Published: October 23 2009 23:32 | Last updated: October 23 2009 23:32
Chrystia Freeland, US managing editor, interviewed George Soros, the fund manager, about the state of the world economy, relations between the US and China, his investment performance and regulating bankers' compensation. This is a transcript of that interview.
FT: Thank you for joining us, Mr Soros.
GS: It's a pleasure.
FT: How do you judge the state of the world economy? Has the world recovered from the crisis of 2007/2008?
GS: Well, certainly the financial markets have regained their composure so they're beginning to function again, and also the world economy has overcome the shock that it has suffered because for a while everything froze and now things are moving again. So there is rebound, but I think that the facts of the crisis will take a long time for the world to absorb and the main source of the problem is in the United States. This is where consumers have spent more than they earned for a period of 25 years; where we have accumulated current account deficit that reached 6.5 per cent at its peak, which actually could have continued because there were other countries – particularly China and the Asian tigers – that were very happy to run a continuous surplus and to finance our deficit. So that could have actually continued, but the households became over-indebted and it's the consumer who accounts for over 70 per cent of the US economy that has to cut down, and that will take a while.
Then also you've got the banking system that basically was bankrupted. It's at the bottom and has to earn its way out of a hole and, again, it's happening at a pretty fast clip because banks borrow at zero and buy 10-year government bonds, yielding 3.5 per cent, and that's a pretty fast rate of earnings for no risk. So, they'll earn their way out of a hole, but it will also take time. And then there's still the whole area of commercial real estate, where the losses have not been recognised. So the source of weakness in the world will be mainly in the US consumer spending and in, let's say, the decline in the banking sector.
FT: And is that weakness in the US sufficiently grave that there could be a W-shaped recovery, that there could be another dip downwards?
GS: Well, I think certainly there could be another dip in the stock market because, right now we are enjoying the confidence multiplier and there's a sort of a hope that this is a crisis like the previous ones and we will just sort of recover in a V-shape recovery. So, when that hope is not fulfilled, I think that will be ...
FT: Which you are certain it will not be fulfilled?
GS: Well, I can't see it being fulfilled. I may be wrong. I've been wrong before, but I just don't see where the growth in the US economy can come from.
FT: Given this continued weakness in the US economy, are people right to start to be concerned about the dollar?
GS: Well, they are of course and the dollar is a very weak currency except for all the others. So there is a general lack of confidence in currencies and a move away from currencies into real assets. The Chinese are continuing to run a big trade surplus and they're still accumulating assets and basically the renminbi is permanently undervalued because it's tied to the dollar. There is a diversification from assets that are normally held by central banks into other assets, especially in the area of commodities. So there is a push in gold, there's a strength in oil, and that is in a way a flight from currencies.
FT: Is there going to be a tipping point, a moment at which the dollar is fatally weakened? Or does it just sort of carry on?
GS: As long as the renminbi is tied to the dollar, I don't see how the decline in the dollar can go too far. Now, of course, to some extent it's very helpful because with the US consumers saving more and spending less, exports can be way for the US economy to be balanced. So, an orderly decline of the dollar is actually desirable.
FT: Does it, at some point, need also to decline against the renminbi? Does there need to be some sort of a new global currency deal?
GS: No. I believe that basically the system is broken and needs to be reconstituted. We cannot afford to have the kind of chronic and mounting imbalances in international finance. So, you need a new currency system and actually the special drawing rights do give you the makings of a system and I think it's ill-considered on the part of the United States to resist the wider use of special drawing rights. They could be very, very useful now when you have a global shortfall of demand. You could actually internationally create currency through special drawing rights and we've done it. We issued $250bn and that's a very, very useful step, except the rich countries don't actually need the additional reserves, so all they can do is put it in the shop window and say, we have got that much extra. But they can't actually use it. Now I think it could be used to provide global public goods. The rich countries could put their allocations in escrow. The problem is that there is a cost to using SDRs. It's a very small cost at the moment; it's less than 0.5 per cent, but still is a cost, so somebody has to pay it and I think we have actually the means to do it because the IMF has very large gold reserves – kept in the books at a very low price – and it has been decided to use those gold reserves to the benefit of the least developed countries. So, the IMF could actually pick up the cost of paying for the special drawing rights ...
FT: Using its gold reserves?
GS: And, in fact, it's being done. It hasn't had any publicity, but I understand that in Istanbul a deal was signed where I think the UK and France actually transferred $2bn of their SDRs, or 2bn SDR worth to the least developed countries, and the IMF picks up the cost. So, it's a road that's already being used and it could be used on a larger scale.
FT: What sort of a financial deal should Obama be seeking to strike when he travels to China next month?
GS: I think this would be time because you really need to bring China into the creation of a new world order, a financial world order. They are kind of reluctant members of the IMF. They play along, but they don't make much of a contribution because it's not their institution. Their share is not commensurate ... their voting rights are not commensurate to their weight, so I think you need a new world order that China has to be part of the process of creating it and they have to buy in. They have to own it the same way as, let's say, the United States owns the Washington consensus, the current order, and I think this would be a more stable one where you would have co-ordinated policies. I think the makings of it are already there because the G20, in agreeing to peer reviews, effectively is moving in that direction.
FT: Do you think it's possible to persuade China to allow the renminbi to become stronger?
GS: I think that they would be ... they've been advocating for it, so I would take them at their word and use this as a special drawing rights more often and make the renminbi, even though it's not convertible, part of the SDR. In other words, it should be one of the currencies used in the special drawing right arrangement, and that will bring them in.
FT: And that's possible even with the renminbi not being convertible?
GS: Yes. Yes. It has been considered before and I think the Brazilian real should also be part of it. I think that a number of currencies which constitute a basket can be and should be increased.
FT: And what about the American concern that aiding and abetting this move away from the dollar as the world's reserve currency ultimately means a weakening of the US economy?
GS: No. I think that is ... I mean, we did have great benefits from it, but we have abused it and I don't think we can continue abusing it anyhow. So it is not necessarily in our interests to have the dollar as the sole world currency because as the world economy grows, it needs an additional currency and, if the dollar is that additional currency, it means that the US has to have chronic current account deficit. And that is not appropriate. I think it's in our interests as well to reform the system.
FT: At least in the short-term, though, isn't it very convenient for America that the rest of the world is underwriting American spending right now?
GS: Yes, it is, but the willingness to do so is greatly diminished. I think that you will find that effectively China will buy less and less of the US government bonds because it will have a smaller surplus for the United States because China will be diversifying. It will be lending to Brazil and South Africa and other countries in order to finance its exports to those countries. So I think this is a healthy, if painful, adjustment that the world has to go through.
FT: If America doesn't actively take part in this sort of renegotiation of global finance, what will happen? What's your nightmare scenario?
GS: Well, the Chinese will go bilateral. They already do it. They already have a clearing arrangement with Argentina and I think they're working on one with Brazil, and you will find that there will be more and more bilateral arrangements. So the dollar will remain the main international currency, but its use will decline. So I think that a world of bilateral relations is less desirable than a continuation of a multilateral system. But the system we have now has actually broken down, only we haven't quite recognised it and so you need to create a new one and this is the time to do it.
FT: In the United States, how worried are you about the budget deficit and maybe about the possibility of inflation?
GS: Well, certainly a decline in the value of the dollar is necessary in order compensate for the fact that the US economy will remain rather weak, will be a drag on the global economy. China will emerge as the motor replacing the US consumer and, of course, it's a smaller motor because the Chinese economy is much smaller. So the world economy will have less of a motor, so it will move forward slower than it has in the last 25 years. But China will be the engine driving it forward and the US will be actually a drag that's being pulled along through a gradual decline in the value of the dollar.
FT: And, domestically, what about inflation? Is that something that you're worried about?
GS: Well, it could be if lending restarts and the balance sheet of the Federal Reserve is not shrunk commensurately, but I think this is something ... it's a delicate manoeuvre, but I think it can be done. So there would be a slow decline in the value of the dollar, a managed decline, and that would be the adjustment that needs to be accomplished. Now it could actually get out of hand and certainly the fear of inflation will precede inflation itself and actually the fear of inflation in the markets – let's say, driving up interest rates – could then forestall the inflation and push the economy back into a recession. So you would have stop/go kind of economy which is similar to the '70s.
FT: How worried are you about the Fed taking maybe a more hawkish position in raising interest rates possibly too soon?
GS: It's unlikely to do it because they have the Japanese example in front of them and they see that the Japanese did it a few times and it has actually set them back. So, 25 years of excesses have to be worked off .
FT: And what about President Obama? Should he be more worried about budget deficits or more worried about the recovery fading away?
GS: I think he is more concerned about the recovery fading away. He's concerned about the unemployment and I think he is right to be concerned. Now, the trouble is that it seems that businesses are extremely cautious and even as you have some recovery, they don't actually hire. They actually are producing good profits by cutting costs and so you're going to have continued unemployment.
FT: Just over a year ago, Lehman went bankrupt and we had a financial crisis that many people feared would be as severe as the Great Depression. There now seems to be, particularly on Wall Street, a recovery. How real is that recovery?
GS: The stock market is pretty real. We have had a good run because an awful lot of money is on the sidelines and it earns no money at all and gradually it's being sucked in to the market. And probably that process will continue for the rest of the year.
FT: So you expect the market to continue rising to the end of the year?
GS: I mean, one can't predict these things. You never know when the turn comes, but it seems that way because the lack of recovery in employment is going to assure that interest rates are not going to be raised. And, at the same time, earnings are reasonably good and there's a lot of money on the sideline. So, I think those are actually favourable conditions for continued gradual market recovery between now and the end of the year.
However, the economy will continue to require additional stimulus in order to keep it going, because the recovery is basically fuelled by this transfer of payments and deficits that the government is running and if those were withdrawn, then you would have a double dip in the economy. So, in order to avoid that, you will need continuing stimulus. Now, whether politically that's feasible or not remains to be seen, of course, because it does pile up the debt and that means a burden for future generations, but the alternative would be another recession or a longer lasting recession.
FT: How do you rate your own performance as an investor over the crisis? And what are you betting on now?
GS: I came out of retirement in order to preserve my capital and I succeeded in doing that. I've now gone back into retirement and the fund is chugging along and is giving a decent return, so I'm very satisfied.
FT: Do you think the world is safe enough now for you to go back into retirement?
GS: I don't think that I can contribute currently to running the fund because my knowledge now is increasingly out of date and I had to use macro instruments to protect against the storm. But the storm has passed. You now have the aftermath of the storm and now it is, again, a question of knowing individual companies and my knowledge is now outdated, so it would be inappropriate for me to be in there.
FT: It's not a question of also making judgements about the global financial arrangements?
GS: I also feel that actually I can probably contribute more when I spend my time thinking about the system than trying to make more money. The use of my remaining time I think is better spent now on being concerned with reforming the system because the system actually does require reforming and I may have a contribution that I can make to it.
FT: When it comes to financial reforms in the United States specifically, what are the most necessary ones? What are the most necessary measures?
GS: You do need to regulate the banking system. Basically you've now given an implicit guarantee to the banks that are too big to fail and you have to then regulate them in order to ensure that the guarantee is not invoked. That's the job of the regulators. They fell down on it. They let the banks regulate themselves and the banks ran away with that opportunity and got into trouble, so you can't let them get away with it, run away with it. You have to reduce the amount of leverage that they allowed to use. You have to recognise that there are systemic risks that the individual participants don't necessarily have to take into account because, as individual participants, they can expect to sell the securities to someone else, but if everybody is on the same side, then you can't. You create a crash when the individuals try to do it. That's what happened. So you have systemic risks which are not identical to the risk of the individual participants and that is the job of the regulators to guard against.
And you have to recognise that the whole concept of how financial markets operate was false, namely the idea that they tend towards equilibrium. They don't. They actually are prone to generate asset bubbles and so the regulators have to accept responsibility about not letting those bubbles become self-reinforcing and create a crash. That responsibility they expressly refused. They said, we can control the money supply, but not asset bubbles, and they have to accept responsibility for it, knowing that they will always mistakes. However, when they control credit, they take a step and then they get a feedback from the market and so the feedback will tell them whether they've done enough or whether they have to do more. So this feedback helps to correct and get close to maintaining balance. This is a responsibility that they have shirked and they now have to accept, and for that purpose, they have to use instruments which have fallen into disuse. These are the margin requirements and minimum capital requirements. Now, those requirements have to be varied from time to time to counterbalance the prevailing mood of the markets. So if the markets are euphoric, you have to tighten the margin requirements. If they are, as they are now, despondent, then you can let it loose. And because of that, this is not actually the time that you want to impose those requirements, but you have to prepare for doing it. And at the time when the economy restarts, lending restarts. That will be the time to impose tighter capital requirements on banks.
FT: Are you confident that when things get better, when the economy, when the financial sector are more robust, there will be sufficient political will to impose the sorts of restrictions you're discussing?
GS: No. No. Because actually banks are very influential politically and now the remaining banks ... we've got three or four banks that dominate the banking scene in the United States. They have a quasi-oligopolistic position and they want to use that clout to protect that position. So you will have a big political struggle to get the right kind of regulation through.
FT: Do you think the government, the Obama administration, will win that struggle? Or are they engaged in that battle or have they given up?
GS: I am afraid that they have not done enough and I hope that they'll do more, and I'll certainly be out there urging them to do it.
FT: Should proprietary trading by too-big-to-fail institutions be limited?
GS: I think that the payment, the incentive schemes, have to be controlled because if you give them a guarantee, you have to ensure that they are not taking risks with their own capital that could then force you to put in additional capital. With the too-big-to-fail concept comes a need to regulate the payments that employees receive.
FT: So the government should regulate compensation at Goldman Sachs, for example?
GS: That's right.
FT: And how should it be regulated?
GS: And that would push the risk takers who are good at taking risks out of Goldman Sachs into hedge funds where they actually belong, because hedge funds take risks with their own capital, not with the deposits and not with the government guarantees.
FT: How should compensation at the too-big-to-fail institutions be regulated? Should there be pay taps, should there be clawbacks that are required?
GS: First of all, there would have to be a much longer period over which payments are made because certainly they would have to last the lifetime of the contracts ... I mean, in the case of derivatives. And I think that right now, banks are actually getting hidden subsidies of very enormous amount because of their ability to borrow at effectively zero and buy 10-year government bonds at 3.5 per cent. So those earnings are not the achievement of risk takers. These are gifts, hidden gifts, from the government, so I don't think that those monies, for instance, should be used to pay bonuses. And so there's a resentment which I think is justified.
FT: And what should the President do or Tim Geithner? Should they say there's no Goldman Sachs executive can be paid more than $5m this year? How should they act?
GS: Yes, probably. Frankly, I have not thought it through, but there would have to be some limits on what you can earn if you are working for a bank whose deposits are guaranteed.
FT: And you think it's appropriate for the government to actually set a dollar figure on the maximum, say?
GS: Yes. I mean, I don't know whether there should be an absolute cap. That I haven't thought through.
FT: I think if Lloyd Blankfein were participating in this conversation, he might argue, Mr Soros, that you're talking your own book and saying all the best risk takers should work for hedge funds rather than for banks like Goldman Sachs. How would you respond to that?
GS: I am on record in advocating the regulation of hedge funds as well and make a big point of not taking my personal interest into account when I'm talking about systemic reform, so I stand by my position on that.
FT: Do you think the big Wall Street firms are sufficiently aware of the public resentment of the big profits some of them are making this year? Is it a dangerous moment for them?
GS: I don't know if they are, but I think that there is a resentment and I think it will make itself felt, and it may easily lead to the wrong kind of regulation. The danger is with regulation that because of these emotional issues, you get the wrong kind of regulation, so it's not in the interest of the industry actually to lobby too hard to protect itself.