George Soros (Soros Fund Management Founder) – George Soros Lecture Series (Oct 2010)

Chapters

Abstract

Exploring the Interplay of Prediction, Reflexivity, and Market Behavior: Insights from Soros, Popper, and Merton

Engaging the Complex Dynamics of Financial Markets and Human Behavior

In a world where the dynamics of financial markets and human behavior intertwine in complex patterns, understanding the underlying principles governing these interactions becomes crucial. This article delves into the insights of renowned thinkers like George Soros, Karl Popper, and Robert Merton. We explore concepts like reflexivity, self-fulfilling prophecy, and the Oedipus effect, shedding light on how predictions and perceptions shape financial and societal outcomes.

Merton’s Self-Fulfilling Prophecy and Popper’s Oedipus Effect

Robert K. Merton, a sociologist, coined the term “self-fulfilling prophecy,” a phenomenon where a false definition in the beginning evokes a new behavior which makes the original false conception come true. Merton’s example of a bank run caused by a crisis of confidence illustrates how public definitions and predictions can affect subsequent developments, leading to the prophecy’s fulfillment. Merton’s concept emphasizes the unique aspect of human affairs where prophecies or predictions become integral to the situation and influence outcomes, unlike in the natural world.

Karl Popper’s “Oedipus effect” illustrates how predictions can influence the events they predict, a concept that transcends the boundary between social and natural sciences. In his autobiography, Unending Quest, Popper discusses the “Oedipus effect,” emphasizing how a prediction can influence the event predicted. Initially, Popper believed this effect was unique to social sciences, but later acknowledged its existence in molecular biology as well.

Both Merton’s self-fulfilling prophecy and Popper’s Oedipus effect highlight the influence of predictions on the events they predict. Popper’s formulation struck the speaker as particularly insightful. The speaker’s research aims to explore how Mr. Soros’ idea of reflexivity relates to these earlier concepts and how he sees similarities or differences.

Soros’ Theory of Reflexivity

Central to our discussion is George Soros’ theory of reflexivity. Soros, drawing from these foundational ideas, posits that market behavior and human affairs are not just influenced by external realities but also by the perceptions of those realities. He argues that in social sciences, and especially in financial markets, the observer and the observed are interdependent, challenging the traditional economic assumption of market efficiency and rational expectations. This reflexivity has two functions – cognitive, where it helps in understanding, and manipulative, where it influences outcomes, leading to inherent uncertainty in economics.

Soros emphasized the reflexivity of the subject matter itself, rather than just social theories. He recognized the reflexive nature of social phenomena and its pervasive influence on human affairs. Soros drew inspiration from self-reference and the paradox of the liar to understand reflexivity as a cognitive and manipulative phenomenon. He highlighted the interference between cognitive and manipulative functions, creating uncertainty as a characteristic of human affairs.

Soros applied the concept of reflexivity to the behavior of financial markets, where it had a significant impact and allowed him to understand economic notions. He criticized economic theory for attempting to eliminate uncertainty and reflexivity, leading to costly mistakes. Soros’ unique contributions and critique of economic theory have had a profound impact on the understanding of financial markets and human behavior.

The Limitations of Market Efficiency and Rational Expectations

Soros is critical of the conventional wisdom in economics that seeks to eliminate uncertainty. He aligns with Frank Knight’s concept of uncertainty, emphasizing its fundamental role in human affairs. This perspective is highlighted by the oversight of reflexivity in financial formulas, such as those developed by Robert Merton’s son, which earned a Nobel Prize yet failed to account for the reflexivity phenomenon. The irony of Robert Merton’s son’s Nobel Prize highlights the contrasting approaches to understanding economic phenomena.

Popper’s Methods and Historical Study: Soros argues that the methods of natural science, as described by Popper, do not apply to the study of history. Historical processes require different methods because they are one-directional, time-bound, and conditions change and do not repeat themselves.

Social Sciences and Universal Laws: Soros believes that social sciences cannot aim to have universal laws like physics due to the unpredictable nature of human behavior. However, he acknowledges the existence of some statistical generalizations and distinguishes between near equilibrium and far from equilibrium conditions.

Government and Regulatory Challenges in Reflexive Markets

The role of government and regulatory bodies in managing reflexive relationships is complex. Soros points out that these entities, like market participants, are subject to the same limitations of knowledge and foresight. This reality poses significant challenges in effectively regulating markets and financial systems.

Trend Following and Market Fundamentalism Critique

The article also touches upon the strategy of trend following in financial markets, acknowledging its validity due to the persistence of trends, but also noting the potential for sudden reversals when reality diverges from expectations. Soros extends this critique to Adam Smith’s concept of the invisible hand, arguing that markets, while powerful, are limited in addressing social issues and are often influenced by the visible hand of politics.

A trend follower strategy often proves effective as trends can self-validate for extended periods, contradicting efficient market and rational expectations paradigms. However, reality may deviate from expectations, leading to trend reversals, making trend following risky beyond certain points.

Adam Smith’s “invisible hand” theory, often attributed to the idea of market fundamentalism, is criticized for overlooking the need for political regulation of markets. Markets fulfill individual needs but are not designed to address social issues like regulation, which requires the “visible hand” of politics. Market fundamentalists extol the virtues of markets while obscuring the political decisions shaping market functioning.

The Role of Education in Shaping Market Outcomes

Education plays a crucial role in the reflexivity effect. An educated society can both amplify and mitigate this effect, depending on the level of rationality and awareness among individuals. Soros advocates for an education that emphasizes the understanding of uncertainty and fallibility, moving away from dogmatic beliefs.

In a highly educated society, individuals may have a more significant impact on the reflexivity effect due to their enhanced understanding of market dynamics. Conversely, an educated society can also lead to greater rationality, potentially reducing the reflexivity effect. The precise role of education in shaping the reflexivity effect remains a complex issue requiring further exploration.

Bolsa Escuela and the Importance of Education: Bolsa Escuela, a program in Brazil that provides financial assistance to families to allow their children to attend school, has been a success and has been replicated in other countries. Education is crucial for an open society and should teach uncertainty rather than dogma.

Fallibility and Imperfect Understanding: Soros emphasizes the limitations of human understanding and fallibility. Understanding these limitations allows for improvement in policies and social reform. Perfectionism can hinder progress and lead to unintended consequences.

Bridging the Gap Between Social and Natural Sciences

Soros’ exploration extends to the relevance of biology, evolutionary systems theory, and network theory in understanding the human condition. He argues for the integration of these disciplines in studying financial markets and human behavior, challenging the traditional separation between social and natural sciences.

Biology, Complexity, and Reflexivity: Soros explores the relationship between reflexivity and complexity, particularly in evolutionary systems theory and network theory. He sees parallels between these theories and human society, where general rules about networks apply to financial markets and banks. Reflexivity, however, is a specifically human characteristic related to the thinking-reality relationship.

Primate Ancestors and Reflexive Relations: Soros suggests that primate ancestors may have had reflexive relations, such as recognizing when another primate is attempting to take over their position as the alpha male. He also proposes that marriage can be viewed as a reflexive relation, and that monkeys may qualify for this type of relationship.

The Interplay of Emotion and Reason in Market Behavior

The relationship between emotion and reason in market behavior is another crucial aspect. Soros contends that markets are not purely irrational but are rational responses to perceived opportunities. He challenges the notion that bubbles are solely driven by emotions like fear and greed, arguing that they are an inherent feature of financial markets due to their structure.

Reflexivity and Emotions: Soros acknowledges the connection between reflexivity and emotions, recognizing that reason and emotion are intertwined.

Cognitive Science and Hume’s Contention: Brain science has confirmed Hume’s idea that reason and emotion are inherently connected, challenging the notion of a purely rational intellect.

False Dichotomy of Reason and Emotion: The traditional view of reason and emotion as separate entities has been replaced by a more nuanced understanding of their interconnectedness.

Alan Greenspan’s “Irrational Exuberance”: Greenspan’s description of bubbles as “irrational exuberance” is misleading. Market participants who recognize a bubble may still buy in for financial gain, contributing to the bubble’s growth.

Market Limitations in Preventing Asset Bubbles: Relying solely on markets to prevent asset bubbles is ineffective. Market participants may act rationally within a bubble, even if it leads to irrational outcomes.

Soros’ Lecture Insights: History, Economics, and the Human Uncertainty Principle

In his lecture, Soros critiques the application of natural science methods, as proposed by Popper, to history and economics. He argues for the uniqueness of human behavior, proposing the human uncertainty principle as a universally valid hypothesis. This principle acknowledges the unpredictability of human actions, challenging the quest for universally valid laws in economics.

Popper’s Theory of Falsification: Soros has become more critical of Popper over time and believes that Popper took for granted the purpose of thinking and discourse as getting closer to the truth, which is a false assumption. Soros criticizes Popper for not emphasizing the positive feedback aspect of reflexivity, where the prediction of an event changes the event itself and, in turn, changes the way the world is perceived.

Reflexivity, Complexity, and the Role of Education

Soros’ concept of reflexivity serves as a cornerstone in understanding market dynamics. He emphasizes its two-way connection between biases and objective reality, suggesting that misconceptions can indeed alter objective conditions. However, education alone is not a panacea, as reality can be manipulated, and values guiding this manipulation can vary widely.

Reflexivity and Fallibility: Human fallibility is essential and universal. Reflexivity is a two-way connection between biased or misconceptions and objective reality. Misconceptions can change objective conditions through reflexivity. Reflexivity requires misconceptions or biased views to exist.

Reflexivity and Complexity: Complexity and reflexivity are not necessarily the same. Reflexivity can be simple or complex. The relationship between reflexivity and complexity is still being explored.

Determinism, Free Will, and the Progress Debate

The article concludes by touching on the debate between determinism and free will, highlighting Soros’ acknowledgment of both the influence of reality and individual agency. It revisits the contrasting views of Plato and modernity on the impact of time, with Soros’ perspective influenced by Popper yet distinct in acknowledging the need for continuous reassessment and improvement in understanding.

Reflexivity and Economics: The prevailing dogma in economics assumes perfect knowledge, which is unrealistic. Reflexivity challenges this assumption and introduces the concept of biased and misconceptions. Reflexivity provides a more realistic understanding of economic behavior.

Reflexivity in Human Behavior and the Influence of Values: Reflexivity arises from consciousness and awareness of others’ attitudes and beliefs. Humans can be influenced by others’ beliefs, which can change their own behavior. Education is valuable, but reality can be manipulated, leading to varied outcomes. Manipulation depends on one’s values, which can be questionable and subjective. Reflexivity and Natural Instinct: Reflexivity is a conceptual idea that may not guarantee success for everyone. Natural instinct and other factors also play a role in determining outcomes. Reflexivity and Free Will: Determinism and free will are both partially accurate in explaining human behavior. Human actions are influenced by reality and free will, not solely determined by fixed laws. The Influence of Time: Plato viewed time as having a degenerative effect, while modernity sees it as progressive. The speaker expresses uncertainty about his stance on the influence of time. Karl Popper’s Influence: The speaker’s attitude towards Plato is influenced by Karl Popper’s critique. The speaker is asked about his belief in progress, to which he responds affirmatively.

A Call for Critical Thought and Continuous Reassessment

This exploration into the theories of Soros, Popper, and Merton presents a nuanced view of financial markets and human behavior. It underscores the importance of critical thought, the recognition of our limitations in understanding and predicting market behavior, and the need for continuous reassessment and adaptation in our approaches to economics, education, and societal issues. As we navigate the complex interplay of prediction, perception, and reality, these insights offer valuable perspectives for both policymakers and individuals in shaping a more informed and responsive approach to the challenges of our time.

Supplemental Update:

Response 10:

Reflexivity in Human Affairs:

– George Soros believes in progress and the improvement of understanding.

– Understanding reflexivity makes dealing with human and political problems more difficult.

– Some preconceived ideas need to be discarded to gain a deeper understanding.

Insoluble Problems and False Solutions:

– Soros views death as an insoluble problem that humans tend to avoid confronting.

– To cope with the prospect of death, humans have devised false solutions and myths.

– The drug problem is also seen as an insoluble issue due to the innate nature of drug addiction.

– Society’s approach to drug addiction often exacerbates the problem rather than solving it.

Impact of Societal Responses:

– Soros argues that society’s response to death has made dying harder, more painful, and more expensive.

– His foundation’s initial projects in America focused on addressing death and drug policy.

Connection to Philosophical Argument:

– Soros’s perspective on insoluble problems stems from a philosophical argument.

– He believes that attempts to remedy insoluble problems can worsen the situation.

Response 11:

End of Time Limit:

– The discussion was interrupted due to time constraints.

Closing Remarks:

– The moderator thanked the audience in Budapest and London.

Gratitude to George Soros:

– Appreciation expressed for sharing thoughts, experiences, and philosophy.

Launching an Extraordinary Journey:

– Participants embark on a journey with George Soros.

Colin McGinn’s Contribution:

– Acknowledgment of Colin McGinn’s role in facilitating the event.

Overall Summary:

– The event concluded with expressions of gratitude to the speakers, participants, and organizers.

Notes by: Ain