Monday, June 18, 2012

Soros on Europe


"Best thing ever written on the Euro crisis"

"Brilliant ... a dynamo"

That, and more, are the phrases being flung about for a speech given by George Soros at the Festival of Economics, Trento Italy. You can read the speech here and it really is a remarkable piece of analysis.

Points I could gather (but you really should read the speech on your own and draw conclusions):

  • Economics is a social science; modelling it on Physics is a waste. Current economic theory ignores participants
  • Economics tried to make up for this by using an axiomatic approach. Upto a point it worked, but current theories are far removed from it.
  • Quote: "I am not well qualified to criticize the theory of rational expectations and the efficient market hypothesis because as a market participant I considered them so unrealistic that I never bothered to study them." (And this is the stuff churned out in countless MBA colleges as gospel)
  • Different approach: Relation between participants and situations. First, people seek to understand the situation and second, to impact it. When both are working together, they form a feedback loop (reflexivity). Together, it ensures that "people's interpretation of reality never quite corresponds to reality itself".
  • His model is boom-bust process or bubbles which are built into the markets and not the result of outside influence. As per above theory, there is an underlying trend, but people misinterpret it, leading to bubbles. Develops slowly but bursts fast because of leverage.
  • Financial markets tend equally to bubbles as to equilibrium. Bubbles lead to crises lead to regulation; all the while in a reflexive loop.
  • TA, DA! - The European Union is a bubble. Read again, not the Euro, not the Euro crisis, but The Union, as a political entity is a bubble. Euro crisis is a result of this bubble. 
  • Goes on to describe the boom phase - ideal of a unified, democratic, equal Europe, to be achieved via piecemeal social engineering (solve one problem, confronted by another, solve that and go on and on), led by Germany and German sacrifices.
  • Indirectly hints at the exact moment in time when Euro crisis really started - When Angela Merkel said that guarantees to financial institutions should come from individual countries and not Europe. Ideal of a united Europe was lost there.
  • Main problem of Europe - monetary union without political union, which was believed to be surmountable. But now it is known that even bigger problem was that states simply couldn't print money (in effect, members did not have control over money supply). When crisis came, Europe was simply divided between debtor and creditor states.
  • Debtors countries were like third-world countries (like in Asian crisis) having issued bonds in a currency it did not control (effectively of the creditor countries)
  • When markets finally realized that those countries could default, risk premiums rose and now banks hold bonds which are already defaulting, or about to.
  • Two major components of crisis - Sovereign Debt crisis (mainly Greece) and Banking crisis (rest of Europe)
  • Creditor countries equally, if not more to blame for flawed policies
  • All countries tried to buy time, usually it works, this time failed because of political disintegration of the European Bubble mentioned above. 
  • Some more technical stuff that you really should read about how this break-up will actually come about
  • In his opinion, authorities have 3-months time to reverse current trends. Oh, and authorities = Germany
  • Possible solutions and ways out...
  • Orderly breakup of Euro possible
We don't even begin to think like this...Fantastic.