I was on a call this morning with George Soros organized by Steve Clemons of the New American Foundation. Soros is coming out with a new book called The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means discussing what he calls the deflation of the 'super-bubble'. In terms of political news, Soros made it clear he will not be spending as much money on the 2008 election. He believes, as do I, that 2004 was a special decision, and the consequences of 2008 are far less significant. He doesn't like partisan politics, and now seems focused on financial regulation and energy and climate problems.
The call was organized around Soros's ideas on the current financial crisis, which he thinks is the worst since the 1930s. There are many elements to what is going on, but the gist of the macro-economic shift is that the dollar is losing its status as the world reserve currency and the 'mortar' of the world economy will no longer be the American consumer. This crisis is different from previous busts, because the shift in global power constrains the ability of the Federal reserve to lower interest rates.
Soroes believes that the financial market's fall was acute, but is basically over. The problem now is the fall-out, which is going to cascade throughout the economy. People are going to feel it in a nasty recession and further drops in the price of housing, as the market overcorrects to the downside. The crisis was driven in the short-term by a failure of the regulators to exercise the powers they have, to allow a totally unregulated market in financial instruments to develop. The scariest market, he says, is the Credit Default Swaps market, which equals half the entire US household wealth and five times the national debt, and the biggest player there is JP Morgan.
In the past week, I have had the opportunity to ask both Paul Krugman and George Soros what the worst case scenario will look like. Krugman suggested a slightly less bad Argentine style collapse, followed by a pretty good resurgence of growth. In the end, everyone will just move 'one house to the left' as legal wrangling gets fierce. Soros believes that authorities are pretty qualified and won't let the financial system collapse, so he sees the problem as crushing the dreams of the poor and upwardly mobile African-American Latinos buying their first homes. He specifically cited Prince George's County, a wealthy African-American county hit harder by the foreclosure crisis than anywhere in the country. The county incidentally will soon be represented by Donna Edwards.
Soros was clear that this is not a natural cycle, it is an entirely man-made crisis, and it will ripple through the economy and slow down or reverse wealth creation because of a credit crunch. What we need to do, he believes, is establish a clearing house or exchange where all these trades needs to be registered and settled according to well-established rules, until that is cleared up there's uncertainty as to the value of the various unregulated instruments out there, which is why there is a credit squeeze. No one wants to lend because no one knows what anything is worth, and no one knows who the counterparties are on many of these transactions.
In terms of further prescriptions, he thinks we need to minimize the downturn by seeking to limit foreclosures in the short-term. In the longer term, he believes that the American consumer will no longer be acting as the key driver of the global economy (the 'mortar'). The next driver of demand, or the next 'mortar' of the global economy, should be infrastructure investments necessary to reduce and reverse global warming. There's trillions of legacy infrastructure that needs to be overhauled, and that's the only way we're going to find a new global equilibrium.
I believe this is what is called an 'inflection point'.