Page last updated at 12:35 GMT, Thursday, 28 January 2010

Davos 2010: George Soros full interview

Robert Peston interviewing George Soros

Robert Peston (RP): George Soros, you were one of those who warned that a financial crisis was looming. Now that the acute phase is past, do you think we've seen yet the kind of reforms we need to make the banking system safe?

George Soros (GS) Not at all. We are at the very early stage of that discussion. Now we can take time because what happened in 2008 is not going to be repeated for the next 50 years or so, so we have time to redesign the system. And actually the way we're correcting the collapse is a two-way, two-step manoeuvre. When a car for instance is skidding, first you have to turn the wheel in the same direction and then you turn it back. So we are still … we have not yet completed the first stage. Now during that stage, you have to rebuild the capital of the banks. We are actually doing it the wrong way, we can talk about it, but that's the phase we are in. So at that stage, to limit them is really counterproductive. Even taxing them is counterproductive. Now, unfortunately, the banks which have been producing phenomenal results pretended that they actually earned that money. Actually it was a gift, a hidden gift from the governments which made money available at zero cost. So they then distributed part of those earnings as bonuses and that created a political storm in every country. And that is what is now sort of agitating this process, which is unfortunate because it needs to be a well considered, well balanced programme.

RP: And just to be clear, you would take the view that paying bonuses from 2009's profits is wrong?

GS: I would definitely argue that because … because of the hidden gift that the banks have received.

RP: Now President Obama last week announced some quite radical proposals to reform the banking system. He wants them out of what he calls "proprietary trading", using their capital to speculate on their own account, and also he wants a limit on their size.

Are these constructive measures, in your view?

GS: Very much so. These are the right … it goes in the right direction. In my opinion, it doesn't actually go far enough because it still leaves the problem of too big to fail. In other words, if you let's say now again Goldman Sachs gives up its banking licence, it becomes then an investment bank …

RP: To escape these restraints?

GS: Right. It would still be too big to fail.

RP: So what do you do? How do you … How do you solve the too big to fail problem, the risk that whenever a bank gets into trouble taxpayers have to bail it out?

GS: Well it's mainly through requiring adequate capital requirements for speculative positions. Effectively investment banks have been acting as hedge funds; but while hedge funds may be leveraged let's say three or four times …

RP: So capital of 25% of their investments?

GS: Right. Investment banks were leveraged 30 or 40 times, and of course that was very unsound and it cannot be allowed.

RP: So your view would be that in order to make the banks safe, they've got to raise colossal amounts of additional capital?

GS: Or do less speculation. You may also want to possibly break them up because you have the problem of contagion. One market collapses, but because the participants are engaged in a number of other markets, it spreads from one market to the other. And that is in fact what happened during the crisis. So that's because institutions are engaged in every market. That used not to be the case. You know let's say you had commodities trading houses merged with investment banks. Maybe they should be separated.

RP: Now one of the most striking trends in the world at the moment is we're seeing very rapid recovery and growth in places like China and India, and really very low, rather anaemic growth in places like the United Kingdom and the United States.

GS: But that's not astonishing.

RP: It's striking is what I was saying. How long do you think this disparity between the fast growing East and almost zero growing West is going to continue?

GS: I think it has just begun because so far the collapse and the recovery was more or less synchronised. It was global. Now it's beginning to be differentiated, and that reflects the very different position of the countries concerned. China has a tremendous trade surplus. It continues to have. United States has a pretty big deficit. They both stimulated, but in the end the fact that in the United States the households have to rebuild their savings, their balance sheets has to affect the economy.

RP: And just to be clear, you are one of those who believe that it is the burden of debt in places like the United Kingdom and the United States that is bearing down on growth; and until those debt levels have reduced, we are going to struggle in those countries to grow at an adequate rate?

GS: That is correct.

RP: How long do you think it'll take us to reduce debt to what we might call a sustainable level?

GS: Well actually we are making faster progress than let's say Japan did. The United States chose the same route as Japan did in dealing with the crisis. And Japan, after 50 years there's still no growth, and the banking system stayed in trouble for nearly a decade. It's happening faster in the United States. In Japan, you could borrow at zero cost. You could invest in government bonds, but the government bonds were yielding - 10 year government bonds - were yielding 1.5%. In the United States, they're yielding 3.5%. So it's happening at least twice as fast in the United States because there's the yield curve. The difference between short-term interest is much, much steeper.

RP: Even so, if it's happening twice as fast, it still means that in places like the UK and the US we've got to come to terms with low growth for, I don't know, 5 to 7 years. Is that the reality we have to face?

GS: This is the reality we have to accept.

RP: And because of the accumulation of debt, there's nothing we can do to speed that up?

GS: Well a lot depends on how you handle it. To some extent actually inflation would be beneficial in dealing with the erosion of the debt. Growth, economic growth would be beneficial. That's why the stimulus is so useful.

RP: But it's a double edged sword, the stimulus, because the stimulus increases you know the public sector element of the debt, which again obviously has to be dealt with as it were. So you still have a long-term problem of having to deal with the debt.

GS: Yes, yes you do. And Britain in particular now has a very sharp rise in the national debt beginning to push the limits. United States has a lot more room on building up its national debt. Not a good thing to do and of course we want to reverse it. But if you get too concerned about this, to the point where you cut off the stimulus too soon, then you have the danger of a double dip that the economy again declines, and that would be a much worse situation.

RP: Now I'm afraid to say in the United Kingdom you're probably still most famous for having made you know all those billions in the early 90s from betting on the fall in sterling. There's a chap called Bill Gross, who runs Pimco, who has recently made some very negative comments about the outlook for sterling and he also says he wouldn't invest in gilts, in government bonds. Is he right to be so nervous about investing in the UK?

GS: Well I abstain from making these comments because I don't want to influence the markets.

RP: But that said, you plainly think that the UK has a significant economic challenge ahead?

GS: I am on record in saying that the UK has a very serious problem because the financial sector has weighed so heavily in the economy, more so than in the United States. And of course housing … there's been a bigger let's say housing bubble in terms of appreciation in England and in the US, but you haven't quite interfered with the lending standards to the same extent as in America. And also you do have the benefit of the currency depreciating, which makes it easier. So the UK faces a very bleak outlook because of the accumulated excesses of the past, but whether it's worse than America or not at this stage, I wouldn't say.

RP: There's a very lively debate in the UK about whether it's better to tackle the debt problem sooner or later. There's a consensus that we borrowed too much and we've got to reduce the level of the debt, but then there is this uncertainty - and it stems back to some of the things you were saying about the mistiming of the end of the Japanese stimulus - there's a lively debate about whether or not we should in a sense cut the public sector support for growth now or delay that and continue to accumulate a bit of debt to sustain the economy. Where do you stand on that?

GS: Well I think that it's a bigger problem in the UK than it is in the US because the debt has grown much more. The bailing out of the banks has added tremendously to the indebtedness, the national debt. So Britain is pushing against the limit more than other countries. But then you see …

RP: So does that mean … Would you be somebody who'd therefore recommend earlier measures to reduce the cut, the debt?

GS Well undoubtedly there has to be some tightening on …

RP: Sooner rather than later?

GS: Even in the coming year. But then you see you have Japan, for instance, that the debt there is approaching 200% of the GDP, and still the interest rates are at 1.5%. So exactly how much the markets can tolerate is … is really unknown, but there will be much less tolerance towards the UK than there is towards Japan because in Japan all the savings are domestic.

RP: Absolutely. There's one final thing I want to put to you, and I'm afraid it's not a small question. One of the persistent sources of chronic instability for the world is the surpluses in places like China whose corollary are these great deficits in places like the United States and the United Kingdom - what are known as these global imbalances.

GS Yes.

RP: There's been very little progress in solving that particular problem of getting the Chinese to consume more and in a sense us in the West to consume less. What needs to be done to solve this chronic source of global fragility?

GS: Well you raise a very, very important problem. It's a imbalance in the exchange rate of tying the renminbi to the dollar on the value of the renminbi.

RP: That's the Chinese currency, the renminbi?

GS: The Chinese currency. Now this would be right now at the moment when the Chinese would be well advised to allow their currency to rise because they have actually generated inflation and they have to deal with it. They have over stimulated the economy. It's running away and it needs to be reined in - partly by reducing credits, reducing level of activity. So it needs to be slowed down and one way, a very healthy way to do it would be to allow the renminbi to appreciate. Now it's difficult to give the Chinese advice because they resent it. So I am not advising them. I am just telling you.

RP: Very good. And these ideas about sort of a global currency, less reliance on the dollar, possible expansion for the role of the special drawing rights of the IMF - are these things we should be looking at?

GS: Yes, absolutely, and I think that the whole global system, financial system needs to be rebuilt on different principles than it is currently running. You see the whole globalisation has occurred on the false premise that markets can be left to their own devices, and it was a contagious development because once the US and the UK deregulated, all the other countries had to follow because otherwise capital would go away from there. And you need the capital, so they had to attract the capital by making conditions equal to those in the US and … So it was a contagious process. Now you have the problem of devising a regulatory system, and if you want to have a global economy you need global regulations. And that is far from contagious. It's the other way because regulation still remains based on the sovereignty of states and each have their own interests and it will be extremely difficult to coordinate those interests. Already let's say the people on the continent are beating up on Britain to regulate more as a way of downsizing London. So there has to be a global regulatory system and I think you will need something like a new Bretton Woods to design this. Unfortunately, we don't have a Keynes around to provide us with a blueprint.

RP: George Soros, I'm very grateful. Many thanks.

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