Greater-fool theory, Soros-style

Carl Remick carlremick at hotmail.com
Tue Feb 20 17:41:58 PST 2001


[From Warwick University Political Economy Professor Robert Skidelsky's review of George Soros' _Open Society: Reforming Global Capitalism_ in NY Review of Books.]

Soros claims that in his concepts of reflexivity and fallibility are to be found the clues to much of what "goes wrong" in human affairs. Flawed thinking, precisely because it cannot be readily corrected, can take on the character of self-fulfilling prophecy. Only abject failure -- a collapse in the market -- reveals the character of the flaw. Trend-following behavior explains how prices of shares and currencies can deviate for long periods from their "fundamental" values. Soros writes: "In my days of actively managing money, I used to get particularly excited when I picked up the scent of an initially self-reinforcing but eventually self-defeating thesis. My mouth would water as if I were one of Pavlov's dogs." Soros attributes his success to his private understanding that all his hypotheses were flawed. "I liked to invest in flawed hypotheses that had a chance of becoming generally accepted, provided I knew their flaws. This approach allowed me to sell in time."

Social and political life, no less than financial trading, is riddled with flawed hypotheses that persist long past the time when reality should have shown them up to be fraudulent. Social science, he writes, is a compendium of flawed thinking disguised as scientific understanding." In social, political, and economic matters, theories can be effective without being valid. Although alchemy failed as science, social science can succeed as alchemy."...

One interesting reflection arises. A great deal of modern economics is based on the accommodation of the discipline to the demands of mathematics. Models based on dynamic disequilibrium or nonlinearity such as those suggested by Soros are intractable to mathematical formulation. Without the postulate of general equilibrium there is no solution to the system of simultaneous equations which economics needs to prove that markets allocate resources efficiently. That is why economics has been uncomfortable with attempts to model economies as sequences of events occurring in historical time -- which is what they are. There is a nice irony here. The more "formal" economics becomes, the more it has to treat reality as a purely logical construction. When it looks on the market system and finds it good, its admiring gaze is actually directed at its own handiwork. Fortunately, when it comes to giving policy advice, most economists' common sense overcomes their mathematics.

[Full text: http://www.nybooks.com/nyrev/WWWfeatdisplay.cgi?20010308010R#top]

Carl

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