George Soros, economic illiteracy and monetary policy
Gerard JacksonBrookesNews.ComMonday 21 April 2008
Soros's main thrust against economics is that it is based on the theory that markets bring supply and demand into balance thus securing the best allocation of resources. He argues that this theory cannot apply to the real world because it is based on the model of perfect competition, on which he thinks modern economics depends.
Economics does not assume that the market tends to allocate factors to their most efficient use — it knows. Moreover, the concept of perfect competition does not and never has underpinned economic theory. Soros would be acquainted with that fact if he had any real knowledge of economics or the history of economic thought. In fact, the theory was not fully completed until 1921 when Frank Knight finished refining it, even though its origins go back to the 1870s.
If Soros had done his homework he would have discovered that the Austrian School of economics had demolished the theory of perfect competition decades ago. Moreover, the classical economists never used the concept of perfect competition. The Austrians fully understand the futility of the perfectly competitive approach because they recognise that the notion of imperfect markets is a fallacy. Markets exist because perfect knowledge and foresight are impossible to attain. In short, markets are a substitute for perfect knowledge. This is something the neoclassical school has failed to grasp.
The Austrian School, on the other hand, stress the fact that the market is a dynamic, spontaneous process. By spontaneous, they mean that it is not the product of any conscious design; that it is an extraordinary complex coordinating process whose knowledge. It would be completely impossible for any agency or individual to collect, let alone organise, all the subjective knowledge that the market daily generates, processes, coordinates and distributes*. This explains why interventionism causes so much damage. (Witness the awful economic, social and political consequences of subsidising bio-fuels). At the heart of the market process is entrepreneurship.
The Austrians fundamental objection to perfect competition, therefore, is not that it is unrealistic but that it tells us nothing about market processes and how those processes can bring about equilibrium. It is, in fact, a dangerous economic fiction. Dangerous in the sense that it results in bad economic policies. But according to Soros the real danger from this model is that it poses an ideological threat to democracy. This is unbelievable nonsense.
Regardless of what Soros thinks, competent economists do not treat supply and demand as given in the market place other than for illustrative purposes, nor do they ignore the role of expectations. Austrian thinking on these matters has made a significant, and yet to be generally recognised, contribution to the nature and role of expectations. It continually stresses the fact that the sole source of all economic activity is purposive human action and that demand and supply are ultimately shaped by the expectations and valuations of individuals.
Soros made the ridiculous assertion that economics could not say how prices are determined without the concept of equilibrium. This is a clear case of putting the cart before the horse. Prices are determined by the supply of a good and the demand for its services. The market clears where the two intersect. Supply and demand are in turn determined by the participants' value scales which include their anticipations. Therefore it is price theory that leads us to equilibrium, not vice versa. Now this ridiculous assertion was followed by the equally ridiculous claim that the "absence of equilibrium" means markets cannot allocate to the margin. (The Atlantic Monthly, The Capitalist Threat, February 1997).
He simply does not understand that if the market has achieved optimum allocation it has, ipso facto, ceased to exist for as long as the optimum situation persists because general equilibrium has been achieved. The market, through its marvellous and inimitable processes, tends to allocate resources to the margin. It follows from this that those states with the freest markets would have the most efficient allocation of factors as measured in terms of productivity and returns. The curious thing is that Soros basically agrees with me, thus emphasising his own confused thinking. In his own words:
There is a powerful case for the free market mechanism, but it is not that markets are perfect; it is that in a world dominated by imperfect understanding markets provide an efficient feedback mechanism for evaluating the results of one's decisions and correcting mistakes. (Ibid).
Exactly. He then accused economics of creating a world where all the opportunities and preferences facing market participants are independent of each other. There is a grain of truth in this accusation when levelled at the neoclassical school that only pays lip service to economic actors. However, even it recognises that equilibrium does not mean that the participants and their preferences, etc., have been isolated, only that their expectations and plans have been brought into consistency with each other.
Soros revealed the source of his confusion and ignorance when he admitted that his experience of money markets led him to his present views. (I knew it couldn't have been serious study). This apparent revelation leads him to merely parrot the old cry that financial markets are inherently unstable, leading to breakdowns and depressions. And that this instability led to the evolution of central banks. Yet, according to him, free market "ideologues" (how lefties love that word) argue that it was faulty regulations, not markets, that were really responsible.
Markets are basically stable. What is not stable is monetary policy. And it is faulty monetary policies that destabilise economies. When the gold standard reigned supreme financial markets never witnessed the kind of prolonged financial gyrations that we are now experiencing. These wild fluctuations are basically caused by constant changes, and anticipated changes, in money supplies, price levels and exchange rates.
Furthermore, nineteenth century depressions were caused by banks unofficially going off the gold standard by artificially lowering their interest rates through credit expansion. The roots of this monetary theory of the business cycle can be found in Ricardo and the Currency School. The Austrians refined the theory and integrated it into capital theory. (Unfortunately the Austrian view has been successfully suppressed in Australia — and not by the left, who probably do not even know it exists).
Another charge he levelled against free market "ideology" is that it "does not recognise the need for a world order" (ibid). If by "world order" he means world government, then he is absolutely correct, and probably very lonely. On the other hand, if he simply means an absence of disorder and the supremacy of the rule of law then his accusation is nonsensical and malevolent.
Mr Soros is obviously a very successful currency speculator, but he is no theoretician or deep thinker. He has only demonstrated the adage that you do not need to be clever to make lots of money. He needs to be reminded of the late Ota Sik's (former economic adviser to Dubcek) warning: "You defy the market at your peril." But then he knew from experience the immense misery that millions suffered as a consequence of the anti-market policies of the late socialist states. But the lessons of history has not stopped Soros from funding anti-market forces in Eastern Europe as well as the US.
He makes much of his commitment to democratic values. Yet Soros spent close to $15,000,000 to help get McCain-Feingold passed. This atrocious bill restricts political speech in defiance of the First Amendment. It also served to increase Soros's influence in the Democrat Party. Having helped financed McCain-Feingold measure he then circumvented the law by financing political groups that are nothing but Democratic Party fronts. And this from a man who said that America needed "To dramatically reduce the role of big special-interest money in American politics" and that the country needs to go through a "de-Nazification process ".
The greatest threat to democracy at the moment is arrogant self-righteous ignorance. And bilious Mr Soros is full of it — and I suspect that it is not the only thing he is full of.
*There is a myth that Hayek improved on Mises' 1920 paper that explained why socialism is impossible. Hayek was deeply influenced by Friedrich von Wieser's general equilibrium approach and his treatment of value. It was this influence that inadvertently caused him to weaken the case against socialism by arguing that the nature and quantity of the data needed for a successful central plan could never be collected and computed. This approach reduced the problem to one of date collection and calculation.
This is a far cry from Ludwig von Mises who stressed that what really mattered is market money prices, without which economic calculation cannot exist. As these prices can only emerge where the institution of private property prevails socialism must therefore be an impossibility. In other words, the data without which resources cannot be successfully allocated are a purely market phenomenon that cannot possibly emerge in a socialist state.
One need look no further than Cuba and North Korea for confirmation of Mises' insight. We can now see that there is a fundament difference between Mises' approach and Hayek's.