Soros on the Global Economic Crisis

Last Thursday George Soros published a piece in the Huffington Post, an excerpt from his new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.  To get a true sense of the difficulties ahead from one of the world's most creative thinkers, I recommend reading this piece, and picking up the book. From what I've read so far it is a very helpful guide to understanding what is happening today, and contributes some important ideas to the debate about what to do now.   I particularly like his thoughts on how to remake the domestic mortgage market.

The Huffington Post article begins:

The bursting of bubbles causes credit contraction, forced liquidation of assets, deflation, and wealth destruction that may reach catastrophic proportions. In a deflationary environment, the weight of accumulated debt can sink the banking system and push the economy into depression. That is what needs to be prevented at all costs.

It can be done by creating money to offset the contraction of credit, recapitalizing the banking system, and writing off or down the accumulated debt in an orderly manner. For best results, the three processes should be combined. This requires radical and unorthodox policy measures. If these measures were successful and credit started to expand, deflationary pressures would be replaced by the specter of inflation, and the authorities would have to drain the excess money supply from the economy almost as fast as they pumped it in. Of the two operations, the second is likely to prove both technically and politically even more difficult than the first, but the alternative--global depression and world disorder--is unacceptable. There is no way to escape from a far-from-equilibrium situation--global deflation and depression--except by first inducing its opposite and then reducing it.

The size of the problem is even larger than it was in the 1930s. This can be seen from a simple calculation. Total credit outstanding was 160 percent of GDP in 1929, and it rose to 260 percent in 1932 due to the accumulation of debt and the decline of GDP. We entered into the Crash of 2008 at 365 percent, which is bound to rise to 500 percent or more by the time the full effect is felt. And this calculation does not take into account the pervasive use of derivatives, which was absent in the 1930s but immensely complicates the current situation. The situation has been further aggravated by the haphazard and arbitrary way in which it was handled by the Bush administration. The public and the business community suffered a shock in the aftermath of the Lehman Brothers default, and the economy has fallen off a cliff. The next two quarters will show rapid deterioration.

To prevent the economy from sliding into a depression, President Obama must embark on a radical and comprehensive policy package that has five major components:

1. A fiscal stimulus package
2. A thorough overhaul of the mortgage system
3. Recapitalization of the banking system
4. An innovative energy policy
5. Reform of the international financial system

Read on here for more, or visit Mr Soros' website here.