The Balham Review of Books

A publisher friend of mine told me that there is only one rule of book reviewing; you’ve got to be rude. Every review should be a vicious exposition of the vituperative arts.

So the book I thought I’d review today – George Soros’ ‘The Credit Crisis of 2008 and What it Means’ – started out in promising fashion. The title was none too snappy, to say the least, and then he got into philosophy. And the problem with philosophy is that most of it is complete gibberish. There’s a great book called ‘The Art of Plain Writing’ – by Rudolf Flesch – that sets out the gold standard for clear prose. I reckon that just one in forty philosophers is capable of constructing a clear sentence. I don’t know the profession got there – after all these boys are there to make sense of the world. But somehow they’ve got themselves so tied up in abstruse isms – they’ve turned into a bunch of Foucaults.

Three chapters in, the Soros book was suitably prolix. It was heading for a good book review.

But, unfortunately, it all went downhill from there – the book started making sense. Because Soros basically has macro down pat. The big point is that nobody knows for sure everything that’s going on. But we act on our imperfect view of the world. And that changes the world, and it changes our view of the world. The problem with this is it means that there’s no such thing as demand and supply curves. Because every purchase and every sale influences how all the players in a market think about demand and supply. And that means that the central tenet of modern macro – that prices today don’t influence prices tomorrow – well, that’s not true. That means there’s no such thing as an economic equilibrium. The future is indeterminate.

It makes you wonder about why people pay so much for economic forecasts.

Now Soros complains that people haven’t taken his ideas on this theme – which he calls reflexivity – seriously enough. But I think there’s loads of serious analysis on this. But it’s by polymaths, not economists. And Benoit Mandelbrot is probably at the forefront of it – with his view that markets are driven by power laws. A power law basically means that prices today influence prices tomorrow. And lots of results come from it. The most fundamental is that the bigger the power law, (or the more ‘reflexive’ the system to use Soros’ term), the bigger the fat tail; the more likely you are to see extreme events. Another is the volatility moves in phases. It puts the lie to VAR. And it means that risk shouldn’t be left in the hands of risk managers. For me, the only way to manage risk is to bet on self-reinforcing processes and extreme events. And that suits me – those are often the best risk/reward trades.

Soros then goes on to run through how he made money backing self-reinforcing booms, and busts, in conglomerates in the 60s, in REITs, in growth banks etc. It’s all good stuff.

He tells how he got back into the action last August, and he sets out his own macro trading diary – something he strangely calls a ‘real time experiment’ – all the way up to mid-March. This kind of thing is fantastic – I love reading how the greats break it down – and this almost in real time.

Soros’ broad brush view is similar to mine – he thinks China and the oil states have enough ‘stuff’ to weather the credit storm. But the developed world will suffer. Because – after a 27 year ‘super bubble’ – there’s hardly a soul who understands how easily housing, credit and consumers in the developed world could form a whirlpool of self-reinforcing capital destruction. When do the problems really start? When the fed cuts rates but the 10-yr yield rises. It hasn’t happened yet. But it’s getting closer.

The basic point; the US dollar is going to pass on the mantle of global reserve currency. And that will be disruptive, to put it, er, mildly.

What was Soros doing to play this from the start of the year? He was long Chinese and Indian stocks, short US and European indices. He was short the dollar and short US treasuries. He was looking for a short term ‘tradeable bottom’ in stocks around mid-March.

Now my overall view is not a million miles from this. But, by virtue of a smaller size, I have been playing it a little differently. I think this market is not one to trade with the big indices – but instead with individual stocks. The slight difference in my view is that, while I believe that Chinese and Middle East growth is self sustaining, the big long opportunities are in resources and infrastructure – and many of those stocks are listed in Europe and the US. So I’ve no problem holding those stocks, as well as the big resource stocks in Brazil.

The second difference is I think the next blow-up comes not from the banks in general, but from the recipients of credit. The banks will do everything in their power to survive – and that means yanking liquidity from the weakest credit. And I think the weakest credit is Eastern Europe. When the credit crisis rears it head again, and I’m betting that it will do exactly that later this year, I think the economies of the Ukraine, Hungary, Slovenia and Lithuania are going to be right at the heart of it.

I’ve been busy losing money at various times over the last month shorting Erste bank, Swedbank and the Greeks as a play on the Eastern European theme – as they are the biggest lenders in the region. I don’t mind losing money on these – I’ve kept the positions very small as the stocks have rebounded, and I’ve been making out like a bandit on my long book anyway. But by keeping these shorts on board, I’ll see it as soon as they start misbehaving – and I’ll get the positions to serious size in rapid fashion.

I’ll be doing the opening presentation at the Citigroup global commodities and currencies conference on Wednesday. Hope to see you there.