditworthiness of the European banking system, depriving them of the capacity to add to their positions.
Although it was the inability of the banks to continue accumulating the government debt of the heavily indebted countries that precipitated the crisis, but it was the introduction of the euro and ECB’s willingness to refinance sovereign debt that got the banks weighed down with these large positions in the first place. It led to a radical narrowing of interest rate differentials and that, in turn, generated real estate bubbles in countries like Spain, Greece, and Ireland. Instead of the convergence prescribed by the Maastricht Treaty, these countries grew faster and developed trade deficits within the eurozone, while Germany reigned in its labor costs, became more competitive and developed a chronic trade surplus. The discount facility of the ECB allowed the deficit countries to continue borrowing at practically the same rates as Germany, relieving them of any pressure to correct their excesses. So the introduction of the euro was indirectly responsible for the development of internal imbalances within the eurozone."
Notes that Germany has been 'traumatized by two episodes of runaway inflation" and so was originally "adamanatly opposed to any bailout." See Weimar republic. At least one country seems to have learned from history. Although it should be noted that Germany's citizenry possesses a stronger nationalist vibe if not outright xenopohobia than that of most developed nations. Its also understandable that hard-working savers running chronic surpluses do not enjoy coming to the aid of reckless speculators (imagine that!).
The crisis forced the creation of the 750B European Financial Stabilization Fund, 500B Euro from the member states, and 250B Euro from the IMF. The Stabilization Fund is, according to Soros, "very far from a unified fiscal policy, but it is a step in that direction...So the crisis has passed its high water mark and the euro is here to stay. But it is far too early to celebrate because the emerging common fiscal policy is dictated by Germany and Germany is wedded to a false doctrine of macro-economic stability which recognizes only the threat of inflation and ignores the possibility of deflation."
Maastricht criteria has no adequate enforcement mechanism.
Deficit reduction by a creditor country such as Germany is in direct contradiction of the lessons learnt from the Great Depression of the 1930s. It is liable to push Europe into a period of prolonged stagnation or worse. That may, in turn, produce social unrest and, since the unpopular policies are imposed from the outside, turn public opinion against the European Union. So the euro, with its aysemmetric directive, may endanger the social and political cohesion of Europe."
"...And the policies [Germany] is imposing on the eurozone are liable to send the eurozone into a deflationary spiral."
On the United States:
"By contrast, interest rates on US government bonds have been falling and are near record lows. This means that financial markets anticipate deflation not inflation."
"Consumption still needs to fall as a percentage of the GDP and fiscal and monetary stimulus are still needed to keep the GDP from falling and to prevent a deflationary spiral."
"I believe there is a strong case for further stimulus. Admittedly, consumption cannot be sustained indefinitely by running up the national debt. The imbalance between consumption and investment needs to be corrected. But to cut back on government spending at a time of large-scale unemployment would ignore all the lessons learned from the Great Depression."
An allusion to his oft commented on reflexivity, "...A quarter century of agitation calling the government bad has resulted in bad government."
"The Obama administration has in fact been very friendly to business."
"I do not believe that monetary policy can be successfully substituted for fiscal policy." AGREED. This has been a theme expressed in previous posts. Why QE2 and not real infrastructure spending, etc? Create jobs, don't destroy the dollar.
"Quantitative easing is more likely to stimulate corporations to devour each other than to create employment. We shall soon find out."
Soros' reflexivity is not a terribly original idea, but I believe it to be a fundamentally accurate picture of how markets work. Markets, and all complex systems, behave in a non-linear way. They are recursive, self-reinforcing. Economist Brian Arthur's work on path dependence and (nonrational) agent-based models basically supports Soros' view.
ReplyDeleteSoros' conception of the credit cycle originated with Minsky and Schumpeter -- expansion of credit leads to increased asset prices, which leads to increased value of collateral, which leads to futher extension of credit, which leads to increased speculation, and so on and so on until there is no marginal buyer, the credit mechanism is tapped out, banks and households retrench their balance sheets and the whole thing rapidly deflates to equilibrium. Except of course for extraordinary government support. Soros' Alchemy of Finance was written in 1987 and reads like a Andrew Ross Sorkin column on the current crisis. Highly recommended.
Soros, and Al, are exactly right on the eurozone. Interestingly, John Llewellyn, ex Euro economist for Lehman Bros, did an interview on Bloomberg Surveillance recently where he suggested that the cultural psyche of different nations might serve as a guide to their policy priorities. For a German, as they were taught in their schoolbooks, the worst national nightmare occurred when public finances were allowed to fall into disarray, and monetary conditions were very loose. The American cultural memory is stamped with the horror of asset deflation and the government's failure to fully support output. These twin cultural prerogatives can tell you as much about policy out of the Fed or Bundesbank as parsing Bernanke/Weber's public statements, or looking at a Taylor curve. A great job for an economic historian--unfortunately, for one who, unlike me, reads German.