Soros sees 'reflexivity' theory of economics as life's work

For most people, being known as a fabulously wealthy investor, prominent global philanthropist and outspoken critic of the current occupant of the White House would constitute sufficient acclaim.

But George Soros, now in his eighth decade and enjoying a personal fortune estimated at $9 billion, yearns to be seen as something other than a financial oracle or Democratic Party sugar daddy. The Hungarian émigré, who built a worldwide reputation by out-thinking markets, desperately wants to be acknowledged as a philosopher.

His bid for such recognition — in a new book published last week — lies in a theory called "reflexivity," which Soros argues should supplant conventional economic thought that's based on coolly calculating rational actors. Soros, 77, who first read philosophy as a teenager during World War II, has promoted the concept for more than 20 years with little success.

But hailing reflexivity as his "life's work," Soros now says the current financial crisis offers an opportunity for him to garner wider acceptance. "I'm actually hopeful this time I'll break through," he says.

It'll be an uphill fight. Critics of reflexivity, especially among the economists Soros disparages, have been brutal. A reviewer of one of his earlier books savaged his "windy amateur philosophy" and attacked him for being unfamiliar with basic economics.

"It is difficult to conceive of a more mistaken understanding of the profession's research in the last 10-15 years. … The great danger of the (earlier) book is that non-economists will take seriously his ill-founded criticism of economic research," wrote economist Christopher Neely of the Federal Reserve Bank of St. Louis.

In his latest work, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means, Soros traces a straight line between today's financial turmoil and what he says are fatally flawed conventional assumptions about how markets behave. If banks, investors and regulators had embraced reflexivity years ago, there never would have been a financial crisis, Soros insists.

Here's why: Since the days of Adam Smith, economists have taught that markets sort out issues of supply and demand by settling at a point of equilibrium. Prices may temporarily deviate from that balanced state, but eventually, they return to it.

Classic free market theory holds that everyone in an economy acts rationally, based on complete information while seeking to maximize their individual welfare or profits.

Of course, real life never matches up exactly with the theory's assumptions. But they represent, economists say, a useful way of making sense of a complex world.

To Soros, the conventional approach is rubbish. Instead of a world of near-identical actors, coolly assessing their economic interests and acting with clear-eyed precision, he sees a world (and markets) governed by passion, bias and self-reinforcing errors. Because fallible human beings are both involved in, and trying to make sense of, this world, they inevitably make mistakes. Those mistakes then feed on themselves in "reflexive" ways that, when taken to extremes, result in situations such as the now-deflating U.S. housing bubble.

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