Being considered one of the most intelligent speculators in the world, anyone would be interested in what George Soros says about finance, investment and global economic issues. In the recent interview with the Wall Street Journal, he comments on a variety of things that we should note.
Soros said once 40% of the total corporation profits would be coming from financial sectors; that was an excessive figure and of course not sustainable for long. George Soros mentioned that there used to be the “Security Analysis” of Graham and Dodd, which said the share price was supposed to reflect the underlying discounted earning power of the company. But people who were running hedge funds only care about the moving up or down of the stock prices, not the earnings. He believes prices depend on how people perceive the market. That was why they all were trying to guess how the market would behave in the future. It reminded him of Keynes' example of the “beauty contest.” A beauty contest is trying to judge how other people were going to judge the beauty.
When asked about Graham and Dodd’s buy-and-hold value investment strategy, he said that when he first saw a bubble, the first thing he would do was a buy, because if he was right, and the bubble developed, he would make a lot of money. And if he saw the flowing of the bubble, he would be very happy.
He advised people that we couldn’t get the timing right. And he lost a lot of money in the IT boom market because he shorted it too soon. He shouldn’t be shorting in the rising market but should wait for the market to fall. At the time when the IT bubble began to form, the “fake” Amazon drop of 20% made him short but right after that when it was going to a new high, he had to cover. “So the fact that the market was unpredictable doesn’t mean that you can predict it,” he said.
Soros insisted on the need of the regulators in the market place. He believes that when Alan Greenspan talked about “irrational exuberance,” it was wrong because it was not “irrational,” it was “rational exuberance.” We cannot restrict people from joining the bubble, but we could expect people to join it. Then, when everybody joins it, it comes to an end.
So we would need an outside force to prevent it from going too far to avoid significant damage. Nevertheless, regulators might stop a “bubble” that didn’t exist. They would be wrong sometimes. And they have to recognize the fact that they were going to be wrong. They would interfere as little as possible but they had to interfere. And the first thing that comes to their minds is to control the Money Supply (MS). The theory is that when we control the MS, the market will take care of itself. But it is false. People should realize that the market has moods, and the regulators should control both credit conditions as well as the MS, so that when the market has exuberance, the regulators raise the capital requirement, the margin requirement, etc., to counteract it.
We certainly couldn’t prevent the bubble from forming, but we can prevent it from getting too big until it becomes self-reinforcing. In the old days, when Soros was young, the central banks sometimes sent out letters to all the banks and they might make recommendations, such as, “Do not lend on real estate, it is getting overheated; do not let your real estate portfolio grow...” And those actions were exactly what the market needed to prevent the wrongdoing and the bubble from getting bigger.
On choosing which currency to park, Soros said it was difficult to see the alternative to the dollar at the moment. If the Chinese allowed their currency to be convertible in the capital account, the renminbi would be a very, very attractive currency, but they didn’t, and because of that, it is not the international currency. Another fact is that China owns $2 trillion of reserves, the majority of it in U.S. dollars, and we can see they are not very happy about it. So China is seeking a way to diversify their currencies into real assets, such as oil and commodities. The recent strength in oil and commodities largely resulted from the Chinese buying.
The economy is out of the recession, but not sure to have a rosy future right away, as the U.S. has 25 years of excess to work off. We couldn’t see the kind of growth that we had for the past 25 years. And remember there is always uncertainty, but that element is left out by financial engineers, who are good at understanding risks. But they forgot about the uncertainty. The range of uncertainty was also uncertain. Right now in the current market condition, it is not the time for us to have firm conviction about anything; it was much more balanced in the narrow range than in the period of 2008-2009, while the market had been subjected to a much boarder range of uncertainty.
Psychologically, the reality could be manipulated. However, the outcome might not correspond to our expectations. So we would still need to understand the reality. There was reality that was beyond our ability to manipulate it. Soros introduced the book named “Animal Spirit” written by Robert Shiller and George Akerlof, where it talked about confidence multiplier. If we could rebuild confidence, the market would rebuild itself, and after confidence was restored, investors would go buy bank shares so the banks could be recapitalized and that changed the fundamentals.
In other words, perception can change the fundamentals but reality has to fulfill the expectations, otherwise we would be very disappointed. So we have to respect the reality beyond our ability to influence it. People often think that the reality is out there, and his is to separate so we can look at reality to acquire knowledge. Reality is independent of the way we look at it. But in social science, it is not always that way. That is what Soros mentioned in many of his books and writings, "reflexivity theory." On one hand, we are trying to understand the reality and on the other hand, we can also influence it. So there are two ways of interaction, a feedback between understanding the reality and what happens in the world.
The last note was a bank recap. Soros stressed that it is a bad idea to nationalize the banks. The Treasury should be the underwriter, not the one who actually puts the money into the banks, but be willing to put it in if the shareholders don't. There is the internal separation of old banks and new banks, as some banks were heavily loaded with bad assets, and the injection should be into the new banks. The old capital should be taking care of the old assets. Soros said he would be very happy to put all his capital into the new bank.
Soros said once 40% of the total corporation profits would be coming from financial sectors; that was an excessive figure and of course not sustainable for long. George Soros mentioned that there used to be the “Security Analysis” of Graham and Dodd, which said the share price was supposed to reflect the underlying discounted earning power of the company. But people who were running hedge funds only care about the moving up or down of the stock prices, not the earnings. He believes prices depend on how people perceive the market. That was why they all were trying to guess how the market would behave in the future. It reminded him of Keynes' example of the “beauty contest.” A beauty contest is trying to judge how other people were going to judge the beauty.
When asked about Graham and Dodd’s buy-and-hold value investment strategy, he said that when he first saw a bubble, the first thing he would do was a buy, because if he was right, and the bubble developed, he would make a lot of money. And if he saw the flowing of the bubble, he would be very happy.
He advised people that we couldn’t get the timing right. And he lost a lot of money in the IT boom market because he shorted it too soon. He shouldn’t be shorting in the rising market but should wait for the market to fall. At the time when the IT bubble began to form, the “fake” Amazon drop of 20% made him short but right after that when it was going to a new high, he had to cover. “So the fact that the market was unpredictable doesn’t mean that you can predict it,” he said.
Soros insisted on the need of the regulators in the market place. He believes that when Alan Greenspan talked about “irrational exuberance,” it was wrong because it was not “irrational,” it was “rational exuberance.” We cannot restrict people from joining the bubble, but we could expect people to join it. Then, when everybody joins it, it comes to an end.
So we would need an outside force to prevent it from going too far to avoid significant damage. Nevertheless, regulators might stop a “bubble” that didn’t exist. They would be wrong sometimes. And they have to recognize the fact that they were going to be wrong. They would interfere as little as possible but they had to interfere. And the first thing that comes to their minds is to control the Money Supply (MS). The theory is that when we control the MS, the market will take care of itself. But it is false. People should realize that the market has moods, and the regulators should control both credit conditions as well as the MS, so that when the market has exuberance, the regulators raise the capital requirement, the margin requirement, etc., to counteract it.
We certainly couldn’t prevent the bubble from forming, but we can prevent it from getting too big until it becomes self-reinforcing. In the old days, when Soros was young, the central banks sometimes sent out letters to all the banks and they might make recommendations, such as, “Do not lend on real estate, it is getting overheated; do not let your real estate portfolio grow...” And those actions were exactly what the market needed to prevent the wrongdoing and the bubble from getting bigger.
On choosing which currency to park, Soros said it was difficult to see the alternative to the dollar at the moment. If the Chinese allowed their currency to be convertible in the capital account, the renminbi would be a very, very attractive currency, but they didn’t, and because of that, it is not the international currency. Another fact is that China owns $2 trillion of reserves, the majority of it in U.S. dollars, and we can see they are not very happy about it. So China is seeking a way to diversify their currencies into real assets, such as oil and commodities. The recent strength in oil and commodities largely resulted from the Chinese buying.
The economy is out of the recession, but not sure to have a rosy future right away, as the U.S. has 25 years of excess to work off. We couldn’t see the kind of growth that we had for the past 25 years. And remember there is always uncertainty, but that element is left out by financial engineers, who are good at understanding risks. But they forgot about the uncertainty. The range of uncertainty was also uncertain. Right now in the current market condition, it is not the time for us to have firm conviction about anything; it was much more balanced in the narrow range than in the period of 2008-2009, while the market had been subjected to a much boarder range of uncertainty.
Psychologically, the reality could be manipulated. However, the outcome might not correspond to our expectations. So we would still need to understand the reality. There was reality that was beyond our ability to manipulate it. Soros introduced the book named “Animal Spirit” written by Robert Shiller and George Akerlof, where it talked about confidence multiplier. If we could rebuild confidence, the market would rebuild itself, and after confidence was restored, investors would go buy bank shares so the banks could be recapitalized and that changed the fundamentals.
In other words, perception can change the fundamentals but reality has to fulfill the expectations, otherwise we would be very disappointed. So we have to respect the reality beyond our ability to influence it. People often think that the reality is out there, and his is to separate so we can look at reality to acquire knowledge. Reality is independent of the way we look at it. But in social science, it is not always that way. That is what Soros mentioned in many of his books and writings, "reflexivity theory." On one hand, we are trying to understand the reality and on the other hand, we can also influence it. So there are two ways of interaction, a feedback between understanding the reality and what happens in the world.
The last note was a bank recap. Soros stressed that it is a bad idea to nationalize the banks. The Treasury should be the underwriter, not the one who actually puts the money into the banks, but be willing to put it in if the shareholders don't. There is the internal separation of old banks and new banks, as some banks were heavily loaded with bad assets, and the injection should be into the new banks. The old capital should be taking care of the old assets. Soros said he would be very happy to put all his capital into the new bank.
