Alchemy of Finance

by
Paul A. Volcker

George Soros

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Alchemy of Finance

From the Publisher

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 throughhis Open Society Fund and the Soros Foundation.

Biography

GEORGE SOROS is Chairman of Soros Fund Management, which serves as the principal investment advisor to the multibillion dollar Quantum Group of Funds. Soros’s flagship Quantum Fund is recognized as the most successful investment fund ever, returning an average 31 percent annually for more than thirty years. Soros has been an important philanthropist since 1979. His charitable foundations are active in more than fifty countries and spend nearly half a billion dollars each year to support projects in education, public health, civil society development, human rights, and many other areas.

	Foreword to the New Edition	xi
	Foreword to the First Edition	xv
	New Preface	xix
	New Introduction	1
Part 1	Theory
1.	Reflexivity in the Stock Market	49
2.	Reflexivity in the Currency Market	73
3.	The Credit and Regulatory Cycle	85
Part 2	Historical Perspective
4.	The International Debt Problem	95
5.	The Collective System of Lending	107
6.	Reagan's Imperial Circle	115
7.	Evolution of the Banking System	123
8.	The "Oligopolarization" of America	133
Part 3	The Real-Time Experiment
9.	The Starting Point: August 1985	145
10.	Phase 1: August 1985-December 1985	153
11.	Control Period: January 1986-July 1986	201
12.	Phase 2: July 1986-November 1986	241
13.	The Conclusion: November 1986	295
Part 4	Evaluation
14.	The Scope for Financial Alchemy: An Evaluation of the Experiment	307
15.	The Quandary of the Social Sciences	317
Part 5	Prescription
16.	Free Markets Versus Regulation	325
17.	Toward an International Central Bank	333
18.	The Paradox of Systemic Reform	351
19.	The Crash of '87	355
	Epilogue	371
	Notes	377
	Appendix	381

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Details of Book:

Alchemy of Finance

Book:
Alchemy of Finance
Author:Paul A. Volcker, George Soros
ISBN:0471445495
ISBN-13:9780471445494, 978-0471445494
Binding: Paperback
Publishing Date: -
Publisher: John Wiley Exclusive
Number of Pages: - pages
Language: English

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Book Reviews of Alchemy of Finance

Book Review from the Aleph Blog

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.

The "hidden", unrealized by many sophisticated investors

The book focuses on how to utilize fund flows.

Very different from what Value Investors considers "value", different in a way that many Values rejected this idea, but to those who are interested in using the power of speculating to maximize your investment power, I recommend you to try this out.

Lengthy but worthwhile

Although the book is a bit lengthy, Soros concept of reflexivity in financial markets is a highly relevant one.

Good discussion on feed back loops but fails to deliver solid advice.

How to become a billionaire? don't look here. In the end Soros provides no cookbook ways to become a billionaire. He is very intuitive and that ultimately determines his success. In the book, Soros documents his investment experience as if each is a scientific experiment. The price movement ultimately determines if his theory is correct. If he is wrong he dumps his investment. Extreme discipline. Most of us claim the market (or Mr. Market as Buffet says) is wrong and over time we will be right. Soros claims that price makes its own realities. The way he uses leverage is also a mystery at times he appears to be completely un-leveraged - rare in the hedge fund world.

The only gold in the book is his discussion of feed back loops. This I feel is so relevant to today's financial and real estate crisis. In a rising housing environment Loan to Value ratios go down, this creates success for the lender. The desire to loan is high and the supply of available money drives up prices further feeding this loop. In a declining real estate model the loan to value ratio increases exposing the lenders risk making it undesirable to lend no matter what the interest environment. The lender is stuck he can hope that his loan portfolio will be paid down or he can sell them for a loss in the open market. With loans hard to find and lenders wanting more money and higher qualifications from borrowers this assures there will be fewer buyers (buyers market). This feeds the downward loop with loan to value ratios rising even more as prices fall.

hard to follow

Honestly this book was hard to follow and I'm still not sure how Soros does it. He is an excellent thinker but I think this book was over the top for me.

Source - Amazon

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