The makings of the financial crisis were all there. Times are good, so people are willing to take on risks and banks are willing to extend them credit. The credit generates more spending, creating the impression that the economy is getting stronger, which feeds demand for yet more credit, which is backed by collateral generated by the debt rather than actual earnings. “Everything builds on itself until it collapses,” says White. “This is how it always has worked.”
These days, White is thinking about how to fix economics as much as he is thinking about how to fix central banking. He joined INET’s advisory board because he appreciates the group’s emphasis on history as a guide to policy. For White, the study of economics went wrong when its practitioners began to think of themselves as physicists. They embraced mathematics to prove theories that assumed economic agents behaved the same way, all the time. The financial crisis found the models wanting.
“Mechanical physics would say, ‘Big shock in, big shock out.’ This new way of looking at the world would say, ‘No,’” White says. There’s an illustration called the Sand Game. “You drop a piece of sand and another piece of sand. So it continues. At a certain point, you drop a piece and nothing happens. Then you drop a second piece and a little avalanche happens. And maybe you drop a fourth piece and the whole thing collapses. Underneath the surface of the pile of sand is all these fracture points having to do with friction and inertia. One grain of sand can be enough to trigger the whole thing.”
The point of the Sand Game is not to render the study of economics pointless, but to be humble about the limits of human knowledge. “Maybe we need a different framework, a biological framework that will evolve over time,” White says.
Soros says INET is already one of his most successful ventures. Less than two years after the group’s founding, some of the research it has sponsored is getting published in mainstream economics journals. The revolution has begun.
If he makes it to his 90s, Soros might see the return of a functional international monetary system. Many at the conference are persuaded by theories shared by Barry Eichengreen, an economic historian at the University of California, Berkeley, and Hélène Rey, an economics professor at the London Business School. They say it is only a matter of time before the euro and the yuan become viable options to the dollar. The U.S. is bringing this shift on itself by running massive budget deficits and setting its benchmark interest rates at 0, undermining confidence in the dollar. Investors are turning to the euro as the next best thing, and are likely to continue to do so. Meanwhile, Chinese authorities are steadily allowing more yuan to circulate outside of China, an acknowledgment that their economy has become too big to control from Beijing.
Says Eichengreen, “1944 was special. The Second World War was raging. The U.S. was the dominant power. Lots of countries, because they were in the enemy camp, were not even at the table. Now, when the G20, with its diverse interests, has to agree on anything and everything, the process is going to be a long, slow one.”
The long, slow road comes at a cost. Eichengreen previously attended a conference on the international monetary system at Bretton Woods in 1992, a fact he raises to illustrate that economists and officials have been grappling with these issues for a long time. Since that gathering, the world has endured the Asian financial crisis, the Latin American financial crisis, the Russian financial crisis, the U.S. technology bust, another U.S. recession in 2001 and the Great Recession. How many crises are the leaders of the world’s major economies willing to endure? If the future is clear, why not bring it forward? This is what Soros will be telling every politician he sees.
“Their role is to lead the markets,” Soros says. “That is what makes them statesmen. If they lead, the markets will follow.”