BOOK REVIEW Tarnished 'truth' The New Paradigm for Financial Markets by George Soros
Reviewed by Nicholas Kiersey
"Wall Street got drunk," or so says President George W Bush. But blaming
America's recent credit crisis on Wall Street and its "fancy financial
instruments" is a little too simplistic. For it is an analysis that speaks
neither to the radically neo-liberal regulative framework that permitted such
instruments to develop nor the insurmountable challenges now facing America's
homeowners.
Ironically, for this sort of analysis, we could do worse than turn to George
Soros's new book, The New Paradigm for Financial Markets: the Credit Crisis of
2008 and What it Means. A financial speculator, Soros has made and lost
more money than most can
imagine. He writes, too, and is a sometimes philosopher.
The book argues that blame for the current crisis should focus not so much on
Wall Street but on its regulators and the economic worldview that guides them.
Trained to think in the mode of
contemporary economic theory, many of these regulators work under the
misbegotten notion that their analyses of the market are in fact "scientific".
Yet nothing could be further from the truth, says Soros. For as with any sphere
of social activity, economic relations tend to resist scientific inquiry.
The root of Soros's complaint is just this: while the methods of natural
science may be appropriate for studying the stuff of the natural world, such as
nuclear physics, they often produce misleading results when applied to realm of
human affairs. For the study of human life is confounded by the dilemma of
"interference reflexivity". That is, because students of human affairs are also
participants in the ongoing processes which they are trying to study they can
never completely remove their preconceived prejudices from their analysis.
The solution to this problem on the philosophical level is relatively
straightforward. We simply have to recognize the problem of "interference
reflexivity" and modify our expectations about what we can claim to know with
certainty about social life.
Yet it is not enough simply to resolve the reflexivity issue on an esoteric or
philosophical level. For as Soros argues, we have "bet the farm" on a global
financial system built around a set of non-reflexively developed assumptions.
We would be gravely mistaken if we did not now subject these assumptions to
critical scrutiny.
As a science of human relations, economics proves its worth by identifying
generalizable patterns of human behavior over time. To do so, however, it
necessarily relies on metaphor to limit the complexity of the things it sees.
Take for example the fundamental argument of classic economic theory, that
supply and demand always tend towards "equilibrium" in the long run. The idea
is that, with good enough information, the unrestrained pursuit of
self-interests will always lead to an optimal allocation of resources.
However, while the idea of economic equilibrium may hold up for long periods of
time, its utility as a metaphor for economic analysis is limited. For it is
based on the rather narrow premise that human nature is fundamentally
unchanging and that we each of us have inbuilt or "given" preferences for the
way we want to see our lives turn out in the long-run. Indeed, these desires
are so deeply embedded in our psyches that they can be taken for granted.
Now, certainly, if we really possessed such enduring traits then our analytical
dilemma would be over. For these preferences would make our behavior in
different contexts predictable, following basic laws of cause and effect over
time. The problem, however, is that in financial markets the participants are
not passive entities. They are reflexive beings, with capacities both as actors
(agents of change) and observers (agents of knowledge). And given that each
capacity has the potential to influence the other, those fundamental traits
posed by economic science appear anthropologically specious.
If we are reflexive beings then the premise that we engage in the market in a
purely rational fashion appears somewhat overstated. For where rational actors
adapt their expectations to new information in order to maximize their
interests, reflexive beings develop beliefs which, if held collectively, can
create fundamental shifts in the nature of the market itself.
So what does all of this mean for the current debt crisis? Well, Soros is clear
here. From time to time, our fundamental understanding of the nature of the
market will be subject to change. However, these beliefs are more than a mere
reflection of what is actually going on in the market. Rather, because they
tell actors in the market what sort of world they are living in, new sets of
beliefs can change the very rules of the game, altering regulative contexts and
inciting more or less risky patterns of behavior.
Soros goes through a series of booms and busts to show how well his theory
holds up: the Conglomerate Boom of the 1960s, the 1980s International Banking
Crisis, the late-'90s Asian Financial Crisis, and so on. At each point, his
model is used to show that the market and its participants were engaged in
reflexive behavior conditioned by certain basic understandings of what was
"normal" in the game. In the 1980s, for example, the credit worthiness of
borrowers and the willingness of the debtors to lend were involved. But the
credit worthiness of Mexico was not a real thing in its own right. Rather, as
it turned out, Mexican credit worthiness mattered historically only to the
extent that it existed in the heads of the independent banks who narrated it.
And they narrated it as "just fine" all the way to the bust. That is, the
"moment of truth" where "reality can no longer sustain the exaggerated
expectations". Indeed, even at this moment they did not necessarily correct
their behavior. Like lemmings over a cliff, beliefs can drive the market often
far, far on, past the moment of truth, and into calamity. "As long as the music
is playing, you've got to get up and dance," as Soros cites former Citibank
chief executive Chuck Prince.
There is, then, little that is rational in global finance. In this sense, all
economic crises seem to follow a basic identifiable pattern. Crises occur when
"some form of credit or leverage and some kind of misconception or
misinterpretation" begin to play a determinative role in shaping economic
behavior.
Yet the current crisis is unlike any that has occurred before. For it involves
two speculative bubbles, not just one. While the US mortgage crisis is the
immediate "trigger" bubble, another "longer-term super- bubble" is by far the
more important of the two. For where the misconception driving the property
boom was that "the value of collateral is not affected by the willingness to
lend," the super-bubble is driven by a more foundational issue: "market
fundamentalism," the desire to extend the principles of laissez-faire economics
to the entire domain of human global activity.
This is a philosophical book then, but not without its merits as a serious
commentary on the economic crisis. Soros goes into some detail about the
ideology behind the super-bubble, and the development over time of a range of
"synthetic" securities of such complexity that they were beyond the
understanding even of the regulators. Nevertheless, believing in the myth of
market equilibrium, the regulators confidently abdicated their responsibility
to investigate these instruments. All too casually, as we now know, they
assumed the market would automatically correct any excesses.
How does Soros propose we remedy the situation? Case-by-case solutions are
required. But at the general level, he argues, we need a more cautionary
approach to the use of leverage. If creditors can expect to be continuously
bailed out by central banks when their willingness to lend gets them in trouble
then regulators should exact a price for this. And the public should support
this, too. For given that the US housing market is especially unlikely to
bottom out on its own any time soon, it is clear that the costs of this
breakdown will dwarf the costs of the regulative regime that might have
prevented it.
What are we to make of these arguments? Social science theorists will not find
anything particularly new or innovative in this text. But the books importance
lies not simply in what it is saying, but who is saying it. This is not the
sort of radical free-market ideology you would expect from a financial
speculator. And while I am not an economist, I am nevertheless fascinated that
someone like Soros should start to enter into the realm of social science
philosophy for guidance on the operations of economic markets.
Obviously enough, this book won't be put on any freshmen economics course
reading lists. On the one hand, its just too incendiary - I can't imagine many
economists would want their students to read about why the most essential
assumptions about economic science are perniciously wrong. On the other, its a
little too self-indulgent. But no surprise there. Its not an academic book, and
its not meant to be. After all, these are the critical musings of a
multi-billionaire with an enormous ego and little personally at stake.
Yet I can't help but feel that this book ought to be read. For there is far
more at stake in the current crisis than the drunken debauchery of brokers on
Wall Street. Backed up by the hard "science" of economics, our regulators have
encouraged us to abandon vast tracts of public government to the logic of the
market in the hope that it will arrange optimal (read efficient) outcomes for
us all. Moreover, perversely, we tend to think that any effort to to
re-regulate any of these lending practices would be incommensurate with the
values of democracy. But just how democratic is a way of life governed by an
ideology of binge capitalism?
Economists say they are simply scientists telling us the truth about ourselves.
But they are so much more than that. When they teach us that we are essentially
creatures of the market, they are creating a powerful metaphor about man's
nature, and passing it off as a universal "truth". Warranted by their status as
"scientists", this truth works to erect limits on the horizon of questions we
may be permitted to ask legitimately about what life is and what it is for.
It is to this deeply political question that Soros wishes to draw our
attention. And if he is right that we are witnessing the end of the current
economic era, one can only hope that his message will get a fair hearing as we
move to debate the terms of whichever system of exchange emerges to replace it.
The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It
Means by George Soros. PublicAffairs, 2008. ISBN-10: 1586486837. Price
US$22.95, 208 pages.
Nicholas J Kiersey is an Assistant Professor, Political Science, Ohio
University, Chillicothe, Ohio.
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contemporary economic theory, many of these regulators work under the
misbegotten notion that their analyses of the market are in fact "scientific".
Yet nothing could be further from the truth, says Soros. For as with any sphere
of social activity, economic relations tend to resist scientific inquiry.
