Book Review: The Alchemy of Finance by George Soros

“The man who broke the Bank of England” is widely acclaimed as one of the investment greats of our time so I thought it worthwhile to absorb his insights. I’m not sure if it was the tone, or approach or language, but reading the book was actually quite hard work. I struggled to engage with the main chapters where Soros ran through his interpretation of the financial events of the 1970’s and 1980’s. It felt like he kept on delving into too much detail and I lost the general thrust and main points he was trying to convey. In fact, I didn’t read the full book and focused mostly on the first and last few chapters of the book. That being said, I found Soros’s philosophical exploits intriguing and beneficial. He thinks about markets deeply, is able to contextualise market events in his own head very well and makes numerous profound observations. There must loads to learn from this approach despite the difficulty in digesting the book itself. I’d advise any prospective reader to jump around the book and not remain committed to reading each detail on every page.

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The concept of reflexivity is powerful, applicable and resonated with me, particularly given my interest in Austrian business cycle theory and the praxeological approach of Mises and Hayek. Soros argues, in situations with thinking participants there is a two-way interaction between the participants thinking and the situation in which they participate. There is a feedback loop between understanding the situation and the actual situation. For example, we try to predict the future and make a decision for that future but our decision today can influence the future. We must always be careful and aware of the limited predictive power in situations with thinking participants due to the persistent uncertainty this feedback loop creates.

Many academics are unwilling to appreciate the theory of reflexivity due to the lack of scientific grounding and true predictive power. Soros does, however, note that pure scientific pursuit leads us to theories like the efficient market hypothesis. The efficient market hypothesis makes predictions, is useful, but it is actually wrong because it doesn’t fully explain complex human interactions within markets. Clearly, markets aren’t efficient otherwise there wouldn’t be sudden repricing’s of risk nor would a money manager like Soros beat the market performance over an extended period of time. Soros takes this debate further by arguing that social sciences like economics tried too hard to copy the success made by natural scientists. Soros disagrees with Karl Poppers “unity of knowledge” – that the same standards and criteria apply to natural and social sciences. Natural scientific phenomena are impervious to what people think about them but social phenomena are strongly influenced by human feelings and emotions. He goes as far as to say “social science” is a false metaphor and we’d be better off if we recognised as much.

I strongly agree with Soros that a different approach is required in social sciences. I think an overly scientific approach to monetary economics, for example, leads to technocrats within organisations like the Federal Reserve who are single-mindedly focused on their theoretical models of the economy. The myopic focus implies that the technocrats don’t properly understand the broader impact of their policies on the human psyche, business cycles and qualitative aspects of the economy. For example, low-interest rates encourage risk-taking and shorten people’s time horizons, which leads to more consumption relative to production. A greater focus on consumption optically boosts economic output in the short-term but restraints output in the future because capital is consumed rather than re-invested into productive activities.

Soros has an amazing appreciation of the qualitative. He clearly appreciated the hollowing-out of the US economy in the 1980’s saying that increasing financial volatility creates financialisation of the economy because financial assets can respond more quickly than real assets. I am sure he must have great insights on this theme today, during the Trump Presidency. A strong argument could be made that the US economy has continued to hollow-out since the 1980’s due to increasing focus on low-interest rates, consumption and a weak currency as the potential drivers of economic activity rather than real productivity.  The economic hollowing-out has led to unemployment and disgruntled voters who are more receptive to Trump’s politics.

Cultural values can be viewed through the reflexive lens because if a concept proves fruitful, society is more likely to accentuate the importance of that concept. For example, the predominance of economic values within western society is a function of the economic success achieved in these countries. That economic activity has borne positive results, has enhanced the value people put on economic values. There is no doubt in Soros’s mind that American emphasis on material values, profit and efficiency has been carried to an extreme. In fact, all reflexive processes are bound to lead to excesses. But it is difficult to determine what is excessive and what is normal. Does normal even exist? Perhaps the current backlash against western capitalism is a sign that western focus in this direction was excessive?

Dwelling on normality again, Soros argues that the concept of equilibrium is redundant. It makes more sense to claim that markets tend towards excesses, which become unsustainable and are eventually corrected. In his eyes, markets fail to allocate resources perfectly but uses a Winston Churchill quote on democracy to indicate his continued faith in the market. “Democracy is the worst form of government, except for all the other ones.” Soros’s ability to be so sceptical about the market but at the same time be such a strong advocate is powerful and refreshingly different from the dogmatism espoused by many others.

While I agreed with the broader philosophical approach, there were a few conclusions that appeared somewhat inconsistent. For example, Soros displays a great understanding of credit creation and the credit cycle. He seems to recognise that the eventual credit cycle bust is inherently created by the credit creation in the first place. But he argues that the inevitability of the credit cycle makes regulation a necessity. He also recognises that regulation itself can create a reflexive and unsustainable system, creating its own boom and bust cycle. What if the regulation exacerbates the cycle rather than reduces it? In this case, is regulation necessary or a hindrance? Modern-day central banking, for example, has tried to eliminate recessions and business cycles but could very likely have just made these cycles longer and more extreme, with more systemic consequences. So while regulation might have been implemented to reduce the inevitability of the credit cycle, perhaps it has exacerbated the consequences?

Another great insight is the salesman principle – don’t get emotionally attached to an investment. Soros argues that an investor needs to have a passionate interest in the truth in order to be successful, which is one of the reasons why financial markets have been such a rewarding exploit for Soros over the years. “The market is a harder taskmaster than academic debate.” He also notes that he has always had a strong survival instinct, which may have been bred into him when his family escaped Nazi persecution when they fled Hungary for England in the 1940’s. Part of this instinct is trusting his gut and the physical signals he receives. For example, Soros would often experience back-pain just before something monumental was going to happen in the market and wouldn’t relent until he had figured out the cause for his anxiety.

Not only are the specific philosophical insights powerful, but I took great solace from the fact that an investment giant like Soros spends such a large proportion of his time engaged in philosophical pursuit. There are times when I feel I spend far too much time meditating about a market event rather than honing directly into the investment implications. While I will continue to focus on pragmatic investment implications because this is an important discipline, the extent of Soros’ philosophical exploits highlights the on-going importance of deep critical thinking.

Soros spends that last chapter conducting a fair amount of self-reflection, which was both fascinating and entertaining. He admits that he has always held an exaggerated sense of self-importance, sometimes comparing his own ideas to those of Keynes and Einstein. In the past, he had enough self-awareness to keep this self-importance to himself but his failure to contend with the emotions was a considerable source of unhappiness. The challenge of the financial markets and his success within them implied that Soros fulfilled his sense of grandeur, which lead him on the path to this book. Writing the book has been fantastic, created a major sense of accomplishment and reduced the unhappiness. I loved Soros’s recognition that writing exposed him to criticism, both from himself and others, which allowed him to properly appreciate his limits and accurately challenge those limits. I think that writing down our thoughts and exposing them to criticism is a remarkably rewarding process!

The philosophy gets grand enough for Soros to offer an intriguing attempt to condense the meaning of life in the conclusion. “Every human endeavour is flawed. But if we were to discard everything that is flawed there would be nothing left. We must, therefore, learn to make the most of what we have. The alternative is to embrace death. Death can be embraced in many ways. For example, the pursuit of perfection is equivalent to choosing death over life because true perfection in complex human endeavours is impossible. Carrying this line of thinking to its conclusion, the meaning of life consists of the flaws in one’s conception and what one does about them. Life can be seen as a fertile fallacy.”


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