Azim Premji University gave investors residing in Bangalore a reason to rejoice today, the 9th of January 2012. They had invited George Soros to deliver a talk, as part of their public lectures series. I had obviously subscribed to the event immediately and reached the venue 30 minutes early to grab the best seat. If there are three investors in the world that I wanted to see and interact with in my life, they are Warren Buffett, George Soros and Seth Klarman. George Soros check.
The lecture began in the form of a conversation with the Chancellor of Azim Premji University, Mr. Anurag Behar. Soros in his unimitable fashion took over the conversation with gusto (and without anybody noticing – credit to Mr. Behar not to interrupt like some news anchors would have done). I scribbled down notes as fast as I could and am presenting with what I wrote down. I definitely would have missed some points – so anybody reading this who also attended the lecture – please fill in the gaps. Caution though – investors who follow George Soros religiously will of course find nothing new in here. Notes follow (all italics are statements made by George Soros, emphasis mine) –
Soros talking about his initial days –
A lot had to do with my father. Year 1944. World War II. I was a Jew. Persecution loomed. My father saved me from persecution by taking a lot of risks. If he hadn’t taken those risks, I probably wouldn’t be in this position. That gave me my first insight ‘Sometimes, its more risky not to take a risk and act all precautionary’
Soros talking about his Guru, Karl Popper –
Karl Popper shaped my philosophy. He was a strong proponent of ‘critical thinking’ and idea of a ‘open society’. I was very young when I read him. He influenced me a lot, and I have read all his books.
The big topic. 2008 Financial Crisis –
The theory of financial markets states that markets do not tend towards equilibrium. Boom-bust cycles happen regularly. The problem of this super bubble that led to the crisis of 2008 started in 1980 with the Reagan Administration.
If financial capital is free to move around, that capital will tend to find a place where there is least regulation and taxes. Therefore, globalization and de-regulation always go hand-in-hand. Govt. authorities always come to rescue – whether it was the S&L crisis, the Asian crisis, IT bust in 2001, leading to moral hazard. Growth of credit and leverage led to the super bubble. I thought that the bubble would pop in 1997 during the Asian crisis, but the authorities intervened. Then IT bubble-bust happened, and authorities reacted by reducing interest rates and kept low interest rates for too long, which led to the housing bubble. In the crash of 2008, the authorities let Lehmann Brothers collapse and the financial markets essentially stopped functioning. Subsequently, financial rescue came through and the market was put on artificial support. What the authorities essentially did was to substitute financial credit with state credit. But they did not try to address the underlying imbalances.
On the Euro situation and crisis –
The Euro crisis is a direct consequence of that replacement of credit. Due to that, sovereign credit is in question now. The 2008 crisis revealed the inherent weakness in Euro and the region as a whole. This Euro crisis is larger than the financial crisis.
In case of Euro, there is a Central bank (ECB), but there is no Treasury. Central Banks deal with liquidity. Treasury deals with solvency. There is no Treasury in Europe currently and they are currently in the process of creating it.
When the Euro was brought into existence, the authors (or its creators) knew that there were chinks, but rationalized that with a common currency, political integration would come through and these chinks would be ironed out. But that didn’t happen. Now we realize that only in the time of crisis, politically impossible becomes possible.
Slowly, Treasury will have to be created. We are in a more dangerous situation than 2008. Euro banks failing would be catastrophic because of the current state of financial integration across the world. The chances of failing poses a great risk to the economy of the world.
The point is – if the crisis is brought under control, period of austerity has to begin and creditors will call the shots. Essentially, Germany will call the shots. And Germans might come up with a draconian austerity program. There is a real possibility of a deflationary cycle, hence impacting the real economy. Deleveraging is already happening and I am afraid, there is more to come.
On the Developed vs Developing world debate –
This crisis is hitting the developed world. 2008 crisis was primarily hitting the US. But the repercussions of this crisis will also be felt by the US. Developing world will be affected by the crisis too, but less affected than the developed world. There is an underlying shift from the developed to the developing world happening right now. The rate of growth in the future in the developing world will be positive while in the developed world, it might be negative.
India is a fascinating country, and I am long term optimistic on India.
On Market fundamentalism, Economic theory and Reflexivity –
Market fundamentalism is a political interpretation of the prevailing economic dogma – the economic dogma being ‘Markets left to their own devices will find the optimum outlets…’. I don’t subscribe to it. Financial capital will move to wherever there is less regulation and taxes. It is difficult to globally regulate economy and still ensure that the financial capital moves freely. The regulation of Banking system is not going well.
As they say, Economists predicted 8 out of the last 3 recessions. Economic theory doesn’t resemble the real world. It is just being mistaken to be relevant to the real world. Economic theory tries to imitate Newtonian physics and hence tries to arrive at a equilibrium by modeling the real world using universal laws. This equilibrium is a mirage. Social affairs have thinking participants and hence lead to in-determinant situations.
Reality and people’s view of reality are never equal and are more often divergent. There is always a two way connection between thinking and actual course of events. There are two aspects that everyone is trying to grapple with. One, understanding reality. Two, impacting that reality. These often stretch in opposite directions and creates a feedback loop (termed as ‘reflexivity’). This impacts the state of affairs depending on the type of feedback. Positive feedback reinforces prevailing trend, introduces bias and creates distortion. Negative feedback corrects the reinforcement. Due to the nature of feedback, there will always be booms and busts. Reflexivity disturbs the equilibrium while Economics explains only theory.
On Regulation –
Markets are prone to create bubbles and busts and therefore, you need regulation. Ever since financial markets existed, financial crisis have happened. Every time crisis happened, regulation was created. Regulation is a part of the financial markets. There is always an interplay between Regulation and Financial markets. Both are imperfect and both exhibit reflexive interplay.
This reflexive concept has not been invented by me. It was explained long ago by Frank Knight, in the Knightian Uncertainty. Risk management techniques ignore unquantifiable uncertainty, thereby creating financial crisis (impact of fat tails). We should rebuild economics on imperfect understanding of the markets. I have had an edge and made money by understanding the concept of reflexivity better than others, till I explained it in my book ‘Alchemy of Finance’ (laughter!)
In today’s world, the business of spending some money to create a loophole in the regulation so that it benefits one party is growing tremendously.
On Democracy and his Charity Foundation –
I am less optimistic about democracy in the US than in India due to a combination of financial and political crisis.
There is a theory that poor share more than the rich, and probably the reason why they have remained poor.
I have found, through my foundation that the theory of fallibility and reflexivity work not only in the financial sphere but also in the political sphere. For example, I did not foresee the collapse of USSR, but became more alert as it was collapsing. I immediately set up a foundation for democracy. Similar in Burma, where I was in recently.
Time was running short and Soros seemingly had multiple engagements today that he had to rush to.
I personally wanted to ask a question ‘What are the 2 subjects/industries that you would encourage students of investing to learn today, to be successful investors 25 years into the future’, but never got the chance. Always next time.
Hearing it from the horse’s mouth, as they say, is an experience in itself. Soros walked after a thunderous applause from the audience (the auditorium was jam packed by the way!). Calm, collected, humble and seer-ish. You never could make out he was one of the smartest guys in the world (apart from being one of the richest). Absolutely phenomenal stuff.