Book: A man unmoved by markets

The Crisis of Global Capitalism by George Soros Little, Brown pounds 17.99
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The Independent Culture
George Soros is the man who notoriously made a billion pounds at the Bank of England's expense by betting that sterling would not be able to remain within the European Exchange Rate Mechanism in 1992. More recently he has been denounced by Prime Minister Mahathir of Malaysia for having destabilised the Malaysian currency. And when he wrote a letter to the Financial Times saying that the rouble should be devalued, it duly fell through the floor. Although he doesn't always win his bets, his Quantum Fund has been one of the biggest players on world financial markets for more than 20 years and has made Soros a very rich man.

He is an unusual super-rich speculator/investor. He is a philanthropist on a grand international scale; he is deeply interested in politics, but in a liberal undogmatic, centrist way (nothing could be further from the paranoid anti-interventionist political philosophy of the archetypical self-made billionaire such as James Goldsmith); and he believes that the financial markets through which he has made his fortune are fundamentally flawed and need to be reformed.

He sees the main threat to the "Open Society" - by which he means a free, pluralistic democracy, fallible but with the capacity to learn from its mistakes - which in the Cold War came from the totalitarianism of the communist regimes, now coming from an opposite ideology: the dogmatic antagonism to any form of intervention, regulation or control. He is concerned that the rise in the laissez faire doctrines espoused particularly by Reagan and Thatcher (which he wants to re-christen market fundamentalism on the reasonable ground that very few adherents of the doctrine can speak French) has led to dangerously destabilising international flows of capital.

Soros has two main criticisms of market fundamentalism. Both are important and, in my view, correct, though he is not as lonely in holding them as he seems to think. First that economic developments are "reflexive", by which he means that apparently objective facts and predictions are influenced by those who observe and participate in them: if enough people think something is worth investing in, it will prove to be so - at least for a time. And secondly, that markets (even in the famous ideal conditions of perfect markets and perfect information) never reach equilibrium, indeed can often be deeply destabilising, and that to analyse them and their alleged (beneficial) effects in terms of an ideal equilibrium state of affairs brought about by the "invisible hand" is wrong and dangerous.

Markets need regulation and control. Domestically, through a long and painful learning process, the framework for a properly functioning capitalism has been built up. For enterprises, the concept of limited liability and the evolution of bankruptcy law were fundamental. For banking, central banks have had to learn how to exercise control - not so that there are no failures or even no crises - but so that financial failures and crises do not plunge the real economy into catastrophe. The essence of the approach is to be as punitive as necessary on the management and shareholders of individual banks, while always being aware of the wider dangers of financial contagion and prepared to provide as much liquidity to the system as necessary. The last big lesson was in 1929, when the Federal Reserve turned what would have been a painful but necessary correction into a full-blown collapse of the banking system - and hence of the US economy.

Soros sees the prime cause of the Asian crisis precipitated by Thailand in mid 1997, the Russian crisis of last summer and the current fragility of a number of Latin American countries as an unbridled expansion of international capital - he goes so far as to call it "a new global imperialism" - combined with the inability of the international supervisory authorities to act as they would have done in their own domestic markets.

He concedes - how could he not? - that corruption and economic mismanagement in most of the countries concerned played a big part in their subsequent misfortunes. But individual national mistakes are not sufficient to explain what has happened and is continuing to happen. The heart of the matter is that the international banking system lent too much and then withdrew it too quickly.

One solution much canvassed for this problem is greater "transparency": if everyone could see how much was being lent to a particular borrower, they might cool off earlier. Soros gives some support to this approach, pointing out how many of the new, up-to-date ways of advancing capital, such as derivatives, do not appear on the balance sheets of the banks. But desirable as more transparency would be, it wouldn't go far to solve the problem. The Bank of International Settlements publishes quarterly figures of international bank lending and these were already showing highly excessive borrowing by many of the countries concerned months before their balloons went up.

Much more fundamental, both in influencing the behaviour of the banks before the crisis and in making things worse after it had broken, has been the traditionally asymmetric treatment of lenders and borrowers. Soros recognises the difficulties the international authorities face in penalising banks in the aftermath of a sovereign debt crisis: continued support from private banks is always needed for the survival and recovery of the country concerned; there will never be enough official international credit to do the job. And so, as he points out the US banks lost much less as a result of their years of excessive lending to Latin America up to 1982 than they did in the domestic Savings and Loans crisis.

Nevertheless, in the recent crises, the protection of lenders and the lack of arrangements for converting debt to equity have meant that the effects on domestic ownership and operation of businesses have been excessively harsh and will have serious long-term effects. And this has been exacerbated by what Soros plausibly argues was the IMF's misdiagnosis of the crisis. Confronted for perhaps the first time by countries in trouble where the public sector was in pretty good shape and the problem lay in the over- borrowing of the private sector, the traditional remedies of fiscal tightening high interest rates and devaluation were entirely inappropriate. What has been needed is a reconstruction of private balance-sheets in the context of greater, not less, liquidity.

Soros is gloomy about the outlook but appropriately so. He believes we are in a phase of global deflation; but outside continental central banks that is not a very controversial view. He recognises the power of the international authorities, despite all their shortcomings, to prevent ultimate financial catastrophe. He says baldly (and in my view correctly) that they have already saved the system four times - in 1982, 1987, 1994 and 1997. He admits to having been pleasantly surprised by the extent of the recent recovery in stock markets, though he still sees the underlying trend as bearish. But he is acutely aware of all the dangers and lost opportunities - especially in Russia. Moreover, even in the "optimistic" and more likely scenario of a world slowing down but muddling through, he sees the danger of more and more countries opting out of the global market system, "doing a Malaysia", with long-run damage to the liberal trading framework. It is hard to argue against such judicious pessimism, especially when it comes from a man who was able to make more than 100 per cent on his money by shorting the Thai baht.