George Soros warns against optimism about US recovery

His book is an elaboration of an ongoing thesis about the decline of the US economy, and the recession predicted as long ago as January 2006 by Soros.

‘We are in the midst of the worst financial crisis since the 1930s,’ he writes in ‘The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means'.

‘The United States is facing both a recession and a flight from the dollar. The decline in housing prices, the weight of accumulated household debt, and the losses and uncertainties in the banking system threaten to push the economy into a self-reinforcing decline’.

Soros is shorting US and European stocks, the dollar and 10-year Treasuries, preferring non-US currencies and equities in China, India and the Gulf States. That should be a comfort to Gulf investors tired of waiting for local currency revaluations or dollar de-pegging, and concerned about the poor performance of Gulf stock markets so far this year.

US relief rally

But Soros thinks that any US stock market relief rally that now follows the Bear Stearns fire sale is going to be just that. It could be another year before capital markets really hit rock bottom.

The next shoe to drop could be credit default swaps, or CDSs, a synthetic financial instrument or derivative used as an insurance policy against debt defaults.

‘This is a totally unregulated market hanging like a Damocles sword over the financial system,’ Soros told reporters last week ‘You don't know whether your counterparty is good for its payment or not.’

Soros pointed to an unregulated $45 trillion CDS market that has become separated from actual hedging against defaults. ‘People who have these contracts need to know whether or not the counterparties are good or not, and you will only know that when you know who the counterparties are,’ he said, adding that the amount invested in this derivatives market is around half the entire US household wealth.

Derivatives crisis

CDSs sound obscure but then who had heard of sub-prime mortgage securities before they blew up last August? Few outside the industry, and then only an even smaller number appreciated what the downside might be.

Perhaps the man who broke the bank of England in late 1992 with his bet against sterling, and who spotted the US housing problem two years ago is right again. The derivatives problem in the financial system threatens a structural crisis of immense proportions.

In the meantime, any US equity rally should be used to sell stocks and reallocate capital to safe havens like Gulf currencies and stocks and precious metals. Whether Soros is right about Chinese and Indian equities after the huge falls seen in recent months remains a more controversial call.

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