Davos 2011: Soros warns UK cuts could cause recession

Mr Soros demanded a fundamental rethink of economic theory at an event at Davos

The UK government's austerity policy could push the country back into recession, the famous investor and fund manager George Soros has warned.

While the UK government "may be right by embarking on [cuts], I think they will probably have to modify it when the effects are felt," Mr Soros said.

While he had been very positive at first, the policy was "unsustainable".

Mr Soros is known as "the man who broke the pound" during the 1992 currency crisis, forcing a sterling devaluation.

Speaking on the sidelines of the World Economic Forum in Davos, Mr Soros said the biggest threat to the UK economy had been a deflationary trap, where rising debt and falling prices reinforce each other in a hugely damaging spiral.

This "has been successfully fought off," Mr Soros said, although the "balance is now tipping the other way", towards inflation.

However, while Mr Soros' words often carry a lot of weight in financial markets, he is not without his detractors.

And Mr Soros himself refused to elaborate on his remarks, acknowledging that he did not follow the UK economy "that closely".

Euro trouble

Asked whether the euro and the eurozone in its current form could survive, Mr Soros said that while the euro could "potentially fall apart", he was convinced that this would not happen.

The euro was changing its current form, he said, with the permanent European Financial Stability Fund providing support.

However, he warned that instead of bringing economic convergence, the euro "effectively created divergence".

Nonetheless, the "euro is clearly here to stay, there's a clear commitment to the euro," Mr Soros said, "but it could put into motion a two-speed Europe... that is going to be politically very disruptive".

Market failure

Instead, Mr Soros continued his assault on what he called the "false" and failed economic theories that "actually were the root cause of the financial crisis" - the assumption that markets are efficient, and that participants in the economy act on rational expectations.

"We have to come to terms with the fact that in the world we live, human affairs are imperfect," Mr Soros said.

"And the fact that markets are not perfect, doesn't make regulators perfect, and the fact that regulators are not perfect doesn't make markets perfect."

Markets had moods, Mr Soros said, they could be "exuberant or fearful, a given amount of money supply can generate different suppliers of credit facilities". That could create bubbles and imbalances, and efficient market theory could not account for that.

He demanded a "fundamental rethinking of economic theory", and hoped that a think tank he sponsors, the Institute for New Economic Thinking, would help to deliver it.

Helping him in the effort will be Paul Volcker, a former chairman of the Federal Reserve and until recently leading the Economic Recovery Advisory Board of President Barack Obama.

Mr Volcker will lead the fundraising effort for the institute, which counts six winners of the Nobel prize for economics on its advisory board.

Mr Soros said the Institute would be joining forces with the Centre for International Governance Innovation, based in Canada and backed by Jim Balsillie, the co-chief executive of Research in Motion, makers of the Blackberry.