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Soros: Prepare for 'Wealth Destruction'

Thursday, 15 May 2008 02:32 PM

George Soros doesn’t mince his words when it comes to the credit crisis.

The U.S. has weathered the “acute phase” of the crisis, which he calls the worst since the 1930s, the chairman of Soros Fund Management and founder of the Quantum Fund said in several interviews recently.

“The days of rapid financial wealth creation are over. We’re now in a period of wealth destruction. It’s going to be very hard to preserve your wealth in these circumstances,” he told Money magazine.

The Fed’s rate cuts, down to 2 percent from 5.25 percent eight months ago, ultimately won’t prove enough, Soros says.

“The Fed’s first duty is to prevent the financial system from collapsing. It’s shown it can do that, and the markets are breathing a sigh of relief. But we can’t avoid the fallout in the real economy,” Soros says.

Recession is ahead, as is inflation and a flight from the U.S. dollar. But the Fed cannot simply increase the money supply as it might in normal circumstances to fight the recession. At least not without serious inflationary consequences, Soros warns.

“That’s why I think this crisis is so serious. The Fed’s power to intervene is limited,” Soros says.

Soros anticipates further sharp declines in housing prices.

“Americans ultimately won’t escape this episode without suffering a noticeable decline in their standard of living,” he warns in an interview with USAToday.

Soros says the Fed’s efforts to pump cash into the banking system to ease liquidity and the government’s $168 billion economic stimulus package, including millions of tax rebate checks, will not be enough to ignite a recovery.

What’s more, he adds, even as the clean-up continues, new bubbles are already forming in commodities markets and perhaps in China.

The Asian giant faces serious domestic inflation and export weakness if the U.S. downturn spreads abroad, Soros warns.

“China is not immune to the worldwide dislocation that started here,” he says.

As for his own money, Soros has put most of it in the hands of other managers in the form of an endowment fund. But he’s back in the game in this market, he tells Money.

“I came out of retirement and set up an account to hedge their positions,” he says. The strategy then was to short the dollar and U.S. and European markets and to go long in emerging markets.

“That worked last year, but this year bonds kept going up and emerging markets down, so I’m about even,” Soros says.

As for how we got here, Soros turns toward the philosophical side of economics.

He sees the subprime crisis as the event that pricked both the housing bubble and what he calls a 25-year-long “super bubble,” one he contends originated in the “debt-laden policies of the Reagan administration.”

Soros even goes a step further. He believes that the credit crunch wouldn’t have happened at all if the bankers who developed collateralized debt obligations (CDOs) had believed in the concept of “reflexivity” that he’s advocated for more than 20 years — albeit with little success — and not just conventional, classic free market theory.

Unlike free-market thought, which suggests that prices tend to balance over time and thus to reflect underlying value, reflexivity holds that prices affect fundamentals, leading to unbalanced markets and misunderstood value. Soros has invested heavily on that principle over the years.

According to Soros, standard economy theory “is flawed because it treats markets populated by thinking human beings as if they operated according to the natural laws that govern atoms and molecules.”

“If banks, investors, and regulators had embraced reflexivity years ago, there never would have been a financial crisis,” he insists.

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George Soros doesn’t mince his words when it comes to the credit crisis.The U.S. has weathered the “acute phase” of the crisis, which he calls the worst since the 1930s, the chairman of Soros Fund Management and founder of the Quantum Fund said in several interviews...
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