Soros predicts the AI bubble: We live in a self-fulfilling market.

Original Title: Busting the myth of efficient markets

Original Author: Byron Gilliam

Source of the original text:

Reprint: Mars Finance

How do financial markets shape the reality they are supposed to measure?

There is a world of difference between the rational “knowing” and the experiential “understanding.” It's like reading a physics textbook versus watching “MythBusters” blow up a water heater.

Textbooks will tell you: heating water in a closed system will generate hydraulic pressure due to the expansion of the water body.

You understand the text and comprehend the theory of phase transition physics.

But “MythBusters” showed how pressure can turn a hot water heater into a rocket, shooting it 500 feet into the air.

You watched the video and truly understood what is meant by a catastrophic steam explosion.

Demonstration is often more powerful than narration.

Last week, Brian Armstrong gave us a hands-on demonstration of George Soros's “theory of reflexivity,” the effects of which were enough to make the team at MythBusters proud.

During the earnings call at Coinbase, after answering analysts' questions, Brian Armstrong read out a series of additional words. These words were what market players were betting he might say.

At the end of the meeting, he said: “I have been paying attention to the predictions the market has made regarding our financial report meeting. Now, I just want to add the following words: Bitcoin, Ethereum, blockchain, staking, and Web3.”

In my opinion, this vividly demonstrates how most financial markets operate, as George Soros's theory states: market prices affect the value of the assets they are pricing.

Before becoming a billionaire hedge fund manager, Soros aspired to be a philosopher. He attributed his success to discovering a flaw in the “efficient market theory”: “market prices always distort fundamentals.”

Financial markets are not merely passive reflections of the fundamentals of assets, as traditionally perceived; rather, they actively shape the realities they are supposed to measure.

Soros cited the example of the corporate conglomerate boom in the 1960s: investors believed these companies could create value by acquiring smaller and more refined companies, so they drove up their stock prices, which in turn allowed these conglomerates to actually acquire these companies at inflated stock prices, thereby “realizing” value.

In short, this forms a “continuous and circular” feedback loop: the participants' thoughts influence the events they bet on, and these events in turn influence their thoughts.

Fast forward to today, Soros might cite companies like MicroStrategy as an example. Its CEO, Michael Saylor, promotes this very circular logic to investors: you should value MicroStrategy's stock at a premium above its net asset value, because the fact that it trades at a premium makes its stock more valuable.

In 2009, Soros wrote that he used the theory of reflexivity to analyze and pointed out that the fundamental cause of the financial crisis was a basic misconception, namely that “the value of (real estate) collateral is unrelated to the availability of credit.”

Mainstream opinion holds that banks have simply overestimated the value of real estate as collateral for loans, while investors have paid excessively high prices for these loan-backed derivatives.

Sometimes the situation is indeed like this, just a simple asset mispricing.

But Soros believes that the enormous scale of the 2008 financial crisis can only be explained by a “feedback loop”: investors buying credit products at high prices pushed up the value of the underlying collateral (real estate). “When credit becomes cheaper and more accessible, economic activity heats up, and real estate values rise.”

Rising real estate values, in turn, encourage credit investors to pay higher prices.

In theory, the prices of credit derivatives like CDOs should reflect the value of real estate. However, in practice, they are also helping to create this value.

This is at least the explanation of Soros's theory of financial reflexivity according to the textbook.

But Brian Armstrong didn't stop at explaining; he demonstrated it in the style of “MythBusters.”

By stating the words that people bet he would say, he demonstrated that the participants' views (prediction markets) can directly shape the outcomes (the actual words he said), which is exactly what Soros meant by “market prices can distort fundamentals.”

The current artificial intelligence bubble is a trillion-dollar upgrade of Brian Armstrong's experiment, which allows us to timely understand this principle: people believe that AGI will be achieved, so they invest in OpenAI, Nvidia, data centers, etc. These investments make AGI more likely to become a reality, which in turn attracts more people to invest in OpenAI…

This perfectly illustrates Soros's famous assertion about bubbles: he rushes in to buy because buying drives up prices, and higher prices improve the fundamentals, which in turn attracts more buyers.

But Soros also warns investors not to be overly trusting of this self-fulfilling prophecy. Because in extreme cases of bubbles, the speed at which investors push up prices will far exceed the speed at which prices can improve the fundamentals.

Soros wrote while reflecting on the financial crisis: “A fully functioning positive feedback process is self-reinforcing in its early stages, but ultimately it must reach a peak or turning point, after which it will self-reinforce in the opposite direction.”

In other words, trees do not grow to the sky, and bubbles do not expand forever.

Unfortunately, there hasn't been an experiment like “MythBusters” that can demonstrate this in the field.

But at least we now know that market prices can drive things to happen, just like a few words spoken during an earnings call.

So, why wouldn't AGI (Artificial General Intelligence) be the same?