Lunch in Davos with George Soros. In the early 1990s, he was the speculator?s speculator: the man who cleaned out Britain?s gold and foreign currency reserves on Black Wednesday. Today, he has become the scourge of market fundamentalism, warning that the deregulation of finance that has been underway since 1980 has pushed the global system to the point of its biggest crisis since World War II.
Soros is honest enough to admit that he has been here before. He called the Asian financial turmoil of 1997 a crisis of global capitalism. But this time, he says, it really is the big one. The other tremors over the past 20 years were merely the overture to Gotterdammerung. It?s a brave call, for there is no shortage of people saying that cuts in interest rates and lower taxes in the US will lead to any recession being short and shallow, while the developing world will keep growing strongly.
Nor is the Soros remedy?an audit of the books of financial institutions to make sure that the risks of what they are doing with their fancy products are fully recognised, followed by a far tougher regulatory regime?whole-heartedly supported. What?s more, those who believe allowing the market to work is the least-worst option, argue that the inevitable human failings of regulators mean that they are bound to make any bad situation worse.
Soros is right, though, to say that this crisis has the potential to be far bigger than anything that has been seen in living memory. Firstly, it is a crisis that is affecting the centre of the global financial system?the US?rather than the periphery. Secondly, the global economic balance of power is changing, with a shift from west to east. Historically, that has always added to geopolitical tension. Thirdly, there are doubts about whether the normal policy instruments will work. Soros says the Federal Reserve was right to cut interest rates after being asleep at the wheel as the subprime crisis undermined the financial system. But he doubts whether pumping liquidity into the system will have much effect. In part, because consumers are already sodden with debt, but also because cheap money doesn?t make that much difference if you?re going bust. The current crisis, Soros says, is not a crisis of liquidity?which rate cuts can cure?but a crisis of solvency. In that case, the Fed?s action will have more of an impact on inflation, by pushing down the value of the dollar, than on economic activity.
Higher inflation will constrain the Fed?s freedom of action when the solvency problems come to the surface, leading to another, far more serious crisis. At that point, the market fundamentalists may take Soros?s suggestions a bit more seriously. By then, of course, it will be far too late.
Ed Strong
edstrong.blog-city.com