How George Soros Knows What he Knows: Towards a General Theory of Reflexivity

Applying the concept of reflexivity to the question of financial markets valuation, Soros concludes that economic reality is actively shaped by the perceptions of market participants. This leads him to a theory of investment radically different from other existing approaches.

Existing approaches try to make sense of market reality by delineating factors that are determinants of price and identifying indicators that can be used to predict the future course of prices. Different theories emphasize different factors, they differ with respect to the definition of factors that determine market events. But the different approaches share the assumption that market events are determined by factors that function like logical units.

The unit-like factors function like the discrete terms in a logical calculus, remaining fixed, unchanged through the process of events. What is not covered by such factors is viewed as just indeterminate and unpredictable. But this traditional explanatory structure, based on deductive logic, cannot capture reflexive processes. The fluidity and particularity that characterizes the unfolding of events do not match the constancy of logico-mathematical patterns. In reflexive processes, we cannot assume discrete entities at the bottom: any factors we isolate might not survive the process of events in their original form.

Consequently, Soros does not offer an alternative particular cut of market reality, a different set of already defined factors. Instead, he operates with that which eludes any particular cut of market reality: intrinsic uncertainty. Rather than assuming a static order, Soros embraces the lack of fixed references in his guiding principle, the belief in fallibility, meaning both the belief in his own fallibility and the belief that the misconceptions and misunderstandings that go into our decisions help shape the events in which we participate.

Soros goes beyond the denial of a static order. He asserts that the concept of reflexivity allows him to structure situations and recognize profit opportunities. These are found when the participants’ biases lead prices to diverge from an underlying trend which is itself influenced by market prices – a process which is at first self-reinforcing, then selfdefeating. However, Soros could not formulate the general theory of reflexivity he originally intended to put forth. Reflexivity remained mysterious, both at the theoretical and at the practical level: neither his conceptual framework nor the manner in which it gets translated into investment decisions is fully understandable.

This paper resolves the apparent contradiction between Soros’ attribution of his success to his theoretical framework and the guidance that his bodily instincts provide him. Combining Gendlin’s process philosophy and more-than-logical epistemology with Cymbalista’s market theory, it places the theory of reflexivity on firm epistemological and economic theoretical foundations and shows the necessary relationship between Soros’ thinking without assuming fixed units at the bottom and the bodily knowledge expressed by his (in)famous backache. A practice derived from the broader reflexivity framework explains Soros’ operating principle, the belief in fallibility, as a positive methodology that can be taught and learned.