Financial Markets

Three weeks ago, at a meeting of the Centre for European Policy Studies(CEPS) at the Club de Warande in Brussels, George Soros, the investor, author, philanthropist and political activist, presented his latest book, The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means, containing his views on the current financial crisis, its causes and solutions. I generally agree with his views.

He said:

The crisis emerged with the bursting of the US housing bubble and has its origins in the dominance of the current paradigm of ‘efficient markets’, or so-called market fundamentalism or ideology. In his view, this assumption is incorrect from a philosophy of science standpoint. Market fundamentalism assumes that markets function efficiently, move to the equilibrium, and therefore work in everyone’s best interest. However, contrary to the views of his mentor Karl Popper, Soros argues against the unity of science and considers economics a social science that cannot rely on natural science assumptions. Natural phenomena operate according to the law of cause and effect and humans use their cognitive abilities to understand. Yet, humans do not only observe but play a participative-manipulative role in social science phenomena. In terms of the market, the concept of equilibrium is a natural science theory that does not apply to economics. Specifically, Soros focuses on the concept of reflexivity, where individuals with their perception shape reality and create disequilibrium rather than equilibrium when they enter into market transactions. This leads to uncertainty. The evidence shows that contrary to the statistical assumption of normal distribution, reflexivity leads to ‘thick tails’.

Later:

An international financial regulation agreement, for example a Basel III Accord, would be suitable. He proposes to regulate every aspect of financial market, encompassing capital, derivatives and currency markets.

 Secretary Hank Paulson has laid out similar less encompassing views in the Blueprint for a Modernized Regulatory Structure.

Read the whole CEPS presentation here.