The New York Review of Books: The Perilous Price of Oil (By George Soros on September 25, 2008)
The following is adapted from testimony given by George Soros before the US Senate Commerce Committee Oversight Hearing on June 3, 2008. ... While I am not myself an expert in oil, I have made a lifelong study of investment bubbles as a professional investor. My theory of investment bubbles, explained more fully in my recent book, The New Paradigm for Financial Markets, is considerably different from the conventional view. According to my theory, prices in financial markets do not necessarily tend toward equilibrium. They do not just passively reflect the fundamental conditions of demand and supply; there are several ways by which market prices affect the fundamentals they are supposed to reflect. There is a two-way, reflexive interplay between biased market perceptions and the fundamentals, and that interplay can carry markets far from equilibrium. Every sequence of boom and bust, or bubble, begins with some fundamental change, such as the spread of the Internet, and is followed by a misinterpretation of the new trend in prices that results from the change. Initially that misinterpretation reinforces both the trend and the misinterpretation itself; but eventually the gap between reality and the market's interpretation of reality becomes too wide to be sustainable.
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While I am not myself an expert in oil, I have made a lifelong study of investment bubbles as a professional investor. My theory of investment bubbles, explained more fully in my recent book, The New Paradigm for Financial Markets, is considerably different from the conventional view. According to my theory, prices in financial markets do not necessarily tend toward equilibrium. They do not just passively reflect the fundamental conditions of demand and supply; there are several ways by which market prices affect the fundamentals they are supposed to reflect. There is a two-way, reflexive interplay between biased market perceptions and the fundamentals, and that interplay can carry markets far from equilibrium. Every sequence of boom and bust, or bubble, begins with some fundamental change, such as the spread of the Internet, and is followed by a misinterpretation of the new trend in prices that results from the change. Initially that misinterpretation reinforces both the trend and the misinterpretation itself; but eventually the gap between reality and the market's interpretation of reality becomes too wide to be sustainable.
At some point future pricing and guesses about likely returns stop being convincing and the house of cards collapses.
Bubbles are - literally - a confidence trick.
There are some excellent post dot-com bubble books doing the rounds. In one of them someone persuades an investor to 'buy the internet' and sells them a CD of content for a few million.
That's not misinterpretation, that's trying it on and getting it away with it because some investors are stupid.
The dot com bubble was very public, and the con trick was extended to most of the population. Likewise for the housing bubble.
The oil bubble has very few players and isn't public at all, so we have no idea what's going on. But when you get a price spike of 50-75% over a short time, and no one is entirely sure where some of the physical oil is, that looks very bubble-ish from the outside.
Yes, but not always and not only. A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
