Soros - The Boom/Bust Cycle: Why Thin Cows Eat Up Fat Cows

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The Boom/Bust Cycle: Why Thin Cows Eat Up Fat Cows

By EDWARD E. AYOUB


Genesis recounts how Pharaoh had a dream that troubled his spirit: Seven fat cows came out of the Nile, then seven thin cows followed and ate the first seven up. None of the magicians and wise men of Egypt could interpret Pharaoh’s dream; but Joseph, whose family had sold him into slavery in Egypt, could. Joseph's interpretation was as follows: "Behold, there come seven years of great plenty throughout all the land of Egypt: And there shall arise after them seven years of famine…"

The boom/bust cycle has a long and venerable history. Its interpretation has preoccupied clever minds since archaic times. Some, like George Soros, made a great fortune out of deep insight into the cycle’s workings. It should be quite interesting, I mused, to probe the mind of billionaire money manager Soros to discover why thin cows eat up fat cows.

The biblical reference to cows devouring cows is ironic. In the Preface to The Crisis of Global Capitalism (PublicAffairs™, New York, 1998)1, Soros wrote that he sometimes felt like "a gigantic digestive tract, taking in money at one end and pushing it out at the other." Apparently, the "two ends" are connected by "a considerable amount of thought." Luckily, the essence of Soros’ thought can be encapsulated in one word: "Reflexivity."

Should you care about reflexivity in financial markets?

What is "reflexivity"? According to Soros, reflexivity is the dynamic two-way interaction between reality and thinking. Reality affects thinking, and thinking affects reality. By its very nature, reflexivity gives rise to uncertainty. The gap between expectations and reality can expand out of control -- in a "self-reinforcing" or "self-defeating" way. This is especially true in financial markets.

Why should you care about reflexivity in financial markets? Because financial decisions based on expectations about the future can affect the very financial future the decisions anticipate. And what does reflexivity have to do with boom/bust cycles? According to Soros, "what are considered fundamental values or objective criteria are often reflexive and it is the failure to recognize this fact that engenders a boom/bust process." In other words, for Soros, the cause of the boom/bust process is the failure of market participants to recognize the reflexive gap between their collective expectations and reality. But is this really so?

Yes, especially if market participants move in herds. According to Soros, "Trend-following behavior is not necessarily irrational. Just as certain animals have good reasons to move in herds, so do investors." But do clever money managers follow financial trends the way herds do? Most certainly not. Soros, for example, knows financial values are reflexive; and he awaits the opportunities to exploit them -- "both on the upside and the downside."

Why is Soros sounding the alarm? Should you worry?

While Soros does not cling to the fundamentals, many in herds do. And what happens to investors who cling to the fundamentals? They risk getting "trampled by the herd."

Unfortunately, those who cling to the fundamentals are not the only ones to get trampled. The money making game can destabilize whole sectors of the economy -- if not whole countries. The game can be so rigged it can despoil the economic life plans of millions of families. The recent Asian, Russian, and Latin American crises are proofs of massive economic destruction from speculation. More important, they are a forewarning and an omen. With globalization, the money making game can get out of control globally. Unfettered, global financial crises can lead to the collapse of capitalism itself. No wonder Soros is sounding the alarm...>

http://www.mindhat.com/columns-eea/19991215.htm

Release Date: December 15, 1999
© 1999 Macroknow Inc. All Rights Reserved.

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Josephy Schumpeter
http://en.wikipedia.org/wiki/Joseph_Schumpeter

Schumpeter - Creative Destruction
http://www.investopedia.com/terms/c/creativedestruction.asp

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Schumpeter = Greenspan's hero.