Money and risk
George Soros
Reflexivity
George Soros (1930– · Budapest and New York) — Reflexivity.
What actually happened?
16 September 1992, Black Wednesday. Sterling had been forced into the European exchange rate mechanism at a rate that flattered it, and the British economy was paying for the flattery. Soros judged that the position could not hold, that the government would eventually have to leave, and that sterling would fall hard when it did. He borrowed heavily and sold. The Bank of England bought pounds all day and spent billions failing to hold the line. That afternoon Britain announced its withdrawal, sterling collapsed, and his profit for the day passed a billion dollars. He said afterwards that he had not attacked the pound. He had corrected a false equilibrium.
Reflexivity
Mainstream economics assumes markets tend towards equilibrium. Soros says that is simply wrong. Expectations shape behaviour, behaviour shapes the market, and the market reshapes expectations. It is a loop that never converges, and the market is not a machine seeking balance but a system being made by the beliefs it is also making.
Houses rise, buyers expect more rises, more buyers arrive, prices rise again, speculators pile in, the bubble forms. It runs until something outside it breaks the circuit.
Fallibility as a working method
I am more aware than anyone that I might be wrong, and he means it operationally: every position is built on the assumption that the assumption behind it could be false. When it turns out false he cuts immediately and does not argue for himself.
Before shorting sterling he kept asking where his own case could break — what if the Bank defends the rate at any cost? He sized the bet only after judging those branches survivable.
Boom and bust
Applied to the macro picture: every large boom contains a trend that participants have misread, the misreading drives the boom, the boom reinforces the misreading, and the gap between belief and reality eventually grows too wide to hold. Naming the current misconception is his core analytical move.
2008: the misconception was that house prices only go up. It drove the subprime boom, the boom confirmed the misconception, reality punctured it, and the system went down.
Knowing when you're wrong
He credits his fortune to recognising his mistakes rather than to being right, and pairs it with the rule that what matters is not whether you are right but how much you make when you are and lose when you are not. The two together are one system.
Wrong ten times at a small cost each and right once at ten times over is a winning year, and it is only reachable if your pride has been moved off being right.
The open society
Fallibility is a political philosophy too. No institution or ideology is perfect, so a society has to stay open enough for error to be found and corrected. A closed society is one that claims it cannot be wrong; an open one accepts that it will be and builds the machinery to fix it.
How do I use it today?
On the next decision that matters, write down your core assumption first, then interrogate it one line at a time: under what circumstances would this be falsified? If it is falsified, what is the plan? Fix the falsifying condition and the exit before you commit, and give somebody else the job of holding you to it. The point is to build might be wrong into the decision process rather than admitting it afterwards, when the admission costs the most and convinces you least.
Deep read
Read alongside
Further
Lines to keep
I'm only rich because I know when I'm wrong.
Market prices always distort the underlying fundamentals.
There is no shame in being wrong, only in failing to correct our mistakes.
Markets can influence the events that they anticipate.