George Soros (Soros Fund Management Founder) – Imperfect Understanding Is Part of Human Nature (Jul 2018)

Chapters

Abstract

George Soros on the Complexity of Social Phenomena and Market Dynamics: Insights and Philosophies

The Interplay of Imperfect Understanding and Social Phenomena

George Soros, a renowned figure in finance and philanthropy, has provided profound insights into the distinction between natural and social phenomena. In his analysis, Soros underscores the fundamental difference in how imperfect understanding affects these two fields. While in natural phenomena, imperfect understanding does not alter the sequence of events, allowing for universally valid predictive laws, in social phenomena, this imperfect understanding becomes a critical factor, introducing a level of uncertainty that surpasses even the uncertainty principle in physics.

In economics, Soros’s understanding was initially influenced by Karl Popper’s concept that perfect knowledge is unattainable and that scientific theories can only be falsified, not validated. This led Soros to question the assumptions of traditional economic theory, particularly its reliance on mathematical models that assumed perfect knowledge. He recognized that social phenomena, unlike natural phenomena, are influenced by imperfect human understanding, which introduces an element of uncertainty and unpredictability. In natural phenomena, laws can be established to predict and explain events, but in social phenomena, imperfect understanding affects the sequence of events and makes universal laws unreliable. Soros introduced the concept of the “human uncertainty principle,” which refers to the additional source of uncertainty in social phenomena due to imperfect human understanding. He contrasted this with the uncertainty principle in physics, which does not alter the behavior of the quanta it refers to. Soros emphasized that ideas in social affairs can actually change society itself, unlike in natural phenomena. He cited Karl Marx’s theory of history as an example of an idea that had a profound impact on the course of history.

The Transformative Impact of Theories on Society

Soros emphasizes the unique aspect of social phenomena: theories about social affairs can greatly change society itself. He illustrates this with the example of Karl Marx’s theory of history, showing how such theories can have a transformative impact on societal structures and norms.

Alchemy of Finance and Financial Market Dynamics

In his 1987 book, “The Alchemy of Finance,” Soros recognized the limitations of scientific explanations in financial markets and proposed that alchemy, despite its flaws, offers a more suitable explanation. This is due to its acknowledgment of imperfect understanding and the potential for change through human actions. Soros draws parallels between alchemy and financial markets, suggesting that, unlike natural phenomena, the sequence of events in financial markets can be altered by human actions, akin to an “abracadabra” effect.

The Rise of Reflexive Theory in Financial Turmoil

Soros’s concept of reflexivity, which highlights the interdependence of market participants’ beliefs and market outcomes, gained significant traction during the 2008 financial crisis. This concept challenged the prevailing efficient market hypothesis and rational expectations theory, which had largely disregarded the potential for market disruptions.

Market Recovery and the Eurozone Crisis

The post-crisis era witnessed a shift in economic strategy, with a delicate balance between restoring stability and managing the risks associated with sovereign credit. The euro crisis further unveiled a fundamental flaw in the euro’s construction, akin to a foreign currency debt risk, leading to heightened risk premiums and disagreements on recession management strategies.

The financial crisis of 2007-2008 exposed the flaws in the efficient market hypothesis and rational expectations theory, which failed to predict the severity of the crisis. George Soros’s theory of reflexivity and fallibility gained traction after the crisis. It emphasizes the role of feedback loops and imperfect information in shaping market outcomes. Despite the collapse of established theory, a proper understanding of how financial markets operate is still lacking. Synthetic instruments and derivatives have introduced complexities that are not fully understood. The concept of equilibrium, borrowed from Newtonian physics, is not applicable to financial markets. Equilibrium is not impossible but is an extreme state that is rarely achieved. Markets can be close to equilibrium or far from it, with no particular tendency to return to equilibrium. After the financial collapse, authorities intervened to keep markets afloat through quantitative easing and other measures. This involved substituting state credit for collapsed financial credit. The euro crisis revealed a fundamental flaw in the construction of the euro. Member countries have debt denominated in a currency (the euro) that they do not control, creating a foreign currency debt risk. The cheap liquidity introduced during the crisis has raised concerns about a potential credit bubble and runaway inflation. This fear is particularly prevalent in Germany, leading to disagreements on how to handle the recession. Central banks face the challenge of deciding when to withdraw the additional liquidity injected during the crisis. This maneuver is difficult to execute and could lead to a go-stop period of economic recovery and arrest.

Central Banks’ Quandary and Economic Dynamics

Central banks faced a challenging task in deciding when to withdraw the liquidity injected during the crisis. The timing of this action is crucial, as premature withdrawal could hinder economic recovery, while delayed action could lead to inflation. Soros anticipates a “go-stop” economic landscape, with alternating periods of growth and pauses, presenting its own set of challenges.

Philanthropy Influenced by Reflexivity

Soros’s philanthropic endeavors are deeply influenced by his understanding of reflexivity. He focuses on addressing the interconnectedness of social, economic, and political factors, aiming to tackle root causes rather than merely treating symptoms. His initiatives range from supporting education and healthcare to promoting democracy and human rights.

Confronting Misconceptions and Addressing Insoluble Problems

Soros has recognized the influence of misconceptions in shaping history and the need to address deficiencies in open societies. He highlights death as an insoluble problem that society often denies, and his project aimed to challenge this denial, particularly in the medical field, influencing public opinion and medical practice towards accepting death as a natural part of life.

The Importance of Fallibility in Policymaking

Soros underscores the importance of acknowledging the fallibility of all methods and approaches, including those that have been successful. He warns against overburdening successful ideas and stresses the need for policymakers and institutions to learn from past errors and be willing to adapt. The euro crisis is cited as a prime example of a self-inflicted crisis exacerbated by an inability to admit and correct original errors.

Conclusion

George Soros’s insights provide a unique and nuanced perspective on understanding the complexities of social and financial dynamics. His emphasis on the role of imperfect understanding, the transformative power of theories, and the interplay of human beliefs and market outcomes challenges traditional scientific approaches to social phenomena. His ideas have significantly influenced economics, finance, social sciences, and philanthropy, offering deeper insights into the complex interactions and uncertainties inherent in social systems.

Notes by: crash_function