The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means

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PublicAffairs, May 6, 2008 - Business & Economics - 192 pages
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In the midst of the most serious financial upheaval since the Great Depression, legendary financier George Soros explores the origins of the crisis and its implications for the future. Soros, whose breadth of experience in financial markets is unrivaled, places the current crisis in the context of decades of study of how individuals and institutions handle the boom and bust cycles that now dominate global economic activity. “This is the worst financial crisis since the 1930s,” writes Soros in characterizing the scale of financial distress spreading across Wall Street and other financial centers around the world. In a concise essay that combines practical insight with philosophical depth, Soros makes an invaluable contribution to our understanding of the great credit crisis and its implications for our nation and the world.

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This is a great book by the Master himself written in 2007 & 2008. Soros starts by explaining the new theory that he has developed called the "Theory of Reflexivity". He says that the theory of equilibrium and the theory of perfect competition are both insufficient to address the markets as both are based on false premises.
This crisis as per Mr. Soros is different from any previous crisis: the current crisis marks the end of an era of credit expansion based on the dollar as the International Reserve Currency.
The current crisis is the culmination of a super boom that has lasted for 25 years. To understand what is going on a new Paradigm in needed.
The current Paradigm, namely that financial markets tend toward equilibrium, is both false and misleading and our current troubles can largely be attributed to the fact that the International financial system has been developed on the basis of this paradigm.
Mr. Soros proposes a new Paradigm as under:
It deals with relationships between thinking and reality.
It claims that misconceptions and misinterpretations play a major role in shaping the course of history.
The new paradigm is not confined to financial markets alone.
The theory of perfect competition is based in particular on the assumption of perfect knowledge, however Mr. Soros came to realize that market participants cannot base their decisions on knowledge alone. Their perceptions were biased and hence had ways of influencing not only market prices but also the fundamentals that those prices are supposed to reflect.
The participants thinking plays a dual function:
1 - On the one hand they seek to understand their situation - Mr. Soros calls this the cognitive function.
2 - On the other hand they try to change the situation - Mr. Soros calls this the participating or manipulative function.
The above two functions work in opposite directions and under certain circumstances they can interfere with each other. Mr. Soros calls this interference reflexivity. Hence the new theory as propounded by Mr. Soros - Theory of Reflexivity.


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George Soros is chairman of Soros Fund Management and is the founder of a global network of foundations dedicated to supporting open societies. He is the author of several best-selling books including The Bubble of American Supremacy, Underwriting Democracy, and The Age of Fallibility. He was born in Budapest and lives in New York City.

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