George Soros: Europe is headed for recession

I just spotted an interview in L’Express with George Soros while he is in France plugging his book on the credit crisis. His overall point is that markets are not efficient. They tend to excess. Present regulatory controls and banking standards are inadequate to deal with this. Therefore, we must change regulation to adjust with the mood of the market.

The article is a pretty good read and it points to recession in America in its title. But, it also points to some trouble ahead for the Eurozone as the ECB looks to rein in inflation. The original is in French, but below is my translation.

George Soros: Recession in America is inevitable

The finance guru unveiled his “The New Paradigm for Financial Markets” in April of the USA. As his book id being released in France on Thursday, George Soros explains, exclusively for L’Express, why, in his view, the worst is perhaps to come.

In your book, you say that the U.S. will not be able to avoid recession. However, the U.S. economy seems to be coping with the shock.

In appearance only. The decline in the dollar has been strong since the spring, which temporarily limited the effects of financial crisis on the U.S. economy, excluding exports. This at the expense of the rest of the world, including Europe and China, which have been more affected than I had anticipated by the slowdown. But we should not delude ourselves. Recession in the U.S. is inevitable, even if it happens more slowly than expected. All the effects of financial crisis have yet to be felt.

So, the worst is still to come?

I am afraid so. The situation risks deteriorating. The central banks may have injected liquidity, but financial flows to the real economy remain very disturbed. Distrust prevails among financial institutions — doubts about the solvency of each other are far from gone, which affects their ability to lend money and to offer credit. This fear of the future is also reflected by a need to replenish their own capital to cover potential losses. The dislocation of the financial system is even more severe than I thought. For the first time since the 1930’s, we are on the brink of collapse.

How did we get here?

We have to go back to the beginning of the decade. Alan Greenspan, then Federal Reserve chairman, bears a heavy responsibility. His decision to drastically reduce interest rates in the U.S. was directly responsible for the creation of the real estate bubble. It’s bursting served as a detonator to the explosion of a true atomic bomb, which I have called the “super-bubble.” This is the result of several trends in long-term credit expansion, the globalization of markets, the accelerated pace of financial innovation, helped by the continued easing of regulations since the 1980’s … The common thread to all of these trends is excessive faith in market mechanisms on the part of banks and investors.

Therefore, everything is their fault? You see them as “pigs feeding at the trough”, “Panurge’s sheep” …

Financial market players believe, as taught in economic theory, that markets tend naturally towards equilibrium between supply and demand, and that deviations from this balance are the result of chance. They also think that they have perfect information. All their risk assessment is based on these assumptions. But they are wrong! The economy and finance are not exact sciences, the human factor plays a fundamental role, and man, by definition, makes errors … These errors, these misconceptions, affect market prices, which never reach equilibrium. When prices rise, markets are too confident and buyers are wealthy, and when prices fall, the opposite is true. That is why, when a bubble is formed, there is no chance that it deflates smoothly. This is what I call the “boom bust”: first expansion, and then a long, gradual acceleration, then contraction – sudden and brutal.

The world of finance he learned the lesson?

I think not. Other bubbles were formed in oil, food, commodities … Financial markets are exuberant by nature, and they will remain so if we give them too much freedom. They need rules.

It is rather surprising to hear the inventor of hedge funds call for more regulation …

Wait a minute! I am not talking about over-regulation, like we had following the Second World War. Regulators are human beings, they are wrong, too, and in addition they are bureaucrats who make decisions too slowly and under some political influence … But finance has become so unreasonable that it needs to be controlled, without impeding economic activity. The central banks bear this responsibility. They control the money supply, but the subprime crisis has shown that this is no longer enough: they must also control the supply of credit. Moreover, conservative standards set in stone the minimum amount of reserves that banks must hold: it is a mistake. We must be able to regularly adjust to the mood of the market. In general, the rules must change in order to counterbalance the excesses of the market.

You speak little of Europe in your book. What is your diagnosis?

There has not been as much excess in the euro zone as in the US. But there are other problems … In particular, I think the attitude of the European Central Bank (ECB) and the influence of unions. In Germany, they are fighting for very high wage increases, around 7%! This is likely to fuel further price increases. But inflation is precisely the only topic of concern to the ECB. Therefore, it will maintain high interest rates, which will affect consumption and keep the euro overvalued. This could well trigger a recession in Europe too.

La Vérité sur la crise financière, George Soros, Denoël, 216 pages, 18 euros.

Source
George Soros: “La récession américaine est inévitable” – L’Express