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

Soros retired from full-time investing in 2000 and concentrated on philanthropy through a network of non-profit organizations he had established in the 1980s and his Open Society Institute. Together, the groups distribute $400 million to $500 million each year to "civil society" projects in more than 50 countries, such as election monitoring in Tajikistan and a network of community libraries in Haiti. Soros also has emerged as a major financial contributor to the Democratic Party and harsh critic of President Bush and the "war on terror."

The financier's political views have made him the bête noire of many in the conservative movement. Fox News commentator Bill O'Reilly, for example, has criticized Soros for seeking to impose a "radical left agenda" on the USA, while conservative websites such as freerepublic.com routinely assail him as "anti-American."

The credit crunch that erupted last year prompted Soros to return to investing, to protect his portfolio from the gathering financial catastrophe. Several months later, Soros says the U.S. has weathered the "acute phase" of the markets crisis. "But the impact on the real economy is yet to be felt," he says.

Soros makes no bones about his judgment that the current financial crisis is the "worst since the 1930s." He sees the subprime mortgage debacle as the signal event that unhinged both this decade's housing bubble and a 25-year-long "super-bubble" that originated in the debt-laden policies of the Reagan administration.

But despite Soros' apocalyptic rhetoric, the Dow is hovering near 13,000 and unemployment is a relatively low 5%. Soros explains the disconnect with the tale of the man who falls off the Empire State building and thinks to himself halfway down: "So far, so good."

"That's where we are right now," Soros laughs.

Still, for anyone who's listened to some of the gloomier economic prophets, such as economist Nouriel Roubini or The Trillion-Dollar Meltdown author Charles Morris, Soros' analysis of the financial crisis itself is unremarkable. Like others, he blames a failure of regulators, including Alan Greenspan's Federal Reserve, to keep a tight enough rein on Wall Street. He anticipates further sharp declines in housing prices and says, when pressed, that Americans ultimately won't escape this episode without suffering a noticeable decline in their standard of living.

"I'm afraid that will be the case, and it will be hard to take," he says. "And it will be politically unpalatable, and it will probably give rise to all kinds of populist political appeals (for) a way out that will also be very dangerous."

The Federal Reserve's aggressive efforts to pump cash into the banking system and the government's $168 billion economic stimulus, which began sending taxpayers checks this month, will be insufficient to stir a recovery, he says. Talk — from Bush administration officials and Wall Street optimists — of an economic recovery later this year "is totally without foundation," he says.

Even as clean-up continues on the housing bubble's aftermath, new bubbles are forming in commodities markets and perhaps China, he says. Soros acknowledges that his crystal ball is "cloudy" on the Asian giant, but predicts that the country faces serious domestic inflation and export weakness if the U.S. downturn spreads abroad. "China is not immune to the worldwide dislocation that started here," he says.

What Soros sees as the market economy's inherent tendency to lurch from bubble to bubble and excess to excess makes it all the more essential that those at the economy's helm embrace reflexivity, he says. Reflexivity cannot provide firm predictions about the future, only a better understanding of the past and an awareness of all that could go wrong, he says. Regulators and market participants alike will need to accept a much greater amount of uncertainty — as Soros says he has.

"Being aware of reflexivity, I am often overwhelmed," he says. "Genuinely, I am actually overwhelmed by the uncertainties. And I'm constantly on the watch being aware of my own misconceptions, being aware that I'm acting on misconceptions and constantly looking to correct them."

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