Richard Moore

Dear cj,

Below, George Soros relates his latest analysis of global capitalism, and
describes his gambling strategy -- back when he worked the markets
personally. He says he never read the economic-science books, and figured
his emotions -- especially fear -- were his best guide to winning. He
should know what he's talking about, and his analyses are certainly
interesting.  But I suggest caution in interpreting his terminology.

When he talks about "global capitalism" being in danger of collapsing, what
he seems to mean is that the free-trade regime, without national capital
controls, might be in danger. Thus he fears Malaysia's controls might start
a major trend... but he isn't saying "global capitalism", as the dominant
economic paradigm, is in danger of collapsing. (unfortunately)

In his previous writing about "Open Societies", he often says that
"unrestrained capitalism" is the "greatest existing danger" to open
societies. But what does he mean? Evidently he wants a solution to be
implemented at the center -- in the IMF, World Bank, etc -- and not through
national controls. Despite whatever good intentions he seems to display, he
can't seem to countenance elected governments having power over his
precious international casino.


btw> yet another much-revised "final" Intro is on the website.

Date: Fri, 4 Dec 1998 22:48:54 -0400
To: •••@••.•••
From: •••@••.••• (Jan Slakov)
Subject: Soros article

Date: Fri, 04 Dec 1998 13:18:55 -0800
To: •••@••.•••
From: Oscar and Mary Priem <•••@••.•••>
Subject: *Disturbing* Analysis from George Soros

London TIMES  November 30 1998


[ 3 TIMES extracts  from The Crisis of Global Capitalism by George Soros,
published by Little, Brown (RRP #17.99). Readers of The Times can buy this
title for just #14.99 by calling The Times Bookshop on 0990 134 459.]


[In the first extract from his book, The Crisis of Global
Capitalism, the controversial financier George Soros issues a
warning that the world's financial system is set for a complete
breakdown - and only co-operation and reforms on an
international scale can prevent it]

The financial crisis that originated in Thailand in 1997 is particularly
unnerving because of its scope and severity. We at Soros Fund Management
could see a crisis coming and so could others, but the extent of the
dislocation took everyone by surprise. A number of latent and seemingly
unrelated imbalances were activated and their interaction touched off a
process whose results are entirely out of proportion with the ingredients
that went into creating it.

The financial markets played a role that is very different from the one
assigned to them by economic theory. Financial markets are supposed to
swing like a pendulum. They may fluctuate wildly in response to shocks,
but eventually they are supposed to come to rest at an equilibrium point.
Instead, financial markets have behaved like a wrecking ball, swinging
from country to country and knocking over the weaker ones.

It is difficult to escape the conclusion that the international financial
system itself constituted the main ingredient in the meltdown process. It
certainly played an active role in every country, although the other
ingredients varied from country to country. Financial markets do not just
passively reflect economic reality. The role that financial markets play
in the world ought to be radically reconsidered.

To see why, let us look at what has happened. The most immediate cause of
trouble in 1997 was the manner in which currencies were managed. The
South-East Asian countries maintained an informal arrangement that tied
their currencies to the US dollar. It was a situation similar in some
respects to the ERM.

The apparent stability of the link to the dollar encouraged local banks
and businesses to borrow in dollars and then convert dollars into local
currencies, without insuring against the risk of the local currencies
going down in value. The banks then lent to or invested in local projects,
particularly real estate. This seemed to be a riskless way of making money
as long as the local currencies maintained their link to the dollar.

But the arrangement came under pressure because the two biggest economies
in the area, China and Japan, had currencies which were out of sync with
the dollar. The Chinese currency was undervalued, and the yen fell. The
balance of trade suffered in South-East Asia. By the beginning of 1997 it
was clear to us at Soros Fund Management that the position was becoming
untenable. If it was clear to us in January 1997 that the situation was
untenable, it must have been clear to others. Yet the crisis did not break
out until July 1997 when the Thai authorities abandoned the peg to the
dollar and floated their currency. In crude terms, it was their Black

The crisis came later than we had expected because the local monetary
authorities kept on supporting their currencies far too long and
international banks continued to extend credit even though they must have
seen the writing on the wall. The delay has undoubtedly contributed to the
severity of the crisis. From Thailand it quickly spread to Malaysia,
Indonesia, the Philippines, South Korea and other countries. Some of the
countries engulfed in the crisis did not appear to have wrongly valued
currencies. Critics argue the problem was their common dependence on a
distorted or immature form of capitalism, now described perjoratively as
"crony capitalism", but previously extolled as "The Asian Model". There is
some truth in the claim, but attributing the crisis to specifically Asian
characteristics does not give the full picture. The crisis has now spread
to Latin America and Eastern Europe and is now beginning to affect the
financial markets and economies of Western Europe and the United States.
This global crisis is caused by pathologies inherent in the global
financial system itself.


It is not just currency speculation that creates problems, but the nature
of investment. Institutional investors do not generally measure their
performance in absolute terms but relative to each other. They operate as
a herd, following the latest trend. Hedge fund managers and others who
speculate with borrowed money play a similar role. When they are on a
winning streak, they can increase their bets; when they lose they are
forced to sell to reduce their debt. Options, hedges and other derivative
instruments have a similar self-reinforcing quality about them.

But it was not only foreign investors who influenced the situation. In the
countries where the local currency was pegged to the dollar, indigenous
banks assumed the peg would hold and unwisely failed to insure against it
going. When the peg broke they found themselves exposed. They scrambled
for cover, and put tremendous pressure on the local currencies. As the
currencies nose-dived this caused a sudden deterioration in the balance
sheets of local borrowers. This, together with foreign investors fleeing
from declining markets, set up a self-reinforcing process that resulted,
for example, in a 42 per cent decline in the Thai currency and a 59 per
cent decline in the Thai stock market between June 1997 and August 1998.

Financial markets caused this panic to spread; some have referred to this
financial contagion as a modern version of the bubonic plague. Other
countries in Asia had apparently strong economies, the Malaysian trade
deficit was modest and the fundamentals in Indonesia seemed quite sound
but it was not long before they were hit, and the crisis forced Thailand,
then Korea, then Indonesia to seek the assistance of the IMF.

But the IMF programmes did not work. Perhaps, because the IMF had
developed its techniques for dealing with problems caused by improvident
governments, its understanding of how financial markets operate left much
to be desired. The correct solution to the crisis would have been to
convert debts in the stricken countries into equity, giving creditors a
share stake in the vulnerable concerns. But international creditors would
have balked, and without their co-operation no rescue programme can
succeed. Obviously the problem is with the system, and the IMF is part of
the problem, not part of the solution. The IMF is now in a crisis of its
own. Market confidence has been an essential ingredient to its past
success and it has now lost credibility.

>From Asia, the wrecking ball, or bubonic plague, has hit Russia and
Brazil, damaging Eastern Europe and devastating Ukraine on the way. The
international crisis appeared to reach a climax in 1997. Foreign banks
refused to roll-over their loans to Asian banks, Central banks had to
intervene and force commer- cial banks to renew their loans. Soon
afterwards the crisis started to ease. Alan Greenspan, the Chairman of the
US Federal Reserve, made it clear that the Asian troubles ruled out any
possibility of an interest rate rise and the markets took heart.

It was a false dawn. The financial collapse has been followed by economic
decline in Asia and elsewhere. Domestic demand came to a standstill and
imports shrank, but exports did not expand because a high proportion of
the exports were directed towards countries that were also affected.
Semiconductors were particularly hard hit.


I realised that the music had stopped, and I said so at the time, but I
seriously underestimated the severity of the problem. The disintegration
of the global capitalist system will prevent a recovery, turning the
recession into a depression. I have three main reasons. One is that the
Russian meltdown has revealed previously ignored laws in the international
banking system. Banks engage in transactions and trade among each other
and with their clients which do not show up on their balance sheets. When
Russian banks defaulted, Western banks remained on the hook both on their
own account and on behalf of clients. Hedge funds and other speculative
accounts also sustained large losses. Banks are now frantically trying to
limit their exposure, deleverage and reduce risk. Their own stocks have
plummeted and a global credit crunch is in the making.

Second, the pain at the periphery, in Asia, Russia and elsewhere, has now
become so intense that individual countries have begun to opt out of the
global capitalist system. First Indonesia, then Russia, suffered a pretty
complete breakdown. What happened in Malaysia and in Hong Kong is in some
ways even more ominous. The collapse in Indonesia and Russia was
unintended, but Malaysia shut itself off from international capital
markets deliberately. Its action has brought temporary relief to the
Malaysian economy and allowed its rulers to maintain themselves in power
but, by reinforcing a general flight of capital from the periphery, it has
put additional pressure on those countries that are trying to keep their
markets open.

If the capital flight makes Malaysia look good in comparison with its
neighbours, the policy may easily find imitators.

The third major factor working for the disintegration of the global
capitalist system is the evident inability of the international monetary
authorities to hold it together. IMF programmes do not seem to be working
and the IMF has run out of money. The response of the G7 governments to
the Russian crisis was woefully inadequate, and the loss of control was
quite scary.

Financial markets are rather peculiar. They resent any kind of government
interference but they hold a belief deep down that if conditions get
really rough the authorities will step in. This belief has now been
shaken. How events will unfold depends largely on the response of the
banking system, the investing public, and the authorities at the centre.
The range of probabilities lies between a cascading decline of the stock
markets and a more drawn-out process of deterioration. I think the latter
more likely.

The public has learned that it pays to buy during dips to what has been an
everlasting bull market. But it will take time before it discovers that
the bull market does not last forever. Thus it will take time for the
three main negative forces to make their effect felt.

The current false dawn will be followed by a prolonged bear market, just
as in the 1930s and in Asia currently. The public will stop buying dips
and start moving out of stocks. The wealth effect will take its toll and
consumer demand will decline. Investment demand will also decline, for a
number of reasons; profits are under pressure, imports are rising and
exports falling, and the supply of capital for the less well established
enterprises and for real estate has dried up.

Reductions in interest rates will cushion the market decline. The economy
would eventually recover if the global capitalist system held together.
But the chances of it falling apart have greatly increased. If and when
the United States' domestic economy slows down, the willingness to
tolerate a large trade deficit will decrease and free trade may be
endangered. The US is also looking increasingly inward. The refusal of
Congress to provide additional funds for the IMF may play the same role
today as the Smoot-Hawley tariff did in precipitating the Great

Once, I thought that the Asian crisis would lead to the ultimate triumph
of capitalism. Multinational corporations would replace family concerns
and the Asian model would then be assimilated into the global capitalist
model. It is now more likely that countries at the periphery of the
system, in Asia, will increasingly opt out of the system altogether as
their prospects for attracting capital from the West fade away. It is
often said that revolutions devour their own children, and the political
changes in Asia which have seen tyrants fall may not leave the current
reformers in charge. Already, anti-American, anti-IMF, anti-foreign
resentment is building up throughout Asia, including in Japan.

Elections in Indonesia could well produce a nationalistic, Islamic
government inspired by the ideas of Dr Mahathir Mohamad, the Malaysian

Banks and investors have suffered severe losses and there are more to
come. Russia is likely to default on its dollar obligations. Losses in
Indonesia will also have to be recognised. Banks are being punished by
shareholders for their exposure to the periphery. They will not want to
increase their commitments.

Only international governmental action could pump money into the
periphery, but there is no sign of international co-operation.

I can already discern the makings of the final crisis. It will be
political in character. Indigenous political movements are likely to arise
that will seek to expropriate multinational companies and recapture the
"national" wealth. Some of them may succeed in the manner of the Boxer
Rebellion or the Zapata Revolution. Their success may shake the confidence
of financial markets, engendering a self-reinforcing process.

The breakdown of the global capitalist system could be prevented by the
intervention of the international financial authorities at any time. The
prospects are dim because the G7 has just failed to intervene in Russia,
but the consequences of that failure may serve as a wake-up call.

There is an urgent need to rethink and reform capitalism. The problems
will become progressively more intractable the longer they are allowed to


Strange as it may seem for someone who has made his reputation and his
fortune in the very practical world of business, my financial success and
my political outlook have rested largely on a number of abstract
philosophical ideas. One of them is my distrust of social sciences.

There is a prevailing belief that economic affairs are subject to
irresistible laws, like supply and demand, that are comparable to the
natural laws of physics. This belief is false. What is more important,
decisions and structures that are based on this belief are destabilising
economically and dangerous from a political point of view, I am convinced
that the market system, like every other human arrangement, is inherently
flawed. This conviction lies at the foundation of this book's entire
analysis, as well as of my personal philosophy and of my funds' financial

Economic analysis cannot have the same validity as the physical sciences.
But the most important reason for the failure of economic analysis - and
for the inevitable instability of all social and political institutions
that assume the absolute validity of market economics - is not properly
understood. The failures of economics are not simply due to our imperfect
understanding of economic theory or to a lack of adequate statistics.
These problems could, in principle, be remedied by better research. But
economic analysis, and the free-market ideology that it supports, are
subverted by a far more fundamental and irredeemable flaw.

Economic and social events, unlike the events that preoccupy physicists
and chemists, involve thinking participants and not molecules. And
thinking participants can change the rules of economic and social systems
by virtue of their own ideas about these rules. The claims of economic
theory to universal validity become untenable once this principle is
properly understood. People can operate in a way that bucks the rules.
This is not just an intellectual curiosity. For if economic theories are
not scientifically valid - and never can be - the entire ideology of
market fundamentalism is undermined.

I have to confess that I am not familiar with the prevailing theories
about efficient markets and rational expectations. I consider them
irrelevant and I never bothered to study them because I seemed to get
along quite well without them - which was perhaps just as well, judging by
the recent collapse of the hedge fund Long Term Capital Management (LTCM).

The fund's managers aimed to profit from the application of modern
equilibrium theory, and its strategies were inspired by the joint winners
of the 1997 economics Nobel Prize, who won their prize for their
theoretical work on options pricing.

The fact that some successful participants in financial markets have found
modern theories, supposedly explaining how financial markets function,
completely useless may be considered a scathing criticism in itself. But
the failure of LTCM is much more conclusive. I have no quarrel with
economics itself, as far as it goes, except that it does not go far



As a fund manager, I depended a great deal on my emotions. That was
because I was aware of the inadequacy of my knowledge. The predominant
feelings I operated with were doubt, uncertainty and fear. I had moments
of hope, even euphoria, but they made me feel insecure. By contrast,
worrying made me feel safe. So the only genuine joy I experienced was when
I discovered what I had to worry about.

By and large, I found managing a hedge fund extremely painful. I could
never acknowledge my success because that might stop me from worrying, but
I had no trouble in recognising my mistakes. It is wise to be constantly
looking for the fly in the ointment.

Only when others pointed it out to me did I realise that there might be
something unusual in my attitude to mistakes. It made so much sense to me
that discovering an error in my thinking should be a source of joy rather
than regret, I thought it ought to make sense to others as well. But when
I looked around, I found that most people went to great lengths to cover
up their mistakes. It gave me pleasure to acknowledge a mistake, because I
knew that it could save me from future grief.

I will never forget visiting Argentina in 1982 to look at the mountain of
debt that country had accumulated. I sought out a number of politicians
who had served in previous governments and asked them how they would
handle the situation. To a man, they said they would apply the same
policies they followed when they were in government. They refused to learn
from experience.

I carried my critical attitude into my philanthropic activities. I found
philanthropy riddled with paradoxes and unintended consequences. For
instance, charity may turn the recipients into objects of charity. Giving
is supposed to help others, but in reality it often serves to gratify the
ego of the giver. What is worse, people frequently engage in philanthropy
because they want to feel good, not because they want to do good.

When I set up my foundation to advance the aims of the open society in
Eastern Europe, I took a new approach. I subordinated the interests of the
foundation personnel and of the individual applicants to the mission of
the foundation. I used to joke that ours was the only misanthropic
foundation in the world.

I remember telling my staff in Czechoslovakia in 1991 that foundations
were hothouses of corruption and inefficiency, and that I would consider
it a greater accomplishment to have the courage to wind up a failed
foundation than to have the vanity to set up a new one. I also remember
telling a gathering of staff in Prague that networking means not working.

I have mellowed with time. There is a difference between running a hedge
fund and running a charitable foundation. Heading a large foundation
requires people skills, and people do not like critical remarks. They want
praise and encouragement. Not many people share my predilection for
identifying error and even fewer share my joy in it.

I used to find public expressions of praise and gratitude positively
painful. But I have come to realise that this is a reflex left over from
the days when I was actively managing money, when I had to be guided by
the results of my actions, not by what other people thought of them.

I am still embarrassed by gratitude and I still believe that philanthropy,
if it is deserving of praise, should put the interests of society ahead of
ego gratification. But I am willing to accept praise because my foundation
has now met this condition.

Whether it can continue to function properly, given my changed attitude
towards praise, is a question that troubles me. But as long as I am
troubled, the answer will probably still be yes. Worrying is the key to

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