I’ll admit it: I like reading George Soros’ books. I mean, here’s a guy whose made a godzillion dollars in the financial markets, has been behind political destabilizations/stabilizations worldwide, taken on a U.S. president (can you guess which one?), and yet, in spite of this, can write a book in which he talks his own brand of….philosophy and how it relates to life, the universe, and the current financial crisis. Whah?
As you might have guessed I just finished reading one such book: the rushed to market The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means by George Soros. The book is a bit odd: it is short, rehashes many of Soros’ prior points, but contains all sorts of food for thought. Soros is at his best when he’s talking about financial markets, at least from my point of view. But this may just be because I don’t spend my days encased in the workings of things like CDOs, SIVs, CLOs, and the Case-Shiler Home Price Index. But I like to give Soros the benefit of the doubt so I suspect that these portions will be of general appeal to those interested in the take of someone who has either been lucky in the financial markets, or might actually have some skills at understanding how the financial world works. I’d heartily recommend the book to those of the “markets will solve all problems,” not because I think it will change their minds, but because I think it might make them angry.
But what I find most interesting about the book is Soros’ ideas (which are, even he would probably admit, only half shaped) about a point of philosophy he calls “reflexivity.” Here is a 1994 speech by Soros gave on the subject:
I was invited to testify before Congress last week and this is how I started my testimony. I quote: “I must state at the outset that I am in fundamental disagreement with the prevailing wisdom. The generally accepted theory is that financial markets tend towards equilibrium, and on the whole, discount the future correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal by the theory of efficient markets. Such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy.” I did not have time to expound my theory before Congress, so I am taking advantage of my captive audience to do so now. My apologies for inflicting a very theoretical discussion on you.
The theory holds, in the most general terms, that the way philosophy and natural science have taught us to look at the world is basically inappropriate when we are considering events which have thinking participants. Both philosophy and natural science have gone to great lengths to separate events from the observations which relate to them. Events are facts and observations are true or false, depending on whether or not they correspond to the facts.
This way of looking at things can be very productive. The achievements of natural science are truly awesome, and the separation between fact and statement provides a very reliable criterion of truth. So I am in no way critical of this approach. The separation between fact and statement was probably a greater advance in the field of thinking than the invention of the wheel in the field of transportation.
But exactly because the approach has been so successful, it has been carried too far. Applied to events which have thinking participants, it provides a distorted picture of reality. The key feature of these events is that the participants’ thinking affects the situation to which it refers. Facts and thoughts cannot be separated in the same way as they are in natural science or, more exactly, by separating them we introduce a distortion which is not present in natural science, because in natural science thoughts and statements are outside the subject matter, whereas in the social sciences they constitute part of the subject matter. If the study of events is confined to the study of facts, an important element, namely, the participants’ thinking, is left out of account. Strange as it may seem, that is exactly what has happened, particularly in economics, which is the most scientific of the social sciences.
What I find fascinating about this idea, is not really whether it is valid as a philosophical idea, or whether it has helped Soros in his financial deals (or whether, as one of his son claims, that his success has more to do with his backaches than anything else!) No, what I find fascinating is how close this idea is to the works of the Kochen-Specker theorem of quantum theory. While what Soros says is true of old-school natural sciences, I claim that quantum-schooled researchers wouldn’t necessarily be shocked by his idea of “reflexivity” (as to whether it is a valid description of how financial markets work, however, is a separate question!)
The Kochen-Specker theorem says, in its most obtuse form, that any hidden variable theory of quantum theory cannot be non-contextual. For my own Christmas inspired discussion of this theorem see here. Quantum theory gives us a procedure for calculating, from a description of our quantum system, the probability that a different observable will have a particular outcome. For example, a measurement might have three outcomes call them red, blue, and green and when we measure our system we see one of these outcomes (with some probabilities calculateable by quantum theory.) Now one might think that instead of using the quantum version of how to calculate these probabilities, that maybe it is just that a quantum system has a definite hidden state, one corresponding to each of the three colors, and that when we make a measurement we just reveal that color, albeit with some probability of color preexisting. This would be a hidden variable theory of quantum theory. What the Kochen-Specker theorem tells us is that such hidden variable theories have a twist. Suppose that in addition to measuring red, green, and blue, we can measure any three colors of our system (of course my “colors” are analogies here…this is not a real experiment, just an illustrating example!) Suppose instead of measuring red, blue and green, we instead measure red, brown, and purple. Well then we would hope that for identically prepared quantum systems, the hidden variable representing our red outcome shouldn’t be affected by our choice to make the other colors brown and purple. However, what the Kochen-Specker theorem says is that this is not possible: there isn’t a consistent way to construct a hidden variable theory where the correspondence between hidden variables and measurement outcomes is one to one, independent of what other observations are being made.
Back to Soros. Soros conjectures that one reason for boom-bust cycles is the fact that participant’s expectations of a market are influence by how the market acts. There is no way for a participant to get any sort of measurement of the market which is independent of what other measurements are being performed on the market. Okay I’m stretching things here for fun (what does it mean to “measure a market?”) But I do think this has some important consequences for “reflexivity.” In particular Soros insists that the fact that market participants expectations cannot be separated from the market itself leads naturally to the idea that this means that any theory of such markets cannot be scientific. But, while I also share his trepidation of “scientific” theories of financial markets, I’m not sure I share his confidence in the inseparability of the participants from the market they create as a valid reason for why scientific theories will not hold. My counterexample is the Kochen-Specker theorem: there is no hidden variable theory where measurements can be thought of as revealing information independent of the context of the masurement. But this doesn’t mean that we can’t develop a scientific theory of how quantum theory works! So, George Soros, meet Kochen-Specker. Maybe, you three can get together and come up with something new and exciting?!