George Soros in the series of those who got it right 10.19.09

Today we look at George Soros, the billionaire investor and philanthropist, who has a view of ever expanding bubbles.  Soros is notable for being rich, yet advocating normalization and structure to financial markets.

I am sometimes -- not so much recently -- asked, "If you're so smart, why aren't you rich."  I point to -- or pointed to -- Soros, replying, "He's rich, why don't you listen to him?"

Soros is famous for purportedly breaking the British Pound for his own enrichment, which earned him opprobrium from both sides along the lines of, "If you're so concerned with social welfare, Mr. Soros, Why did you do such a thing?"  Converted to an assertive statement, it might be, "It's all right to profit if you're greedy, but not if you have concern for others."

Let's begin from Soros most recent book, The New Paradigm for Financial Markets:  The Credit Crisis of 2008 and What It Means."

(p.7)

"... The central idea in my conceptual framework [is] that 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.  Not only facts are involved, but also the participants views and the interplay between them enter into the causal chain.  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 (which includes both facts and opinions); on the other, they seek to influence the situation (which again includes both facts and opinions).  The interplay between the cognitive and manipulative functions intrudes into the causal chain so that the chain does not lead directly from one set of facts to the next, but reflects and affects the participants' views.  Since those views do not correspond to the facts, they introduce an element of uncertainty into the course of events that is absent from natural phenomena.  That element of uncertainty affects both the facts and the participants' views.  Natural phenomena are not necessarily determined by scientific laws of universal validity, but social events are liable to be less so."

It certainly is necessary to address this question of the difference between economics and a natural science.

Robert Skidelsky, Keynes most famous biographer, pointed out that if economics were a natural science it likely would have responded to the mathematical tools employed so enthusiastically on its behalf to produce some significant progress.  Unlike physics or biology, it has not.  Skidelsky notes we are having the same arguments today as were had in the 1930s.  The exact same, down to the level of vitriol between the parties.  He refers to Krugman v. the Chicago School.  Look for that Skidelsky interview on Bloomberg on the Economy with Tom Keene last week.

Here in Soros we see one explanation for the resistance (near complete resistance in the Demand Side view) of economics to the mechanical tools valid for the natural sciences.  Soros calls it reflexivity.

"I explain the element of uncertainty inherent in social events by relying on the correspondence theory of truth and the concept of reflexivity....

Knowledge is represented by true statements.  A statement is true if and only if it corresponds to the facts.  That is what the correspondence theory of truth  tells us.  To establish a correspondence, the facts and the statements which refer to them must be independent of each other.  It is this requirement that cannot be fulfilled when we are part of the world we seek to understand."

(p.8)

Demand Side has repeatedly referred to no independent variables within the mathematics, no closed system, hence no fulcrum from which to lever the hypothetical world.  If all variables in the model are dependent upon each other, and indeed can morph into each other, there is no causal chain that mathematics can produce.  It becomes radically dependent on its assumptions.

Soros is talking in a different sphere, although he describes a similar recognition he had in his early years at the London School of Economics, where assumptions were allowed in economic theory to:

"produce universally valid generalizations that were comparable to those of Isaac Newton in physics."

As economics was forced to abandon one assumption, it replaced with others until,

"The assumptions became increasingly convoluted and gave rise to an imaginary world that reflected only some aspects of reality, but not others.  That was the world of mathematical models describing a putative market equilibrium.  I was more interested in the real world than in mathematical models, and that is what led me to develop the concept of reflexivity."

...

"I contend that rational expectations theory totally misinterprets how financial markets operate.  Although rational expectations theory is no longer taken seriously outside academic circles, the idea that financial markets are self-correcting and tend toward equilibrium remains the prevailing paradigm on which the various synthetic instruments and valuation models which have come to play such a dominant role in financial markets are based.  I contend that the prevailing paradigm is false and urgently needs to be replaced.

"The fact is that participants cannot base their decisions on knowledge.  The two-way, reflexive connection between the cognitive and manipulative functions introduces an element of uncertainty or indeterminacy into both functions.  That applies both to market participants and to the financial authorities who are in charge of macroeconomic policy and are supposed to supervise and regulate markets.  The members of both groups act on the basis of an imperfect understanding of the situation in which they participate.  The element of uncertainty inherent in the two-way reflexive connection ... cannot e eliminated, but our understanding, and our ability to cope with the situation, would be greatly improved if we recognized this fact."

Soros by his own admission desperately wants to be taken seriously as a philosopher.  He should be.  His conceptual framework brings forward the problem of understanding the world in which we exist by way of concepts that are necessarily symbols or shortcuts to reducing the mass of phenomena to a manipulable scale.  I would say that the exercise leaves us relating to something that is really our own projection.

Graduating from LSE with grades too poor to gain him entry into Academia, he finally hooked on as an arbitrage trader.  Soros interest in reflexivity and fallibility equipped him to handle the states of nonequilibrium, boom and bust, well enough to make one fortune after another.

And indeed, markets proved to be the perfect application of reflexivity, as market players create boom and bust by their participation, not their comprehension.  Perception created reality, a reality that folded back on non-market participants in often harmful ways.

Thinking about thinking and conceptual frameworks which try to define concepts are inherently subject to contradiction.  So when Soros assumes an objective aspect of reality, it may become more useful, but less accurate, just as his theory predicts.  Everyday events are predictable and reflexive processes are not, he says.  But it would seem that reflexivity can provide momentum in stability as well as instability. 

We'll leave Soros here, well short of full development, with the note that his assessments of markets and economic dynamics when he is making his calls is often simple and often intuitive, but what he does show in his practical looks adheres broadly to demand side functionalities.

We also note for the benefit of those who have complete confidence in their economic schemes, but view forecasts as a crap shoot, that Soros passes on the observation from Popper,

"Predictions and explanations are symmetrical and reversible."