The Hindu Business Line : Recipe for success from a speculator

TRUCK-DRIVERS cruising through busy highways during nights would reveal a secret if only you were to ask them how they manage when shadows are deceptive and oncoming lights blinding: "Gut feel." Ditto with financial markets.

"Traders make money by following the perceived trend," notes the foreword by Paul A. Volcker to the new edition of The Alchemy of Finance, a classic by George Soros, published by Wiley (www.wiley.com).

"Markets react to participants' expectations, and those perceptions influence prices, tending to validate themselves in a self-reinforcing process until some unpredictable event jolts expectations."

Something similar, perhaps, to an abrupt accident that happens when drivers' guesses collide.

No different with accounting either, because as only those familiar with the backroom work of financial statements would know, numbers that look exact have but an estimate as the foundation, and tallying pie-to-pie is to put in comfort zone what could be frightening to confront as a broad bandwidth fuzzy figure.

That Soros has a tall goal would be evident from his new preface:

"I seek to lay the groundwork for a new paradigm that is applicable not only to financial markets but to all social phenomena."

The `dense' new intro that runs to 45 pages can put you off, so take care: "I developed a theoretical framework based on the concept of reflexivity to explain the relationship between thinking and reality, and I used the financial markets as a laboratory to test my theory."

What is the concept of `reflexivity'? Very simple, assures Soros, yet be on guard. Thinking participants of situations have two jobs on hand:

One, they seek to understand reality; two, they seek to bring about a desired outcome. Problem is that these two can work against each other.

This interference is what Soros calls reflexivity, "a feedback loop between the participants' understanding and the situation in which they participate", something that "renders the participants' understanding imperfect and ensures that their actions will have unintended consequences."

So, if your understanding of the theory is imperfect, you know what to blame, but remember the author is somebody who made fortunes speculating and it could be too much to expect him to transfer the software through a book you can get for a few dollars.

"When I sat for an examination as supervisory security analyst, I failed in every subject," writes Soros, self-deprecatingly. Yet, he has views on systemic reform:

"Three major problem areas" are exchange rates, commodity pricing and international debt. The trick is not to deal with these in isolation but to tackle them all at the same time, because "problems that appear intractable on their own may fall into place within a larger solution".

Soros's method is alchemy, not science. "Scientific method seeks to understand things as they are, while alchemy seeks to bring about a desired state of affairs," he writes.

"The primary objective of science is the truth — that of alchemy, operational success."

Probably, that explains the paradox of auditors who are after truth and fairness getting brickbats for not being operationally successful.

So, who's writing the Alchemy of Audit?

BooksOfAccount@thehindu.co.in

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