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George Soros always starts his annual lunch at Davos by reminding his guests that while is he is primarily known as a hedge fund manager and philanthropist, his real profession is philosopher. His contribution to that field, which academic philosophers do not yet fully appreciate, is what he calls his "Theory of Reflexivity." Not to be confused with the spa treatment where they rub your feet and you feel it in your back, this is the concept that, as Soros explains, perceptions influence reality, which influences perceptions, which in turn influence … you get the idea.
Applied to financial markets, this means that investing in bubbles is not irrational. "As a participant, when I see a bubble, I rush out and buy," Soros said. The trick, of course, is knowing when to head for the exits. Since it is rational for investors to keep dancing as long as the music is playing, in the now infamous formulation of former Citigroup CEO Chuck Prince, Soros argues that it's up to financial regulators to prick market bubbles before they get too out of hand. He strongly faults former Fed Chairman Alan Greenspan for his position that it is impossible to know when a bubble is forming or to do anything about it.
But if Greenspan is wrong, how can you recognize a bubble when you're in one? This was the topic at another very good panel I attended this morning, which included Britain's chief financial regulator, Lord Turner, and the Yale economist Robert Shiller, who himself called the last housing bubble clearly and precisely. That session was off the record, so suffice it to say that the participants were of many minds about how to distinguish bubbles and about what bubbles might or might not be forming now. Soros's answer to the question of how you identify a bubble amounts to "you can just tell." Or, at least, "I can just tell."
Of course, everyone at the lunch wanted to know what bubbles the billionaire might be investing in at the moment, given his theory. Soros dodged the question when I asked him but subsequently noted, "The ultimate asset bubble is gold." I'm not sure if he meant that gold has been a bubble since the beginning of recorded history or just a bubble over the past couple of years. He never shows too much of his hand.
Asked about Obama's proposed "responsibility tax," Soros answered that the administration's various proposals were both "not enough" and "coming too soon." Responding to a financial crisis, he said, is like dealing with a skid when you're driving—you have to steer into it to regain control of the car before you turn back the other way. (Washington drivers, take note.) Soros thinks it's too soon to start taxing banks, while they are still trying to earn their way out of the hole they dug themselves into. He thinks lenders will remain cautious for some time to come and so is more worried about the risk of putting the economy back into a slump than he is about leaving markets underregulated a bit longer. He also argues a global approach, coordinated through the G20, is the only kind of financial regulation that has a chance of working.