Global financier George Soros broke the Bank of England in 1992. He predicted the economic collapse before many others. Now he says there is no point in repairing a system that is flawed. SIMON CARSWELLreports...
WHEN THE legendary US financier and speculator George Soros speaks, people tend to listen, if only because of the many fortunes he has made by not following the herd. He has many views that fall outside mainstream opinion which have made him a very wealthy man.
A regular attendee at the World Economic Forum in the Swiss resort of Davos, Soros attracted much attention at this year’s forum for his views on how to fix the world financial system and the threats still facing the global economy as countries struggle with mounting fiscal deficits.
In a wide-ranging media briefing, Soros spoke at length on the challenges still facing governments around the world, and his opinions on the measures being taken.
In recent years, Soros, a Cassandra in the financial markets, warned about the looming financial crisis before many others and predicted the economic collapse. However, he is better known in Europe as the man who broke the Bank of England by attacking sterling in a hugely profitable move that forced the pound out of Europe’s exchange rate mechanism in 1992.
As the Greek government bears the brunt of a full-frontal attack by speculators forcing the European Union to step in to protect the stability of the euro, Soros agrees that Greece is correct to be aggressively tackling its high public deficit. However, he believes that the United States and large European countries still have “plenty of room to increase their deficits”.
There is still a need for additional fiscal stimulus in large countries, he says, and the economic adjustment that comes with flooding the system with cash is not complete. Yet there is political resistance to letting national debt burdens grow. “The political resistance to it increases the chances of a double dip in the economy in 2011. That is what makes things now difficult because of the general aversion to increasing deficits,” says Soros.
The billionaire philanthropist is also opposed to introducing severe changes to the global banking system as financial institutions are still trying to trade out of their problems.
US president Barack Obama has proposed new measures, devised by former Federal Reserve chairman Paul Volcker, to prevent further banking meltdowns by cutting the size of large banks and curtailing their riskiest activities. The plan involves stopping the biggest US banks from owning highly leveraged hedge fund or private equity divisions, or trading on the deposits in their own accounts through proprietary trading.
Obama’s plan has come “too soon”, says Soros, as the financial institutions are “not out of the woods”. Repairing banking models and getting the global economy on the road to recovery involves stabilising the banks first and then regulating them more closely. The first task has not yet been completed, he says, and Obama is already moving on to the second.
“It is like a car when it is skidding – first you have to turn the wheel in the same direction as the skid, then you have to re-establish and re-gain control,” says Soros.
Difficulties have arisen because of the means by which governments around the world have chosen to fix their financial systems, he says. Instead of injecting capital into banks at an equity level – which would have wiped out existing shareholders – governments have injected capital by other means.
They are supporting banks with government bonds, which are allowing them “to earn their way out of a hole and they are doing it at remarkable rapidity”.
In contrast to the protracted recovery in Japan after the collapse of its banking system in the early 1990s, government bonds are paying out higher yields, enabling the bigger financial institutions to recover at more than twice the rate. “It is a much faster process,” he says.
Soros says that shareholders and bond holders have emerged “free and clear” while the burden of the banking rescue has been shouldered by taxpayers. “The banks’ management treated these windfall profits as something that has been earned and therefore people have to be rewarded for it so the bonuses created a political storm,” he says.
Obama’s hard-hitting proposals to reform the banking system, which include plans to levy a €66.7 billion ($90 billion) tax on the banks to recover the cost of the financial bail-out, is a reaction to the public furore over the return of the Wall Street mega-bonuses, says Soros. “To tax the banks when you are doing everything to help them to earn their way out of the hole is directly against the policy that you are currently pursuing,” he says.
Soros believes countries cannot go it alone by resorting to isolated moves to correct their financial systems. A global problem requires a global solution, he argues.
The lead taken by the G20 counties in adopting a unified approach is “moving in the right direction”, he says, but the International Monetary Fund might have to change its rules and “reapportion membership” to recognise the shift in economic power in the world.
The world economy needs a new Bretton Woods accord, the agreement that established the current global financial system out of the embers of the second World War, he says.
“The task ahead – and I don’t think this is fully recognised – is not to re-start the economy and the financial system. You actually have to create a new system because the old system has broken down,” he says.
“Globalisation has been pursued very successfully on false premises – that markets don’t have to be regulated.”
De-regulation was “contagious”, he says, because once the US and the UK led the way every country had to follow to stop capital from fleeing their country. “You can’t exist without capital,” he says. “You have to keep de-regulating as was necessary to attract the capital.”
Soros doesn’t just disagree with the timing of Obama’s plans; he believes they don’t go far enough. Even after removing the riskiest parts of the banks, the spun-off investment units will still be “too big to fail” and controls will have to be put in place to make sure they have enough capital to absorb losses and ensure they don’t take too many risks in any one area.
“The idea that you can allow those banks to fail is, I think, not credible. The fact is that when the system is in danger the authorities have always extended their interventions even beyond the area where they were in control. “This has grown and it ended in this blanket reassurance that no institution that poses as danger to the system will be allowed to fail,” he says.
“That implicit guarantee is there and to claim that it isn’t is not credible until the authorities have, over a period of years, shown that they will actually allow some institutions to fail.”
Soros says that controlling the money supply, which has been in the power of governments and regulatory authorities, won’t control credit growth. Central banks should force banks to pull back if they are lending too much to any one particular sector – property, for example. It is still not clear whether China is doing enough to prevent a credit bubble, Soros says, though he points out that the Chinese raised minimum capital requirements 17 times and that the country’s banking system came through the crisis unscathed.
However, he warns that China may face greater demands for credit as the authorities start curbing lending.
“Everybody can see the cut-off and therefore all the people are rushing to get commitments – the demand will be even greater than before. This is a major test for the Chinese economy.”
Soros is a strong critic of Alan Greenspan who maintained a low interest rate environment during his time as Federal Reserve chairman which helped to inflate the credit bubble.
Referring to Greenspan’s description of the economic boom as being driven by “irrational exuberance”, Soros says “there is nothing irrational in a bubble”.
“When I recognise a bubble I rush out and buy. That is the rational thing to do,” he says.
The recent financial crisis saw the creation of “a super-bubble composed of little bubbles that kept cropping up”, says Soros. Politically-driven de-regulation, encouraged by the views of Greenspan and like-minded central bankers and policymakers, exacerbated the problem. “When you have interest rates going very low, that is an invitation for an asset bubble. In a way we are in those conditions right now,” he says.
Soros on the Greek crisis
THE LATEST warning from George Soros is that the euro faces the threat of collapse due to a failure to resolve the Greek debt crisis by introducing proper rescue mechanisms.
In an article published in the Financial Timeson February 22nd, Soros warned that Greek crisis had brought matters to a climax but that "if member states cannot take the next steps forward, the euro may fall apart".
Soros says that the last Ecofin meeting of EU finance ministers pledged their support for the first time “to safeguard financial stability in the euro area as a whole”, but they have not yet found a mechanism because of the limited institutional arrangements within the eurozone.
He suggests the most effective solution would be to issue guaranteed eurobonds to refinance 75 per cent of the maturing Greek debt as long as Athens meets its targets to reduce its deficit from 12.7 per cent of GDP to 8.7 per cent by the end of this year.
“This would significantly reduce the cost of financing and it would be equivalent of the International Monetary Fund disbursing conditional loans in tranches,” he wrote.
A well-organised eurobond market would be desirable, says Soros, but “the question is whether the political will for these steps can be generated”.
Given that Germany is “adamantly opposed to serving as the deep pocked for its profligate partners”, Soros says that “makeshift arrangements” will have to be introduced.
“So makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large a portion of euroland to be helped in this way. The survival of Greece would still leave the future of the euro in question.”
More intrusive monitoring and institutional arrangements are needed for conditional assistance to prepare for the next crisis, he says.
