The following is an edited and expanded version of an interview with George Soros, Chairman, Soros Fund Management, by Judy Woodruff on Bloomberg TV.
Judy Woodruff: You write in your new book, The New Paradigm for Financial Markets, that â€œwe are in the midst of a financial crisis the likes of which we havenâ€™t seen since the Great Depression.â€ Was this crisis avoidable?
George Soros: I think it was, but it would have required recognition that the system, as it currently operates, is built on false premises.
Unfortunately, we have an idea of market fundamentalism, which is now the dominant ideology, holding that markets are self-correcting; and this is false because itâ€™s generally the intervention of the authorities that saves the markets when they get into trouble. Since 1980, we have had about five or six crises: the international banking crisis in 1982, the bankruptcy of Continental Illinois in 1984, and the failure of Long-Term Capital Management in 1998, to name only three. Each time, itâ€™s the authorities that bail out the market, or organize companies to do so. So the regulators have precedents they should be aware of. But somehow this idea that markets tend to equilibrium and that deviations are random has gained acceptance and all of these fancy instruments for investment have been built on them. There are now, for example, complex forms of investment such as credit-default swaps that make it possible for investors to bet on the possibility that companies will default on repaying loans. Such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the US government bond market. The large potential risks of such investments are not being acknowledged.
How can so many smart people not realize this?
In my new book I put forward a general theory of reflexivity, emphasizing how important misconceptions are in shaping history. So itâ€™s not really unusual; itâ€™s just that we donâ€™t recognize the misconceptions.
Who could have? You said it would have been avoidable if people had understood whatâ€™s wrong with the current system. Who should have recognized that?
The whole establishment is involved. The economics profession has developed theories of â€œrandom walksâ€ and â€œrational expectationsâ€ that are supposed to account for market movements. Thatâ€™s what you learn in college. Now, when you come into the market, you tend to forget it because you realize that thatâ€™s not how the markets work. But nevertheless, itâ€™s in some way the basis of your thinking.
You said the Federal Reserve had to step in to engineer the buyout by J.P. Morgan of Bear Stearns to prevent a much bigger catastrophe. Youâ€™ve also said that to do this, the Fed had to take on considerable risk. Is this an unhealthy amount of risk that the Fed has taken on?
This is their job, whether unhealthy or not; I donâ€™t think itâ€™s actually so severe. But that is their job, to save the system when it is in danger. However, because that is their job, it ought to be their job also to prevent asset bubbles from developing. And that task has not been recognized. Greenspan once spoke about the â€œirrational exuberanceâ€ of the market. It had a bad echo and he stopped talking about it. And itâ€™s generally accepted that the Fed tries to control core inflation, but not asset prices. I think that control of asset prices has to be an objective in order to prevent asset bubbles because they are so frequent.
And thatâ€™s more than what the Fed is doing.
Itâ€™s more than what itâ€™s doing now. You have to recognize that just controlling money doesnâ€™t control credit. You see, money and credit donâ€™t go hand in hand. The monetarist doctrine doesnâ€™t stand up. So you have to take into account the willingness to lend. And if itâ€™s too greatâ€”if borrowers can obtain large loans on the basis of inadequate securityâ€”you really have to introduce margin requirements for such borrowing and try to discourage it.
When you talk about currency you have more than a little expertise. You were described as the man who broke the Bank of England back in the 1990s. But what is your sense of where the dollar is going? Weâ€™ve seen it declining. Do you think the central banks are going to have to step in?
Well, we are close to a tipping point where, in my view, the willingness of banks and countries to hold dollars is definitely impaired. But there is no suitable alternative so central banks are diversifying into other currencies; but there is a general flight from these currencies. So the countries with big surplusesâ€”Abu Dhabi, China, Norway, and Saudi Arabia, for exampleâ€”have all set up sovereign wealth funds, state-owned investment funds held by central banks that aim to diversify their assets from monetary assets to real assets. Thatâ€™s one of the major developments currently and those sovereign wealth funds are growing. Theyâ€™re already equal in size to all of the hedge funds in the world combined. Of course, they donâ€™t use their capital as intensively as hedge funds, but they are going to grow to about five times the size of hedge funds in the next twenty years.
Few people know more about hedge funds than you do. Youâ€™ve been enormously successful with your own hedge fund. Should hedge funds be more regulated by Washington?
I think hedge funds should be regulated like everything else. In other words, you have to control leverageâ€”credit obtained for investment purposesâ€”somewhere. Excessive use of leverage is at the bottom of this problem. And there have been hedge funds that have been using leverage excessively and some of those have gone broke. The amount of leverage that people are allowed to use has to be regulated. I think itâ€™s best done through the banks. In other words, the banksâ€™ reserve requirementsâ€”the amounts of money they are obliged to holdâ€”should be tailored to the riskiness of their customers. So investment funds that use a lot of leverage ought to be seen as very risky; and therefore they would not get the amount of leverage they seek because the banks wouldnâ€™t give it to them.
New regulation, though:Â Could that impede the ability of hedge funds to be the big players that they have been in these markets?
Yes, I think that there has been excessive use of credit and it does have to be limited. So we are now in a period of very rapid deleveraging and I think that in the future we ought not to allow leverage to be used to the extent that it has been in the past.
You write, â€œWe are at the end of an era.â€ When this current credit crisis ends, will the US still be, no doubt about it, the world superpower when it comes to the economy?
Not at all. This is now in question. And you now have entered a period of really considerable uncertainty and turmoil because of the general flight from currencies, which manifest itself in the commodities bubble that has developed. The price of gold hasnâ€™t yet gone as high as it might. So what comes out of this turmoil is very open to question. I think that you will have to somehow reconstruct the global financial architecture because you have recognized that, in effect, the economic weight has changed considerably among the different countries. China has become much more important and also India, and so on. What kind of system will evolve from this is, I think, a very open question.
What about China? How much of an economic competitor could it end up being?
Well, China is rising. Itâ€™s been the main beneficiary of globalization. Their currency is significantly undervalued and for various reasons they have to allow it to appreciate, recently at a rate of 10 percent. And itâ€™s been accelerating now to 15, 20 percent, which makes the situation more difficult for the Fed because you now have the prospect of core inflation in the US accelerating because if our imports coming from China go up in price by 15 percent, it will come through in core inflation. The price of goods at Wal-Mart is rising and will probably continue to rise and then accelerate.
So while people are thinking that goods are cheaper from China, youâ€™re saying the prices go up. It affects so many things that we buy in this country. What of Russia and how its economy is doing?
Basically, the country is benefiting from the high price of oil, but, at the same time, it is reestablishing a very authoritarian regime where the rights of investors are not respected. Now it is British Petroleum that is being chased out. So you invest at your own risk. Iâ€™ve done it and Iâ€™m not going to do it again.
The most attractive emerging market?
Soros: At this time, the outlook for India is also very good.
Bringing us back to this country in the midst of this economic credit crisis that you write about and that youâ€™ve been describing, we are also in the middle of a presidential election. You endorsed Barack Obama the day he announced. Why him rather than your home state senator, Senator Clinton?
Soros: Well, I have very high regard for Hillary Clinton, but I think Obama has the charisma and the vision to radically reorient America in the world. And that is what we need because Iâ€™m afraid we have gotten off the right track and we need to have a greater discontinuity than Hillary Clinton would bring.
You have no concern that he lacks the experience to lead in this dangerous time that we live in?
I think that he has shown himself to be a really unusual person. And I think this emphasis on experience is way overdone because he will have exactly the same advisers available as Hillary Clinton, and it will be a matter of judgment whom he chooses. And actually, he is more likely to bring in new blood, which is what we need.
What of your book and the philosophy that comes of it?
When it comes to currencies, no currency system is perfect. So you have to recognize that all of our constructions are imperfect. We have to improve them. But just because something is imperfect, the opposite is not perfect. So because of the failures of socialism, communism, we have come to believe in market fundamentalism, that markets are perfect; everything will be taken care of by markets. And markets are not perfect. And this time we have to recognize that, because we are facing a very serious economic disruption.Â Now, we should not go back to a very highly regulated economy because the regulators are imperfect. You need authorities that keep the market under scrutiny and some degree of control. Thatâ€™s the message that Iâ€™m trying to get across.
From The New York Review of Books