Fallout from credit crisis yet to come, says Soros

THE ACUTE phase of the financial crisis is behind us, but the fall-out has yet to come according to the billionaire investor and philanthropist George Soros.

Speaking to The Irish Timesthis week he said: "This is not what the markets are thinking. The economies of the developed world have shown more resilience than expected, particularly the US. Unemployment has been slow to rise and consumer spending has remained at reasonable levels. This has given rise to the hope that the worst is behind us. In turn, this has caused - until recent days - a substantial bear market rally on Wall Street," Mr Soros continued.

"Here I find myself diverging directly from the prevailing opinion in the US," Mr Soros added.

His contrarian view, amplified in his new book*, holds that this is no normal business cycle, but the end of an era.

"We are in the midst of the worst financial crisis since the 1930s. In some ways, it resembles other crises that have occurred in the last 25 years, but there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency," he writes.

As Mr Soros sees it, the US authorities are now forced to contend not only with the collapse of a housing bubble, but with the puncturing of a much longer boom-bust cycle which he has christened the 'super-bubble'.

In his view, the super-bubble was spawned by a 60-year period of credit expansion based on the US exploiting both its position at the centre of the global financial system and its possession of the only international reserve currency. Once the world was prepared to absorb as many dollars as the US wanted to print, there was no effective curb on US credit growth. Now, with investors taking flight from the US currency, that era is approaching an end.

The flight from the dollar is an important element explaining the recent surge in commodity prices, particularly the spiralling prices of of energy and food, Mr Soros said.

"The rise in the oil prices has very negative implications for the global economy. For the non-oil developing world, the consequences are absolutely devastating. The real 'have-nots' are in a desperate way," he said.

As oil touched $135 a barrel this week, Mr Soros outlined the principal factors he sees as explaining the upward shift in prices.

"First, there is the problem of peak oil and pure scarcity. Oil is depleting faster than previously admitted and the cost of finding new reserves is increasing.

"Second, there is a backward-sloping supply curve," Mr Soros said. The rising price of oil is continuously enhancing the future value of oil reserves. As a result, "there is less incentive to convert oil in the ground to oil above ground".

"Third, demand for oil is up in China and India, but with domestic prices subsidised, the rise in prices is not reducing demand sufficiently.

"Fourth, oil has become an asset class in its own right and it is now the subject of speculative buying."

Despite the flight from the dollar, Mr Soros does not see the euro replacing it as the world's principal reserve asset.

"The euro already is a reserve asset. But I don't think it's going to replace the dollar. The euro may yet appreciate further, but I find it hard to believe that it will replace the dollar. However, we are evolving towards dual reserve currencies and this would be a very unstable situation."

At the start of the year, Mr Soros summarised his investment strategy for 2008 in a single sentence: "Short US and European stocks, US 10-year government bonds and the US dollar; long Chinese, Indian and Gulf States stocks and non-US currencies."

So how had he fared? "I had my head handed to me in India and China also went down," he replied, proving that even the canniest of investors can misread the markets.

* The New Paradigm for Financial Markets - The Credit Crisis of 2008 and What It Means, George Soros, publicaffairsbooks.com $22.95