George Soros - the theory of reflexivity pt1

4 Nov 2011 Institute for New Economic Thinking / CEU

Background: The Greek PM has offered to resign.
George Soros is Founder and Honorary Chairman of the Board, CEU.


George Soros --
Thank you.
This 2-day workshop is discussing the theory and practice of social change. The euro crisis is a very good practical example for studying it. You've been distributed a copy of the paper I gave describing my conceptual framework based on the twin-concept of fallibility and reflexivity.

I had basically explored this mainly in the context of financial markets. There I used this two-way connection between people's perceptions and the actual state of affairs to develop a theory of boom-bust.

A tendency in every bubble.... there is an element of reality, something that is happening in the real world that is in some way misconstrued in people's perception. There is an inter-play between the misconception and the tendency that is initially self-reinforcing.

Where both the tendency and the misconception is reinforced by this inter-play.... this feedback mechanism.....eventually, the perception runs so far away from reality that it becomes unsustainable. And it reaches a plateau, a twilight period. And eventually it generates a self-reinforcing process in the opposite direction [!]. That is the boom-bust process of a bubble.

That actually occurs in financial markets very often. So the theory that financial markets always tend towards equilibrium is false [Wow]. Markets can tend towards equilibrium or move away from equilibrium with equal frequency if you like. Both processes are there. There is feedback which is either positive which then reinforces itself or negative and it corrects itself. If the positive dominates you move away from equilibrium, if negative you come closer to equilibrium. You have near from equilibrium conditions and far from equilibrium conditions.

Now in financial markets bubbles have a peculiar shape. The bust is usually much steeper and sharper and shorter than the boom. The boom develops slowly and gathers momentum, and when the other side sets in it accelerates and leads to financial collapse. That's the crisis. So there's an asymmetry in markets.

Actually both credit and leverage are at the maximum at the peak of the boom.

Then when prices decline, the value of the collateral declines. And there is a lot of doubtful credit outstanding which has to be liquidated. The forced liquidation of leverage and credit is what creates this catastrophic decline.

Now this is in financial markets. But you actually have similar processes in other spheres of human interaction [Amazing]. In politics but also in domestic life -- marriage! {Laughter} It is generally a human phenomenon that makes financial markets worth studying.

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[RandalColling]

Too bad the other two dudes dont let the smart rich guy talk. If they did more listening and less talking those two clowns could learn something and maybe they could make some money too!

[therighttoremain]

Thanks for posting.