In Silver Blaze, one of the Sherlock Holmes stories, a dog not barking was pivotal to Sherlock’s insight.

The talk by George Soros at this year’s Davos is as ever interesting. Amongst his claims is the following:

"The established theory has collapsed but we haven't actually got a proper understanding of how financial markets operate.”

If anyone had made such a claim before 2007, the dog would have bitten, let alone barked. Has the 2007 crisis so fatally undermined belief in free markets that no-one is prepared to defend them, even against Soros?

This is not a minor claim and its repercussions are serious if he is even partly right. If we are theory deficient in how financial markets work, what theory of markets underpins the evolving regulatory framework? It is an important part of systems thinking that to regulate a system the responsiveness of the regulator must be at least in line with the responsiveness of the system itself. Otherwise the system will go out of control. That is not comfortable. Is the lack of response to George Soros that he is saying uncomfortable truths that people would rather not hear?

Looking at the importance of the City to the UK economy both directly and indirectly, do we accept that the UK strength in Financial Services is built on foundations of sand?

I remember having a particular leveraged deal explained to me in 2006. A 1% increase in asset value gave a 5% return to an investor. A 2% fall wiped out over 50% of the investment. That was interesting enough, but it was explained to me that this was “low to medium risk”.

Looking at the various arguments about whether the UK will avoid a triple-dip recession I notice a common set of assumptions about the economy on both sides that, for me, points out where the theory weakness comes from.

All recessions seem to have both a cyclical part, but also a structural part. My conjecture is that the post-2007 world has been more about restructuring than cyclical change. The impact of the digital world and the rise of Asia are two aspects of the structural change that seem the most significant.

The 2013 to 2015 forecasts look to be based on cyclical models.

One of the warnings in Soros’s talk is concerns over another asset bubble.

An interesting aspect of quantitative easing (QE) is that it has sustained asset prices through a severe economic downturn. House prices in the UK are still well above their long-term multiplier of earnings. After the property crash of the late 80s, house prices were more than 10% lower than the long-term average.

We are seeing some evidence of rising prices when, in historical terms, they are already high. More interesting is the commercial property market, especially in retail.

This is not a forecast, I stress, but a downside scenario for the next deleveraging.

The economy starts to pick up and prices rise. With pressure still on consumer expenditure, more retailers struggle along with competitive pressures of e-commerce. With 20% of retail properties already vacant in some towns, retail rents and asset values struggle. The banks have to take a write-off of retail properties, reducing their balance sheets and ability to lend, which stifles growth. Sterling declines, increasing oil prices which feeds through into inflation. Interest rates rise, choking off asset prices and increasing indebtedness. This in turn causes the economy to slow.

This fits with George Soros’s description of go-stop as the next phase. What for me is missing in the forecasts I see is an understanding in this case of the structural changes in finance associated with the rise of internet-based commerce.

I don’t claim to have an answer to the theoretical deficiencies, but what I’d like to suggest is a reading list of the books that I think address the challenge that the talk at Davos makes.

1. “Thinking Fast and Slow” by Daniel Kahnemann. I nominate this for the insights into judgement under uncertainty
2. “Antifragile” by Nasim Nicholas Taleb. If the Black Swan showed the problems of unlikely events, the antifragile metaphor seems to move towards a solution.
3. “End this Depression now” by Paul Krugman. I nominate this for exploring the limits of supply-side orthodoxy.
4. “What Money Can’t Buy” by Michael Sandel. I choose this for the discussion of the moral limits of markets.
5. “Zombie Economics” by J Quiggin. This is chosen for discussion of why dead ideas won’t lie down.
6. “This Time is Different” by Reinhart and Rogoff. If you believe that history doesn’t repeat itself but often rhymes this is a great read.

I’m not necessarily suggesting that I agree with the various authors, distinguished as they may be. However, if we are theory weak, who will and what are we going to do about it?

Are you willing to bark or bite back? Or if you agree with the basic thesis, where would you look for inspiration to build an industry on a theory that works? What would be your reading list?