The Alchemy of Finance (Wiley Investment Classics)
by George Soros
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Book Summary Information
Author: George SorosForeword: Paul A. Volcker
Edition: Paperback
Audio: English (Unknown); English (Original Language); English (Published)
Published: 2003-07-29
ISBN: 0471445495
Number of pages: 391
Publisher: Wiley
Book Reviews of The Alchemy of Finance (Wiley Investment Classics)
Book Review: Book Review from the Aleph Blog
Summary: 5 Stars
One trap you can fall into in life is to not learn from those that you disagree with, for one reason or another. George Soros would be an example of that. His politics are very different from mine, as well as his religious views. He's a far more aggressive investor than I am as well. I am to hit singles with high frequency over the intermediate term. He played themes to hit home runs.
The Alchemy of Finance made a big impression on me 15 years ago. Perhaps it was a book that was in the right place at the right time. It helped to crystallize a number of questions that I had about economics as it is commonly taught in the universities of the US.
First, a little about me and economics. I passed my Ph. D. oral exams, but did not receive a Ph. D., because my dissertation fell apart. Two of my three committee members left, and the one that was left didn't understand my dissertation. What was worse, I had moral qualms with my dissertation, because I knew it would not get approved.
My dissertation did not prove anything. All of my pointed to results that said, "We're sorry, but we don't know anything more as a result of your work here." I have commented before that the social sciences would be better off if we did publish results that said: don't look here -- nothing going on here. But no, and many grad students in a similar situation would falsify their data and publish. I couldn't do that. I also couldn't restart, because I had put off the wedding long enough, so for my wife's sake, I punted, and became an actuary.
That said, I was a skeptical graduate student, and not very happy with much of the common theories; I wondered whether cultural influences played a larger role in many of the matters that we studied. I thought that people satisficed rather than maximized, because maximization takes work, and work is a bad.
I saw how macroeconomics had a pretty poor track record in explaining the past, much less the present or future. In development economics, the countries that ignored the foreign experts tended to do the best. Even in finance, which I thought was a little more rigorous, I saw unprovable monstrosities like the CAPM and its cousins, concepts of risk that existed only to make risk uniform, so professors could publish, and option pricing models that relied on lognormal price movement.
Beyond that there was the sterility of economic models that never got contaminated by data. I was a practical guy; I did not want to spend my days defending ideas that didn't work in the real world. And, I felt from my studies of philosophy that economists were among the unexamined on methodology issues. They would just use techniques and turn the crank, not asking whether the metho, together with data collection issues made sense or not. The one place where I felt that was not true was in econometrics, when we dealt with data integrity and model identification issues.
Wait. This is supposed to be a book review. :( Um, after getting my Fellowship in the Society of Actuaries, I was still looking for unifying ideas to aid me in understanding economics and finance. I had already read a lot on value investing, but I needed something more.
On a vacation to visit my in-laws, I ended up reading The Alchemy of Finance. A number of things started to click with me, which got confirmed when I read Soros on Soros, and later, when I began to bump into the work of the Santa Fe Institute.
I was already familiar with nonlinear dynamics from a brief meeting with a visiting professor back in my grad student days, so when I ran into Soros' concept of reflexivity, I said "Of course." You had to give up the concept of rationality of financial actors in the classical sense, and replace them with actors that are limitedly rational, and are prone to fear and greed. Now, that's closer to the world that I live in!
Reflexivity, as I see it, is that many financial phenomena become temporarily self-reinforcing. We saw that in the housing bubble. So long as housing prices kept rising, speculators (and people who did not know that they were speculators) showed up to buy homes. That persisted until the effective cashflow yield of owning a home was less than the financing costs, even with the funky financing methods used.
Now we are in a temporarily self-reinforcing cycle down. Where will it end? When people with excess equity capital look at housing and say that they can tuck it away for a rainy day with little borrowing. The cash on cash yields will be compelling. We're not there yet.
Along with that, a whole cast of characters get greedy and then fearful, with the timing closely correlated. Regulators, appraisers, investment bankers, loan underwriters, etc., all were subject to the boom-bust cycle.
Expectations are the key here. We have to measure the expectations of all parties, and ask how that affects the system as a whole.
In The Alchemy of Finance, Soros goes through how reflexivity applied to the Lesser Developed Country lending, currency trading, equities, including the crash in 1987, and credit cycles generally. He gives a detailed description of how his theories worked in 1985-6. He also gives you some of his political theorizing, but that's just a small price to pay for the overall wisdom there.
Now, Soros on Soros is a series of edited interviews. The advantage is that the interviewers structure the questioning, and forces more clarity than in The Alchemy of Finance. The drawback (or benefit) is that the book is more basic, and ventures off into non-economic areas even more than The Alchemy of Finance. That said, he shows some prescience on derivatives (though it took a long time to get to the promised troubles), though he missed on the possibility of European disintegration.
On the whole, Soros on Soros is the simpler read, and it reveals more of the man; the Alchemy of Finance is a little harder, but focuses more on the rationality within boom/bust cycles, and how one can profit from them.
Summary of The Alchemy of Finance (Wiley Investment Classics)
New chapter by Soros on the secrets to his success along with a new Preface and Introduction.New Foreword by renowned economist Paul Volcker
"An extraordinary . . . inside look into the decision-making process of the most successful money manager of our time. Fantastic." -The Wall Street Journal
George Soros is unquestionably one of the most powerful and profitable investors in the world today. Dubbed by BusinessWeek as "the Man who Moves Markets," Soros made a fortune competing with the British pound and remains active today in the global financial community. Now, in this special edition of the classic investment book, The Alchemy of Finance, Soros presents a theoretical and practical account of current financial trends and a new paradigm by which to understand the financial market today. This edition's expanded and revised Introduction details Soros's innovative investment practices along with his views of the world and world order. He also describes a new paradigm for the "theory of reflexivity" which underlies his unique investment strategies. Filled with expert advice and valuable business lessons, The Alchemy of Finance reveals the timeless principles of an investing legend.
This special edition will feature a new chapter by Soros on the secrets of his success and a new Foreword by the Honorable Paul Volcker, former Chairman of the Federal Reserve.
George Soros (New York, NY) is President of Soros Fund Management and Chief Investment Advisor to Quantum Fund N.V., a $12 billion international investment fund. Besides his numerous ventures in finance, Soros is also extremely active in the worlds of education, culture, and economic aid and development through his Open Society Fund and the Soros Foundation.
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