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George Soros: We Are Just Entering "Act 2" Of The Crisis

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June 14, 2010 – Comments (11)

This is a very good talk given by Soros, and the transcript is provided in the link below. I have excerpted a few passages with some comments. Please read the whole thing, it really is worth your time. (Thanks for finding Tasty!)

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George Soros: We Are Just Entering "Act 2" Of The Crisis, And We're Totally Screwed
Henry Blodget | Jun. 13, 2010, 9:41 PM

http://www.businessinsider.com/george-soros-we-are-just-entering-act-2-of-the-crisis-and-were-totally-screwed-2010-6

[excerpt]

George Soros recently gave a speech at a conference in Vienna. Here's a transcript, courtesy of Australia's The Age.  We've highlighted the important bits.

In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 — global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counterparties.

As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short term the exact opposite of what was needed in the long term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.

This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.

The first phase of the maneuver has been successfully accomplished — a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.

Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.


[My comment: This is what many of us have been saying. I understand there are doubters to this statement, and people who call us Chicken Little for making such pronouncements, but I believe these concerns are well-founded]

It is important to realize that the crisis in which we find ourselves is not just a market failure but also a regulatory failure, and even more importantly, a failure of the prevailing dogma about financial markets. I have in mind the Efficient Market Hypothesis and Rational Expectation Theory. These economic theories guided, or more exactly misguided, both the regulators and the financial engineers who designed the derivatives and other synthetic financial instruments and quantitative risk management systems which have played such an important part in the collapse. To gain a proper understanding of the current situation and how we got to where we are, we need to go back to basics and re-examine the foundation of economic theory.

[My comment: This is a very important and relevant paragraph. EMH is demonstrably false, because it presumes that the market is always progressing or regressing back to some stable mean. The point about modern economic theory assuming stability is that it is a *flawed assumption*. I think engineers would make better economists than economists. Of Modeling, Risk, Financial Innovation, and Liquidity Crises - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=344745. We need to understand economics and finance from the ground up, why it breaks, and why this is a *feature of the current system*, not just some infrequent and random by product: Maturity transformation considered harmful: an unauthorized biography of the bank crisis - http://unqualified-reservations.blogspot.com/2008/09/maturity-transformation-considered.html. And while this is the base problem, it is amplified by financial and monetary policy, such that risks become truly systemic]

..... Large portion of the article (please read, it is very good) ......

It is clear that the reforms currently under consideration do not fully satisfy the five points I have made, but I want to emphasize that these five points apply only in the long run. As Mervyn King explained, the authorities had to do in the short run the exact opposite of what was required in the long run. And as I said earlier, the financial crisis is far from over. We have just ended Act II. The euro has taken center stage, and Germany has become the lead actor. The European authorities face a daunting task: they must help the countries that have fallen far behind the Maastricht criteria to regain their equilibrium while they must also correct the deficiencies of the Maastricht Treaty which have allowed the imbalances to develop. The euro is in what I call a far-from-equilibrium situation.

11 Comments – Post Your Own

#1) On June 14, 2010 at 10:37 AM, outoffocus (22.35) wrote:

Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.

I think the part that Keynes failed to take into account and inform his followers of, is when times are good, that is the time use the good times to save for the bad.  While times were "good" in the last decade, governments on all levels were running massive deficits, leaving no room to run up deficits during the bad times. 

Its a situation many Americans find themselves in now.  I actually read a Business Week article in 2008 that used the Bible story in the Old Testament of, I think it was Joseph, who had the dream of the 7 fat cows and the 7 skinny cows.  He was warning the king of 7 year famine.  They key was to store up food during the good years so that the kingdom could survive the bad years.  We as Americans did the exact opposite. Instead of paying off our debts during the "good years" we ran up more debt.  Now that we are going through the "famine", we have no more credit to use and are forced to pay our debts with less money.

This is why the Keynesian policies are failing.  Deficits wouldn't matter if we had run surpluses in the good times.  In all things economic there must be a balance. Yea we avoided one tragedy but we set ourselves up for another by simply being foolish.  And no good can come from solving foolishness with more foolishness.

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#2) On June 14, 2010 at 10:51 AM, binve (< 20) wrote:

outoffocus ,

>>While times were "good" in the last decade, governments on all levels were running massive deficits, leaving no room to run up deficits during the bad times. 

Exactly. And while I am not advocating for a gold standard per se, I am very interested in the Austrian economic and monetary policy and think it is far more of a sustainable proposal (i.e. preserves the value of the currency while maintaining economic stablity). Because everything I read about it shows that it is built on sound principles (or at the very least, much more sound than the system that we have now). This is why I find the arguments against the gold standard to be the most perplexing. The detractors always point out that we had booms and busts on the gold standard too. But they are missing the point that the failure is not of monetary policy, but it was economic policy. You can run up defecits on a gold standard (you get credit from outside the country), but you are not allowed to monetize it. So if congress and the Treasury are profligate, you will have booms and busts. Moreover, no system will ever prevent speculation. There needs a much more focused economic policy at the top levels of government. But since that goes against the intrest of powerful lobbies, that will never happen.

But getting back to my point, a fiat monetary system allows you defecit spend *and* monetize the debt, which hides problems during good years, and exascerbates them during bad years. And since we have reached Debt Satruation (as I have discussed in the past), we will have a lot of bad years ahead of us.

>>This is why the Keynesian policies are failing.  Deficits wouldn't matter if we had run surpluses in the good times.  In all things economic there must be a balance. Yea we avoided one tragedy but we set ourselves up for another by simply being foolish.  And no good can come from solving foolishness with more foolishness.

Amen to that sister. Thanks for the comment!..

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#3) On June 14, 2010 at 11:13 AM, portefeuille (99.66) wrote:

'We have just entered Act II of the drama'

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#4) On June 14, 2010 at 12:30 PM, kstarich (30.34) wrote:

Binve

On October 26, 2009 George Soros in Budapest gives a speech and says "International co-operation on regulatory reform is almost impossible to achieve on a peace meal basis, but it may be attainable in a grand bargain where the entire financial order is rearranged"

This statement is so key because that day in Astrology was huge in terms of the future.  I call it my harbinger day of things to come with regard to the wealth of the nation it's holdings and GOLD!

 Obama also proposed the new finance bill on that day that would give the gov. power to dismantle the financial industry.  http:/infowars.com/proposed-obama-bill-would-give-government-power-to-dismantle-financial-industry/

I would like to hear your comments on this.  Looking at coming events August is the month the whole Dubai, Greece, banking coo comes unraveled.  I plan on writing a complete blog on this real soon...it is a major "Watch Out"

Regards,

kstar

 

 

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#5) On June 14, 2010 at 1:16 PM, binve (< 20) wrote:

kstarich,

Hey kstar!

>>On October 26, 2009 George Soros in Budapest gives a speech and says "International co-operation on regulatory reform is almost impossible to achieve on a peace meal basis, but it may be attainable in a grand bargain where the entire financial order is rearranged"

I agree. The financial system is broken, and the economy that is built on top of it is deeply flawed. And the government has transferred all the risk from the last crisis onto its balance sheet, which makes the next crisis a sovereign debt crisis. But it's purpose (in the "grander" scheme) will be to purge excesses and to cause a major change in consciousness in how the public views debt, the economy, the role of financials in that economy, etc. This is why I am bearish for the near and intermediate term, but hugely optimistic for the long term: Why I hold Gold: Why I am a Long Term Optimist and consider holding gold and Optimistic Endeavor, and Why I think the Stagflationary Scenario is more likely Macroeconomically in the Intermediate term (next several years) - http://caps.fool.com/Blogs/why-i-hold-gold-why-i-am-a/402614

The other role of the crisis will be to purge and reset. The current trend of piling debt on top of debt is unsustainable: Debt Saturation - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=357428. And neo-economists and politicians have to get their collective heads out of their collective asses and not allow a vampire industry (financials) hijack the real economy. But since that won't happen willingly, then the market will force a crisis that will fundamentally change how we view politics and the economy. Crony capitalism will go away. Good laws like Glass-Steagall will become reinstated. Too big to fail will be abolished. Grass roots companies will grow like a new forest. The Mittelstand companies of Germany (small/medium firms, mostly family owned) is exactly the economic model that most of the western world should be following, and I believe will in the future.

So that is where I am coming from and where I see things heading.

Thanks kstar!..

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#6) On June 14, 2010 at 2:40 PM, Tastylunch (29.40) wrote:

ah cool you already posted it!

Yeah when Soros speaks I listen. Dude is pretty smart, extremely accomplished investor, and macro is his thing.

May be the most savvy Macro guy out there who talks his book (for better or for worse).

There are other worthwhile macro commentators out there, but none I'm aware of, come anywhere close to his returns...

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#7) On June 14, 2010 at 2:40 PM, kstarich (30.34) wrote:

Binve

ok.  Watch for my blog about August upcoming events.  I will lay it out as I see it and you let me know what it means in the financial world.  There is a big yank coming and I am trying to connect the dots to see what the Fed is going to do.  I do see inflation coming in the US chart and i am going to write about that too.

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#8) On June 14, 2010 at 2:58 PM, Gemini846 (45.99) wrote:

This was a good read, and your comments are likewise good. I never thought to put the words Keynes and Surplus togeather.

The City of Tampa is an interesting case study. During the boom, the Mayor froze spending at 2001 levels despite tax revenue soaring. When the property values bottomed they began to run a slight deficit, however they aren't looking to cut libraries, schools, et et like other municipalities in the Tampa Bay area.

I don't live in Tampa, nor do I agree with the Mayor's social agenda, however her Fiscal policy is to be modeled.

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#9) On June 14, 2010 at 3:55 PM, binve (< 20) wrote:

Tastylunch ,

Yep, I couldn't restrain myself :)

>>Yeah when Soros speaks I listen. Dude is pretty smart, extremely accomplished investor, and macro is his thing.

I completely agree. Thanks man!

kstarich ,

>>Watch for my blog about August upcoming events.  I will lay it out as I see it and you let me know what it means in the financial world.

Definitely! looking forward to it!!

Gemini846,

>>This was a good read, and your comments are likewise good. I never thought to put the words Keynes and Surplus togeather.

Thanks! Exactly, If we saved at the government level and were encouraged to save when times were good at the private level through appropriate monetary policy decisions, we would have a cushion to weather the downturns. But everybody forgets about downturns and crashes and hard times as soon as we pass by one. Oh well.

>>I don't live in Tampa, nor do I agree with the Mayor's social agenda, however her Fiscal policy is to be modeled.

Agreed! Thanks!..

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#10) On June 18, 2010 at 11:46 AM, 4everlost (29.62) wrote:

Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets.
Doesn't that statement seem paradoxical to anyone in Fooldom?  Maybe it means that Keynes missed some of the unintended consequences of that line of thinking.

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#11) On June 18, 2010 at 12:20 PM, binve (< 20) wrote:

4everlost ,

>>Maybe it means that Keynes missed some of the unintended consequences of that line of thinking.

Exactly :)..

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