In his view social sciences cannot escape the fact that we change what we observe. But we observe imperfectly, and hence how we react is never perfectly aligned with how we would act with perfect knowledge. Fallibility enters into all predictions: "people's interpretation of reality never quite corresponds to reality itself" (a la Karl Popper).
A circular feedback loop of "reflexivity" is also at work. "In a reflexive situation the participants' views cannot correspond to reality because reality is not something independently given; it is contingent on the participants' views and decisions." There a myriad of feedback loops, some leading in one direction, some in another.
These two factors—fallibility and reflexivity—give rise to bubbles that are endogenous features of the financial system according to Soros.
Soros' speech provides a brief history of the creation of the Euro and the resulting bubble from 2002 to early 2008 (see chart). Since a high of $1.60 in April 2008, the Euro has fallen to $1.24 today.
Soros' conclusion is startling and troubling:
So Germany is likely to do what is necessary to preserve the euro – but nothing more. That would result in a eurozone dominated by Germany in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer of payments. That would turn the European Union into something very different from what it was when it was a "fantastic object" that fired peoples imagination. It would be a German empire with the periphery as the hinterland [emphasis added].
In an interesting twist, the WSJ reports that Switzerland is considering capital controls in the event of a continued Euro crisis. Usually countries impose controls on capital exports to keep their citizens from fleeing the country with cash after governments muck things up with inflation and interest rate restrictions. But the Swiss are thinking of imposing controls on imports of capital. This would be designed to prevent the rise in the value of the franc and keep Switzerland competitive in exports.
The ethics of forcing your own citizens to save domestically through capital export controls is worthy of debate. Adam Smith argued against it on the utilitarian grounds that such controls were unnecessary, since people naturally could better watch over their capital domestically. It is altogether a different debate whether it is moral to keep outsiders from bringing in capital to access your financial markets!