The New Paradigm for Financial Markets

The Credit Crisis of 2008 and What It Means

by George Soros

Number of pages: 208

BBB Library: Economics and Investment, Technology and Globalization

ISBN: 978-1586486839

About the Author

George Soros is a global financier and founder of a network of foundations that promote the creation of open and democratic societies based upon the rule of law, market economies, transparent and accountable governance, and respect for human rights. He emigrated in 1947 from Hungary to England, and worked as a restaurant waiter. Then, he graduated in 1952 from the London School of Economics and obtained a position with an investment bank. In 1956, Soros immigrated to the United States. He worked as a trader and analyst until 1963. During this period, Soros adapted Popper's ideas to develop his own "theory of reflexivity," a set of ideas that seeks to explain the relationship between thought and reality, which he used to predict among other things, the emergence of financial bubbles. In 1973, he set up a private investment firm that eventually evolved into the Quantum Fund, one of the first hedge funds, through which he accumulated a vast fortune.

Editorial Review

In the midst of the most serious financial upheaval since the Great Depression, legendary financier George Soros explores the origins of the crisis and its implications for the future. Soros, whose breadth of experience in financial markets is unrivaled, places the current crisis in the context of decades of study of how individuals and institutions handle the boom and bust cycles that now dominate global economic activity. “This is the worst financial crisis since the 1930s,” writes Soros in characterizing the scale of financial distress spreading across Wall Street and other financial centers around the world. In a concise essay that combines practical insight with philosophical depth, Soros makes an invaluable contribution to our understanding of the great credit crisis and its implications for our nation and the world.

Book Reviews

"The book proved popular with other investors. Paul Tudor Jones II writes: “When I enter the inevitable losing streak that befalls every investor, I pick up The Alchemy and revisit Mr. Soros’s campaigns.” But many professional economists, who tend to take a more sanguine view of financial markets, dismissed it out of hand. Writing in The New Republic, MIT’s Robert Solow, one of the most respected macroeconomists of the twentieth century, doubted that Soros understood “simultaneous” equations, i.e., systems of equations that involve more than one dependent variable. (For those unfamiliar with economics, this was a bit like accusing a carpenter of not knowing how to use a chisel."- The New York Review Of Books.

"CRISIS breeds opportunity, as the bottom-fishers starting to circle beaten-up mortgage bonds and leveraged loans can attest. For George Soros it offers a chance of a different sort: to revive his favourite intellectual theory." - The Economist

"Soros’ message for citizens, investors, politicians and regulators is to approach this new economy and new political order with humility. Be flexible and never dogmatic. Strive to find truth while realizing it’s unattainable. It’s false certainty that trips us up, in both investing and life."- Forbes

Books on Related Topics

Wisdom to Share

We are in the midst of the worst financial crisis since the 1930s.

The currently prevailing paradigm, namely that financial markets tend towards equilibrium, is both false and misleading.

To understand what is going on we need a new paradigm.

Our understanding of the world is inherently imperfect because we are part of the world and we seek to understand.

The past may be uniquely determined, but the future is contingent on the participants' decisions.

In reflexive situations each function deprives the other of the independent variable which it would need to produce determinate results.

In the realm of natural phenomena, events occur independently of what anybody thinks; therefore, natural science can explain and predict the course of events with reasonable certainty.

Reflexivity will be particularly useful, as we shall see, in understanding the behavior of financial markets.

Misinterpretations of reality and other kinds of misconceptions play a much bigger role in determining the course of events than generally recognized.

The current financial crisis will serve as a persuasive example.

In the stock market, people buy and sell stocks in anticipation of future stock prices, but those prices are contingent on the investors’ expectations, not his knowledge.

In the absence of knowledge, participants must introduce an element of judgment or bias into their decision making.

Economic theory has excluded reflexivity from its subject matter.

Social events have a different structure from natural phenomena.

In natural phenomena there is a causal chain that links one set of facts directly with the next.

In human affairs the course of events is more complicated.

There is a two-way connection between the facts and opinions prevailing at any moment in time. On the one hand participants seek to understand the situation.. On the other hand, they seek to influence the situation.

People are participants, not just ob¬servers, and the knowledge they can acquire is not sufficient to guide them in their actions.

They cannot base their deci¬sions on knowledge alone.

fallibility is a more com¬prehensive condition, and reflexivity is a special case.

People's understanding is inherently imperfect because they are part of reality and a part cannot fully comprehend the whole.

The human brain cannot grasp reality directly; only through the information it derives from it.

The capacity of the human brain to process information is limited, whereas the amount of information that needs to be processed is practi¬cally infinite.

The mind is obliged to reduce the available in¬formation to manageable proportions by using various techniques such as: generalizations, similes, metaphors, habits, rituals, and other routines.

Gaining knowledge requires a separation between thoughts and their objects because facts must be independent of the statements that refer to them.

The human mind has worked wonders in trying to reach that position, but in the end it cannot fully overcome the fact that it is part of the situation it seeks to comprehend.

Cognitive science has made great progress in explaining how the human brain functions.

Consciousness is a relatively recent addition to the human brain, while reason and emotion are inseparable. These features are reflected in the lan¬guage we use.

Ideas expressed in ordinary language do not represent the underlying reality.

There’s a distinction be¬tween thinking and reality; what I wanted to say is that thinking is part of reality.

Once we distinguish between objective and subjective as¬pects we must also distinguish between reflexive processes and reflexive statements.

In the case of reflexive processes the indeterminacy is in¬troduced by a lack of correspondence between the objective and subjective aspects of a situation.

Reflexivity is best demonstrated and studied in the financial markets because financial markets are supposed to be governed by such laws.

Unfortunately, what is desirable is not attainable; the ultimate truth is be¬yond the reach of the human intellect.

Fallibility and reflexivity are difficult ideas to accept and to work with.

The period since the Enlightenment constitutes an exception. The faith in reason temporarily eclipsed religion.

Science cannot disprove religious or secular ideologies because it is in the nature of such ideologies that they are not subject to falsification.

Economic theory seeks to imitate the natural sciences.