Wednesday, January 23, 2008

Worst market crisis? - Comments on Soros

George Soros provided a doomsday editorial in the Financial Times this morning. He makes a number of good focused comments, but his overall thesis is not different than many other commentators and it is filled with his own biases.

http://www.ft.com/cms/s/0/24f73610-c91e-11dc-9807-000077b07658.html.
It is nevertheless important to understand what a key market investor is thinking about the crisis and markets in general.

Soros is not a believer in the fundamentalist view that markets will move to equilibrium. He argues that it was only through the intervention of government that markets were saved from a meltdown. This is a simplistic view of the crisis. Government was needed to provide liquidity at key points in this crisis, but it may have been the government that got us into this mess in the first place. The government provided cheap funds before the crisis began and it was the government which promoted higher home ownership through mortgage innovation. They are also responsible for this mess.

“Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves.”

Soros then argues that the Greenspan put made bubbles more likely which is contradictory with the idea that central banks prevented the breakdown. He then comments on lax regulation.

“The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.”

It is not clear what regulation was lessened that allowed for this bubble. Clearly, more information for consumers is necessary as financial products became more complex but most of the losses have been with sophisticated investors who should have known what were the risks with structured products regardless of the ratings.

His conclusions for what will happen are unsupported with any facts.

“So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.”

What does it mean that there is less likely to be a global recession but a realignment of the global economy? The realignment is going to happen because China and other countries have had significant growth independent of the global business cycle. This growth issue is independent of the current crisis. It may be sped up but will not be stopped. The US has been “in decline” since the end of WWII because the United States helped the development of other countries around the world starting with Western Europe. Global trade is more disperse, but the United States still has been able to grow its economy and increase overall welfare.

He ends with a doomsday scenario of a plunging world economy which is at odds with his previous statement. “The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.”

Should we worry about protectionism? Yes, but we need to consider the financial market issues first before we tackle trade. Threats of another great depression are unwarranted and just sensational writing.

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