A grin spreads across George Soros' tanned face as the legendary investor says that "amateurs like us" can't be expected to know where the world's financial markets will go this fall. Indeed, since Soros' Quantum group of funds lost $600 million on Valentine's Day after making a wrong bet on Japan's currency, stock, and bond markets, Soros might be understandably wary of taking any risks at all right now. Yet the 64-year-old head of Soros Fund Management is hardly holding back. With financial markets establishing firmer footholds in the former communist bloc, Soros has recently begun moving cash into Russia and Eastern Europe. He has set up another fund to invest in power plants and other projects across the developing world.
Over grapefruit, pastries, and coffee in his apartment overlooking Manhattan's Central Park, Soros and his managing director and chief trader, Stanley Druckenmiller, discussed the outlook for global markets with Assistant Managing Editor Robert J. Dowling, Senior Writer William Glasgall, and International Finance Editor Joan Warner.
Are we entering a period of rising interest rates worldwide?
SOROS: Yes. I think we are.
Does that mean the time of falling interest rates in Germany is over?
SOROS: Not necessarily. The Germans have stopped lowering rates at too high a level relative to where we are in the U.S. There is still room for one more easing action after a few months.
DRUCKENMILLER: I wouldn't agree with that. They're probably done with their easing. They'll probably sit a while. If I had to guess, I would say that the next move would be up, not down.
Mr. Soros, last year you said the German mark was overvalued. Is that still the case?
SOROS: I said at the time that the mark was going to fall because the Bundesbank had overstayed its course of high interest rates. The economy was weak, and a weak economy leads to a weak currency. Now, a year later, the economy in Germany is strong. In spite of the high value of the mark, exports are picking up. The U.S. economy is also very strong--stronger than the German economy. The Bundesbank has gone out of its way to ensure the value of the mark by following a very restrictive policy and has erred by lowering interest rates too late and perhaps too little. The Federal Reserve has erred by keeping interest rates too low too long. You have a disparity on interest rates that would favor the mark and a disparity on growth that would favor the dollar. Is it economic activity or interest-rate policy? If I knew the answer, I would take a firmer position.
What did your Japanese losses teach you about the currency market?
SOROS: That this is a time which is not particularly rewarding for currency speculation. The tensions that were there for the past two or three years, the large imbalances that lead to large currency movements, are not currently there. The biggest unresolved problem is in Japan--the war of words [with the U.S.] over the balance of payments surplus. We think it will be resolved, because it makes a lot of sense to resolve it. That is where we have erred since the beginning of the year. We thought it would be resolved sooner, rather than later. Funnily enough, we still think exactly the same thing.
Is the dollar undervalued against the yen?
DRUCKENMILLER: In terms of purchasing power, it is. When the Japanese economy picks up, which we think it will, and when our consumption slows down over the next year or two, that will be the biggest chance to dent the trade imbalance. But even then, we're not going back to neutral. How undervalued can [the dollar] be if Japan continues to run surpluses?
What is your outlook for the U.S.?
DRUCKENMILLER: We just don't think 43/4% short rates, with loan demand booming, are enough to murder the economy. We seem to be having a great surge in September. Pricing looks stronger than we read about, and volume doesn't look bad. Housing is long past its peak, but it seems to have stabilized. It has a very long lead, and once you get it going, you don't need it [to keep up growth].
Is the global recovery sustainable?
SOROS: Yes. For once, we're all in sync. The recovery in Europe is somewhat anemic, but it's there. The [Asian] tigers and Latin America are also strong. It's a worldwide upswing. If properly managed, it could have a long way to go. You certainly won't have a straight line of growth. We could even have a bit of a growth recession. But if it's not too severe, we could have another go at the upside.
Do you see price pressures now?
DRUCKENMILLER: There are shortages out there: chemicals, paper, aluminum, copper. I have read that wages aren't going up yet, but I'm a little bit skeptical. Until proven otherwise, I have to assume that wage pressures will kick in in the next three to six months.
Will U.S. long-term interest rates rise as high as 10%, as some have predicted?
SOROS: We don't rule that out, but we don't think it's a realistic prospect. Financial markets have an allergic reaction to inflation. It's more conceivable that the long bonds would go to 10% than inflation would go to 7%--and I would definitely rule out inflation at 7% in the next few years because interest rates would preempt such a move. If you had the prospect of a weaker dollar, you would also have a greater chance mf higher interest rates. But in the present environment, where the [Clinton] Administration has had a change of heart on its attitude toward the dollar, I would rule that out.
Why are you moving into direct investments in power plants and other ventures?
SOROS: We believe there is now a greater return in the real world than in the financial world, and we are moving accordingly. We are taking some of our financial capital and putting it into the real world. There are great returns to be had in investments in the real economy, particularly in emerging markets. We find that most of our investments are going in that direction.
You recently called Russian President Boris Yeltsin "a spent force." Is the same true for his country's economy?
SOROS: I was hoping to see an orderly transition to an open society, a market-oriented democratic system based on the rule of law. That attempt has basically failed. But you do have the emergence of a new system: robber capitalism. It is very raw and ugly, but is a very vital, self-organizing system. It can succeed. There are now economic interests that know how to defend themselves. You have tremendous natural resources in Russia in which it is worthwhile to invest. You could have new growth to offset the continuing decay of the old. But the system is creating a tremendous sense of social injustice and a decline in civilized values. There is a great and pervasive sense of corruption. There is a grave danger that the sense of frustration and disorientation will lead to a political backlash and a xenophobic, nationalistic mood. To contain the growing resentment, two things need to be done. One is to sustain cultural and intellectual life, which is very important to the sense of identity of Russians. This is what my foundation is seeking to accomplish. But more important, you need to provide a social safety net for the large masses who are very badly hurt. This is where the International Monetary Fund and World Bank can play an important role.