52. Roy Lennox, who was hired by Kovner as a trading associate in 1980, recalls, “When I got the job with Bruce, I called up his assistant for some reading suggestions before I started. One of the books he had her send me was about reading charts. I thought, ‘Oh my god, I was taught in business school that charts don’t work, that markets are efficient.’ But then Bruce told me that charts are just representations of market psychology and therefore extremely valuable, and indeed indispensable, for trading.” Roy Lennox, interview with the author, June 24, 2009.
53. Schwager, Market Wizards, p. 32.
54. Kovner interview; Lennox interview.
55. Burton Rothberg recalls, “There was an infusion of outside money in the late seventies, early eighties. Helmut was opposed to managing outside money, but guys like Bruce wanted to take the money. There was a little a revolt.” (Rothberg interview.) Markovitz recalls, “We had been arguing for at least a year, a couple of years, about trading outside money. Helmut was nervous that once he let traders out of his control, they might leave.” (Markovitz interview, February 5, 2008.)
56. Elaine Crocker recalls, “We tried to hire Paul but he didn’t want that. When he came down to Princeton to meet Helmut, Helmut told him, ‘Remember, you will lose money at some point.’ Afterwards Paul wrote a thank you letter, claiming that he had paid for dinner and been told he would lose money.” Crocker interview.
57. Commodities Corporation continued for many years, eventually being absorbed into Goldman Sachs in 1997. But its heyday ended in the early 1980s. The firm lost money on trading in 1981, but Weymar allowed administrative expenses to grow unsustainably, from $15 million in 1981 to $23 million in 1982 to $27 million in 1983. See Rosenblum, Up, Down, Up, Down, Up, pp. 102 and 106–7.
CHAPTER FOUR: THE ALCHEMIST
1. The historian was Ralf Dahrendorf, director of the LSE between 1974 and 1984. This description of the climate at LSE and Soros’s early life is taken from the excellent Michael T. Kaufman, Soros: The Life and Times of a Messianic Billionaire (New York: Knopf, 2002).
2. Soros reckoned he needed $500,000. Ibid., p. 83.
3. Soros also knew Steinhardt, Fine, and Berkowitz, who had set up their hedge fund two years earlier, in 1967. But A. W. Jones was the chief role model: “Double Eagle was modeled after AW Jones,” Soros recalls. Soros’s exposure to A. W. Jones was reinforced by the fact that his junior partner, Jim Rogers, had worked for Neuberger & Berman, A. W. Jones’s main broker. George Soros, interview with the author, January 16, 2008; Jim Rogers, interview with the author, November 20, 2007. See also John Train, The New Money Masters (New York: Harper & Row, 1989), p. 17.
4. Soros comments, “The key to reflexivity is a misconception of reality, and this is where the fundamental misconception of economic theory comes in. The theory is that people act in their self-interest, but the fact is that they act in what they perceive to be their self-interest, and their best interest is not necessarily what they believe is in their best interest.” Soros interview.
5. Soros’s investment note, “The Case for Mortgage Trusts,” is reprinted in The Alchemy of Finance and explains the reflexive logic of the investment trusts, as follows: Suppose a trust starts with 10 shares worth $10 each and earns $12 of income on total capital of $100. Seeing that high yield, five new investors pay $20 each for a share in the trust, so that the investment fund now has capital of $200. Assuming that the trust puts the new capital to work as efficiently as the first tranche, the trust will now have $24 in earnings to split among fifteen shareholders. Per share earnings will have gone up from $1.20 initially to $1.60 after the new capital injection. See George Soros, The Alchemy of Finance (Hoboken, NJ: John Wiley & Sons 1987), pp. 64–67. In another example of the application of reflexive thinking to markets, Soros observed that acquisitive conglomerates that knew how to talk up their stock price would soon be on a roll: The strong stock price would empower them to pay for acquisitions using their newly valuable equity; the acquisitions would mean higher earnings and an even stronger stock price; the cycle would repeat itself. (Ibid., p. 59.)
6. Rogers recalled that when he attended Oxford he was surrounded by Americans who wanted to become president. He wanted instead to invest all over the world—to be a “gnome of Zurich.” (Rogers interview.) After leaving Soros in 1980, Rogers became known as a commodities guru and as the author of the book Investment Biker.
7. George Soros, interview with the author, June 10, 2008. See also Robert Slater, Soros: The Unauthorized Biography, the Life, Times and Trading Secrets of the World’s Greatest Investor (New York: McGraw-Hill, 1996), p. 78.
8. Soros interview, January 16, 2008.
9. George Soros, Soros on Soros: Staying Ahead of the Curve (New York: John Wiley & Sons, 1995), p. 49. Soros adds, “If a story is interesting enough, one can probably make money buying it even if further investigation would reveal flaws. Then later, if you discern the flaw, you feel good, because you are ahead of the game. So I used to say, ‘Jump in with both feet; take one out later.’” Soros interview, June 10, 2008.
10. Anise Wallace, “The World’s Greatest Money Manager,” Institutional Investor, June 1981, pp. 39–45.
11. Soros, The Alchemy of Finance, p. 42.
12. Ibid., p. 372.
13. Ibid., pp. 39, 42, and 372.
14. There is some dispute about the responsibility for the deterioration in the relationship between Soros and Rogers. In his unauthorized biography of Soros, cited above, Robert Slater suggests that Soros was a poor judge of character and incapable of recognizing the achievements of subordinates. There may be some truth to this, particularly since Soros’s break with Rogers came at a time when Soros was undergoing a broader emotional reorientation, which involved divorce and visits to a psychotherapist. But Henry Arnhold, head of the firm for which Soros and Rogers launched the Double Eagle Fund, remembers Rogers as by far the more difficult member of the duo. (Henry Arnhold, interview with the author, February 27, 2008.) Having encountered both Rogers and Soros, the author is inclined to go with Arnhold’s version.
15. The performance of the Quantum Fund in the years to 1985 is given in Soros, The Alchemy of Finance, p. 150.
16. Soros, Soros on Soros, pp. 56–57.
17. Not all economists believed that currencies tended toward equilibrium. The most influential paper to argue for exchange-rate overshooting was “Expectations and Exchange Rate Dynamics,” by Rudiger Dornbusch of MIT, published in 1976 in the Journal of Political Economy. Dornbusch’s argument did not hinge on the trend following by speculators that Soros emphasized; instead, he explained that currencies overshoot in response to monetary shocks because of the interplay between sticky prices for goods and fast-adjusting capital markets. However, Dornbusch’s sticky-price assumption was a minority view within academic macroeconomics through the 1980s. On this point, see Kenneth Rogoff, “Dornbusch’s Overshooting Model After Twenty-Five Years,” IMF Working Paper No. 02/39. Presented at the Second Annual Research Conference, International Monetary Fund (Mundell-Fleming Lecture), November 30, 2001, revised January 22, 2002. Given that Dornbusch represented a minority view, Soros was not attacking a straw man. On the other hand, other hedge-fund managers were won over to Soros’s view. As described in chapter seven, Stanley Druckenmiller found Soros’s view of currencies valuable after the fall of the Berlin wall. See Jack D. Schwager, The New Market Wizards: Conversations with America’s Top Traders (New York: HarperCollins, 1992), p. 203.
18. Soros also argued that economists tended to exaggerate the extent to which shifts in interest rates would help to drive currencies to equilibrium. If the United States ran a trade deficit, this implied a relatively low demand for investment capital and hence low interest rates; speculators would shift money out of dollars to currencies that yielded more, so weakening the dollar and helping to reduce the trade deficit. But in practice speculators cared less about the interest they could earn on dollars than about the dollar’s trend. Thus, in November 1984, a
fall in U.S. interest rates had been followed after a short pause by a jump in the dollar. The market’s logic was that if the dollar did not drop in response to falling interest rates, the upward trend must be robust and it was time to buy the life out of the currency.
19. In this conclusion, Soros anticipated the views of the economics profession. Writing in 2002, Kenneth Rogoff, a Harvard professor then serving as the International Monetary Fund’s chief economist, commented, “If there is a consensus result in the empirical literature, it has to be that nothing, but nothing, can systematically explain exchange rates between major currencies with flexible exchange rates.” See Rogoff, “Dornbusch’s Overshooting Model.”
20. Soros noted the stock market’s weakness as a reason to short the dollar and noted that other currencies were testing the upper limits of their trading ranges, suggesting that a breakout might be coming. Soros, The Alchemy of Finance, pp. 155–56.
21. Ibid., p. 149. Soros loosely observed a rule that enforced some risk control: He took more risk with his recent profits than with his capital. This might sound peculiar: Capital merely represents previous years’ profits, so why protect it more cautiously than profits earned recently? But Soros’s rule encouraged big risk taking in years when he had performed well, while forcing a cooler approach at times when he was weaker. If the performance of traders exhibits trends, the Soros rule had the effect of encouraging risk taking in periods when he was in sync with the markets. Likewise, the risk-control system at Commodities Corporation reined traders in once they lost a certain percentage of their capital.
22. “We had someone in for lunch in George’s private dining room, upstairs on thirty-three, and something connected and he immediately just went over and picked up the phone and told the trader to put on a position…. He could completely reverse himself.” (Gary Gladstein, interview with the author, March 18, 2008.) Gladstein joined Soros Fund Management in 1985 and was managing director from 1989 until 1999.
23. Soros confesses that he hung on to his dollar shorts by the skin of his teeth. Soros, The Alchemy of Finance, p. 163.
24. Some critics wonder whether Soros was tipped off about Plaza, perhaps by banking sources in Europe. But the fact that Soros bought yen massively after the announcement proves that he did not see the Plaza accord coming.
25. “This was like the biggest move they had ever seen in their entire life. So they were obviously all taking a profit, selling the yen. And this was a man who I worked for for twelve years, I never heard him raise his voice, never heard him swear. You’d only have to be in a room with me about an hour to see either of those events occur. And apparently he raised his voice, he was just furious that these guys were selling the yen and he just had them transfer all the yen over to his account rather than sell them.” (Stanley Druckenmiller, interview with the author, March 13, 2008.) Druckenmiller got the story from Steve Okin, a trader who worked for Soros at the time and later worked for Druckenmiller. Druckenmiller also tells the story in Schwager, The New Market Wizards, p. 208.
26. Druckenmiller comments, “People want to feel good about themselves and feel they have a win. But this is when you really, really want to pile on. You can’t have enough.” Druckenmiller interview.
27. These yen and German mark accumulations are over the baseline established on September 6, 1985, the date of the previous diary entry. However, the buying seems to have occurred in the five days after Plaza. See Soros, The Alchemy of Finance, p. 164.
28. Soros suggests that his political antennae were an important part of his edge. “It’s easier, in a way, to understand the mentality of the authorities than it is to understand the market, because the market is more anonymous…. So I would say, perhaps, that my application of boom-bust thinking has been in understanding how the authorities are acting more than the market itself.” (Soros interview, January 16, 2008.) Moreover, Soros knew political leaders as well as economic officials. Richard Medley, who later worked for Soros, organized a conference featuring top policy makers from the Plaza-accord countries in Washington in November 1985. Medley recalls getting a call from Senator Bradley, who insisted that Soros be allowed to attend, even though the conference was oversubscribed. (Richard Medley, interview with the author, January 14, 2008.) Gary Gladstein emphasizes the usefulness of Soros’s contacts with Quantum backers in Europe: “The board of Quantum was primarily European private bankers. They were very well connected, very well respected, and from time to time I know George would call them and ask them their thoughts.” (Gladstein interview.)
29. The additional buying took place between September 27 and December 6. Soros, The Alchemy of Finance, pp. 164 and 177.
30. Ibid., p. 176. Indeed, Gary Gladstein, who joined Soros’s firm in October to serve as chief administrative officer, was astonished by the leverage in his new firm’s portfolio. Gladstein interview.
31. Soros, The Alchemy of Finance, p. 309.
32. Soros, Soros on Soros, p. 59. Soros pointed out that Quantum’s return over the full fifteen months of the experiment, which included a “control period” in 1986, came to 114 percent.
33. Anatole Kaletsky, “Thursday Book Review: The Alchemy of Finance,” Financial Times, July 16, 1987, p. 20.
34. Paul Tudor Jones recalls that the range of factors that Soros blended together was a revelation. “George Soros is one of the most profound thinkers in the markets. The book was a highly intricate piece of analytics. Looking at the interlocking relationships. He knitted things together; it was an education.” (Paul Jones, interview with the author, April 23, 2009.) Jim Chanos, a celebrated short seller, is another money manager who believes Alchemy was a milestone. The book “really went into the whole feedback loop on perceptions and how they are important in the marketplace. For the first time he put in what traders knew to be true, but in a framework that you could think about; that you could debate and test.” (Jim Chanos, interview with the author, February 6, 2008.) Equally, Scott Bessent, who later worked for Soros, recalls his reaction to the book: “I remember, I’m twenty-five and I read this and couldn’t believe someone would invest this way. You would have some of these and these, short some of those. His risk management was in his head. No fund-of-funds person would have given him any money.” (Scott Bessent, interview with the author, January 18, 2008.)
35. Paul Tudor Jones II, foreword to the first edition of The Alchemy of Finance, p. xvi.
36. Jim Chanos, who operated out of Soros’s offices in the late 1980s, recalls, “It was the quietest place you’ve ever heard. The most raucous you heard was during lunch, when people yelled at the cook for making jerk chicken for the second time that week…. Steinhardt was much different. People screaming. Michael firing people. It was truly a different atmosphere.” Jim Chanos interview.
37. John J. Curran, “Are Stocks Too High?” Fortune, September 28, 1987, p. 28.
38. James B. Stewart and Daniel Hertzberg, “Before the Fall,” Wall Street Journal, December 11, 1987, p. 1.
39. Druckenmiller interview.
40. The Ways and Means Committee of the U.S. House of Representatives was considering legislation to eliminate the tax deductions for some interest expenses and to tax “greenmail”—payments made by companies to corporate raiders to buy back their stock at above-market prices to prevent the raider from taking over the company. See Mark Carlson, “A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response” (Federal Reserve discussion paper, November 2006).
41. Soros, Soros on Soros, p. 60. In conversation with the author, Soros reaffirmed, “I came out and the market had fallen, and I said to myself that I should have been following the market. Had I done that I would have lightened up.” Soros interview, January 16, 2008.
42. Druckenmiller interview.
43. Schwager, The New Market Wizards, p. 199.
44. Druckenmiller interview.
45. The Wall Streeter was Muriel Siebert of Siebert Financial. Quoted in Corey Hajim and Jia L
ynn Yang, “Remembering Black Monday,” Fortune, September 17, 2007, p. 134.
46. Medley interview.
47. Druckenmiller interview.
48. This interchange is presented as told by Druckenmiller, who describes it as “a very clear recollection.” Druckenmiller interview.
49. This is Druckenmiller’s own expression. Druckenmiller interview.
50. This is the conversation as recounted by Druckenmiller.
51. Druckenmiller recalls, “To my horror, I picked up the Barron’s Sunday morning and it turns out he was the guy who was selling his position.” Druckenmiller interview.
52. One London lender, which held stocks belonging to Quantum as security against a loan, came close to triggering a crisis by refusing to release any of them even though it was sitting on more collateral than the loan covenant demanded. (Robert Miller, interview with the author, March 7, 2008.) It was Miller’s job to manage Quantum’s relationships with its bankers.
53. Soros interview, January 16, 2008.
54. “A Bad Two Weeks—A Wall Street Star Loses $840 Million,” Barron’s, November 2, 1987.
55. Gary Gladstein, interview with the author, March 18, 2008.
56. Michael Steinhardt, No Bull: My Life In and Out of Markets (New York: John Wiley & Sons, 2001), p. 176.
57. Ivan Fallon, “Quantum Loss,” Times (London), November 15, 1987.
58. Howard Banks, “Cover Boy,” ed. Gretchen Morgenson, Forbes, November 30, 1987, p. 12.
59. In 1981 Steinhardt announced his arrival in the bond market by borrowing nearly three times the value of his fund and betting that interest rates would soon come down; when the bet came good the following year, the result was a spectacular 78 percent return for Steinhardt and his partners.
60. Paul Tudor Jones, who came out of the commodity tradition, described Alchemy as “a revolutionary book. Remember, this was the period when trend following…[was] the vogue in investing. It was the time when technical analysis…reached its zenith…. [But] an intellectual framework for understanding the course of social, political, and economic events was noticeably forgotten.” (Jones, foreword to Soros, The Alchemy of Finance, p. xv.) Meanwhile, Stanley Druckenmiller, who came out of the equity tradition, was struck by Alchemy for the opposite reasons: Soros broke with the nostrums of fundamental analysis and was ready to buy and sell on technical signals. (Druckenmiller interview.) Soros himself noted that “the Quantum Fund combines some of the features of a stock market fund with those of a commodity fund.” (Soros, The Alchemy of Finance, p. 149.)
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