At first hunters rarely actually spot their quarry. They usually track them following various other signs, like disturbed underbrush or the animal’s spoor. To determine the health and safety of any given market investors have literally hundreds of economic indicators.  Part of the problem with these statistics is that they are usually compiled by some branch of the government. Their accuracy varies widely from country to country. Then interpreting these statistics can be a challenge. Different economists and analysts can read totally divergent meanings into the same numbers.

 Perhaps a better alternative would be to consult local investors. Wealthy people from any given country usually have an excellent pulse on the local economy. Either they actually run businesses or they have connections. In either case they have specific relevant information that will never be available to foreign investors. Much of this information will never be known, because the locals have absolutely no wish to make their activities known to the authorities. But they do leave tracks.

 One of the most interesting indications has to do with capital flight. If the locals are getting out, it is probably not a good idea for foreigners to get in. Capital flight, like bad debts, is also one of the principal indications of the end of a credit bubble.

 Sometimes the signs of capital flight are quite predictable and obvious. With the default of Greek sovereign debt and its membership in the euro probably only a matter of time, it is hardly a surprise that money is flowing out of that country to find safer havens. According to the most recent statistics Greek banks have seen deposit out flows of about €65 billion, or about one third of the total, over the past two years.

 Nor would it be a surprise that certain unstable Latin American countries are hemorrhaging money. In Argentina capital flight is estimated to be at about $3 billion in recent months. This has led the government to institute ever more stringent controls. Citizens must now justify every purchase of foreign currency.

 Hugo Chavez’s policies in Venezuela have nationalized hundreds of companies, which has slashed non oil exports. The capital flight is estimated at $28 billion a month. The cost of this capital flight together with $11 billion in debt service and $100 billion worth of imports has made it difficult for Venezuela to service its debts unless oil remains high.

 One would think that with the price of oil relatively high that Russia, a BRIC country, might be a good place to invest. Not so according to the flight capital statistics. Capital flight in 2011 totaled $84 billion, two and a half times the money that left in 2010. Even with the high price of oil, the ruble has weakened by 5%. According to one of the local billionaires, Mikhail Fridman, Russia’s poor investment climate and lack of protection of investor rights has made the developed world, specifically the US, a much better place to invest.

 Brazil until recently was considered a good place to invest money, but things have changed. Brazilians and other Latin America nationals have helped put a floor under the high end condo market in Miami. The price per square foot bottomed at $200 and thanks to flight capital it has risen to $300. The sellers in Miami are particularly pleased to see the foreign buyers, because 85% of the Brazilians pay in cash.

 Earlier this week markets improved substantially because of what was considered positive numbers coming out of China. The Chinese GDP grew at 8.9%, which was widely interpreted as evidence that China was slowing gradually and that the Chinese authorities had engineered a soft landing for their booming economy. The gaming tables of Macau tell a different story.

 Many wealthy Chinese cannot directly move money out of the country or change their yuan into other currency, so they use other methods. The success of the former Portuguese colony of Macau is built not on the love of gambling, but upon the flood of nervous money leaving China. Macau is already four times bigger than its closest competitor, Las Vegas. More than 13.2 million mainlanders visited Macau in the first ten months of 2011. Awaiting them were many different ways to launder money, according to a local professor, “more than we can think of”.

 It is not only gambling. In November Chinese purchases of gold increased by 20%. Analysts suggested the increase was due to the slight fall in price or that jewelry consumption had risen in expectation of gifts for the New Year celebrations. But the real explanation might have been protection from a failing economy.

 In each of these markets it is important to consider the economic indicators, but the best one might simply to see how the locals vote with their feet. 

In the United States much of the consumer spending takes place before Christmas. In fact the day after the national holiday of Thanksgiving, the last Thursday in November, is called black Friday, because that is when retail stores finally “get into the black” or start making a profit. Since consumer spending makes up 70% of the US economy, growing consumer spending is crucial to the growth of the US economy.

This year the reports of Christmas spending were uniformly positive. Both regular and online sales by retailers were supposed to have broken records. The markets responded positively to this welcome news. But there was one problem. The headline news wasn’t accurate. Today the government came out with the real figures. Instead of robust sales, they showed a marginal improvement of only 0.1%. This is a problem for investors, but it is also a huge opportunity.

Financial headlines and commentary are always filled with predictions. You cannot open a newspaper, watch a television show or visit a web site without hearing all sorts of justifications for the generally accepted trend. If you accept that this trend is correct and invest accordingly, the odds are not good that you will make money, because if the prediction comes true, the market has already discounted it. There is no value to be found by following the herd. On the other hand, if you can discern something that the headlines don’t say, you can do very, very well.

The present assumptions are for slow growth in the US and a recession in Europe. In fact for the past six months it seems that we have heard about little else. With this limited focus, it appears that at least for the financial community only the developed world exists. When emerging markets are mentioned, the general assumption is that “having started on the road to growth, the chances that these markets will continue to grow is good.” While the bulls concede that growth is slowing, they feel that 7 or 8% is certainly the bottom, hardly a recession.

But what if there is an alternative scenario? What if the financial community has things backward? What if the real risk is in emerging markets and Europe only experiences a mild recession? Most commentators feel that this is improbable, but that is exactly the reason why the strategy might be exceptionally profitable.

Europe certainly appears to be a basket case. This is especially true of countries like Spain. It is estimated that there are €176 billion in bad loans and the banks need to set aside reserves of €50 to repair their balance sheets. Worse Spain has an unemployment rate approaching 23%. Still despite these problems there is hope for both Spain and Italy. Both have governments bent on reform, hopefully labor reform. In the present crisis, there appears no alternative, so what seemed politically impossible six months ago may be the only possible solution. Like India after the reform of the License Raj in the 1990s, rapid growth is certainly a possibility.

In contrast to Europe, emerging markets seem positively healthy. The consensus for China is that their tightening has successfully brought inflation under control and that the economy is ready for another round of stimulus. Like many other emerging markets it has enormous foreign currency reserves and is assumed to have little public debt. But there is another side.

As Premier Wen Jiabao admits, the Chinese economy is “unstable, unbalanced, uncoordinated and ultimately unsustainable”. The tightening of the blistering real estate market has lend to 900 failed land auctions in 2011, three times the number as in 2010. One third of the failed auctions occurred in November and December alone.

China is not the only problem. Inflation is exceptionally high in India, Turkey and Brazil. All of these once vibrant economies are beginning to slow. But perhaps the most interesting indicator has been that high end sales growth in Asia for the jeweler Tiffany has slowed from 36% to just 12%.

 What will and will not be is not for us and certainly not for financial analysts to know. The success rate for predictions is less than 50%, but when it comes to making money, the best strategy is to veer away from the herd to find new and different pastures.

Protectionist policies are very popular all over the world. Governments are quite fond of anything that favors their citizens over the citizens of another country. It would initially appear to be a political no brainer. Why bother to pursue a policy that appears to harm the locals and help foreigners? Annoying voters in a democracy could mean the end of political power. It could result in social unrest and eventual overthrow for dictators. Instead it is far easier to pass protectionist restrictions on trade that will only result in unhappy trading partners and interminable litigation within the World Trade Organization. But there is a problem. Protectionist policies while seemingly benign always have unintended consequences, which, over time, back fire and harm those whom they are supposed to favor.

 A recent example has to do with the Chinese attempt to protect their production of rare earth elements. The misnamed rare earth elements include 17 elements that are essential for many high-tech devices. Through a concerted policy the Chinese were able to dominate the world supply by driving the price down and their competitors out of business. They now control over 97% of the world supply.

With almost a monopoly on this commodity, the Chinese tried to drive the price up. In September 2010 they halted shipments to Japan, the principal buyer. They also created an internal monopoly. The largest producer, Baotou Iron and Steel Group, took over or bought out smaller mines in the area and the government went on a campaign to close down the many illegal operations.

Initially these methods worked. The price of rare earths sky rocketed and the local Chinese industry reaped record profits. But the protectionist measures that manipulated prices back fired. Rare earths are critically important for some products like fluorescent lighting and military radars, but these products use minimal amounts. About one fifth of the demand came from low end applications like magnets. As the price of rare earths increased, manufacturers of everything from white goods to cars switched to use cheaper iron magnets in their electronics. The result was that prices slid by 30% since July of 2011. Besides driving the price down, the Chinese restrictions increased smuggling, which deprived the government of revenues.

Even worse than substitution the Chinese restrictions forced customers to find alternative sources. Since the rare earths were a necessity in certain military application, the US passed laws to subsidize production outside of China. While in Japan, large corporations like Toyota have financed exploration in other countries, which will rob the Chinese of their monopoly.

China is not the only advocate of protectionist measures. Although often easy to institute, once in existence they are very difficult to reform as India recently illustrated.

India’s retail sector is highly fragmented; made up of tens of millions of mom-and-pop shops and powerful middlemen traders who link farmers to consumers. The inefficiency of this system result in what the Times of India called a “Criminal waste of food” that occurs due to the lack of integrated storage. The inefficiencies increase the final price and deprive farmers of the potential value of their produce.

Recently India’s Congress Party attempted to open up the $450 billion retail sector to hyper efficient western marketers like the American company, Walmart, the British firm, Tesco and ubiquitous Swedish furniture firm IKEA.  The law stopped short of giving the foreigners unrestricted access, but required them to partner with local firms like Pantaloon, Shoppers Stop, Koutons and Trent. The reform lasted a mere nine days.  The political uproar created by local and opposition politicians forced the government to withdraw the program. The result is that the Indian consumer is deprived of less expensive higher quality food and the local partners shareholders were hit with losses of up to 10%.

The irony is that the protectionist policies in India are nothing new. It is just that the shoe is on the other foot. Three hundred years ago the protectionist policies were those of the United Kingdom trying to protect local weavers from a cheaper and better product, cotton textiles imported from India by the East India Company.

The East India Company started to import cotton because they could not get access to the spice trade which was monopolized by the Dutch. So they searched for an alternative, Indian cotton. But the cotton soon drove British silk and wool weavers out of business and they successfully petitioned Parliament for restrictions. The final restrictions only allowed the importation of cotton thread. But this restriction not only increased smuggling, it also encouraged entrepreneurs to create cheaper ways to use the thread. The result was the industrial revolution that put the weavers out of work for good.

All government economic policies, especially protectionist measures, have unintended consequences. Sadly the demands of a few pressure groups easily outweigh the greater good.

It took some time, but they are finally beginning to get it. Leading financial analysts, money managers and economists have commenced to comprehend that real estate bubbles in many emerging markets could crash. The Nobel Laureate economist Paul Krugman wrote in his New York Times column that China was another emerging danger as its credit fueled real estate bubble burst. The same concept has at last dawned on hedge funds A hedge fund owned by the famous private equity firm Carlyle sent an elite strike team to do a “deep-dive research trip” to China. It won’t help. They might find what is, but they have no idea of what is to be.

To find out we have to look at what was. The United States state of Texas had a real estate bubble in the late 1980s. When the bubble collapsed, the banks were stuck with massive bad real estate loans. To solve the problem the US created one of the first “bad banks”, the Resolution Trust Company (RTC). The banks transferred the bad loans to the RTC along with the job of foreclosing on and selling the property.

The RTC tried to do its job, but was stopped when local real estate interests complained loudly that sales of foreclosed property were depressing the market. When the RTC stopped selling, the market froze. The buyers stopped buying, because they knew the RTC would eventually have to clear its inventory. After a time economics overcame politics and the sales restarted.

Today the US has a similar problem. Almost 30% of houses sold in the US in 2011 were the result of foreclosures. Over 3 million homes have been foreclosed since the real estate market collapsed. But the market still has not cleared. Although many of the foreclosed homes do get sold, they make up less than one third of the houses that the banks actually repossess. The banks are slowly leaking these properties on to the market, because they are terrified that too much distressed inventory would depress prices further. The result is that the recovery has been slow. But at least the process is going forward, which is a lot better than nothing at all.

The United States is not the only country that has experienced a real estate bubble. The easy credit sloshing around emerging markets has had a dramatic effect on property. Luxury homes in Mumbai and Singapore have increased by 138% and 144% respectively over the past 5 years. Real estate in India grew 400% from 2003 to 2008 before the crash and now in some places it is 30% higher than its 2008 peaks.

Prime office rents in Rio de Janeiro are higher than anywhere in either North or South America including New York. House prices in Sao Paulo have nearly doubled since 2008. Some areas of Rio’s fashionable Ipanema district have risen over 30% since last year.

Then there is China. Home prices in Beijing have risen by about 150 % in the past four years. Like India, they have increased 400% since 2001. Beijing theoretically began to tighten lending especially to real estate two years ago, but their efforts have not been rewarded until the last few months when property prices started to decline.

Contrary to some true believers, all markets go down as well as up, even emerging markets. Prices are beginning to fall and the falling prices have begun to accelerate.

The consequences of a real estate bust in emerging markets would create quite a different situation than the real estate bust in developed markets. The rules are much different and so would the outcome. A burst real estate bubble in emerging markets would be far more severe and would last much longer.

The reason is simple. The legal plumbing in these countries, including foreclosures and bankruptcy laws, is either deficient at best or nonexistent at worst. There isn’t even information on it. Despite diligent search in all financial news sources and general internet search, I have found few if any references to emerging market foreclosures.

Many economist’s like to point out that mortgage lending in these countries is still quite small and often requires large down payments. True, but it has been growing at 20% a year in places like India. In China bank financed construction makes up twice the percentage of GDP as it does in developed countries.

For a country to grow after the crash of a real estate bubble, the market has to reach equilibrium. To do so requires that over priced homes with delinquent mortgages have to be foreclosed and sold. If the procedure for foreclosure doesn’t exist, then the entire economy gets stuck with massive dud loans and zombie banks as occurred for over a decade in Japan. So when the emerging markets collapse, the recovery will take years.

The world is moving slowly into another recession. Europe is going through a sovereign debt inspired credit crunch. India’s industrial production dropped 5.1 per cent in October from a year earlier. The Guangzhou government’s land sales program has seized up decreasing the province revenues by 70%. The United States has a massive deficit and political grid lock.

 To resolve these issues the world has resorted to all sorts of economic solutions. In China they tried fiscal stimulus through massive bank loans, but only ended up with inflation and a housing bubble. The US tried quantitative easing, but only helped to create a commodities bubble while devastating savers and pensioners. The EU now is trying fiscal discipline, which will surely result in a recession. They have tried everything except the one thing that actually would work and cost nothing. They can’t resort to this simple solution because of politics. Printing money does not have a political downside. Real reform does.

 Business cycles will always be with us, but economies are more resilient if their legal systems, their legal infrastructures, are economically efficient. In short their systems must make business easier. For example if you look at the World Bank’s Doing Business rankings, the economies that have survived and even prospered during this recession are the same economies that rank very high in the index. They include Singapore, Korea, Hong Kong, Norway, Sweden, Denmark and Canada. The US has a good ranking and has definitely had its problems, but nowhere near the issues of other many other countries. Two other countries near the top also help prove the thesis, Ireland and Estonia. Both countries recently were considered economic basket cases. Yet both countries have been able to go through painful ‘internal devaluations’ and are growing. In fact Estonia’s growth in the first quarter of the year was a blistering 8.5%, the highest in the European Union.    

 Despite their devastating effects countries all over the world continue with disastrous policies. Subsidies are one of the worst. Nigeria is one of the world’s largest oil producers. Not surprisingly with its vast mineral wealth it subsidizes petroleum, which was meant to help the poor. Yet the cost of the subsidy is so great that it almost exceeds the oil export revenues. It also has created enormous inefficiencies and corruption. In the US a subsidy for ethanol has made it this year the cheapest motor fuel, but at the expense of higher food prices.

 Laws in many countries that are supposed to protect labor have resulted in coddling some workers and insuring that others cannot get jobs. The labor market in Spain has become a two tiered system. Older workers with jobs are protected from layoffs and have good benefits. Meanwhile it is so difficult to hire and fire workers that the unemployment rate among younger workers tops 40%.

 Brazil has a labor code taken from Mussolini’s Italy. It is just about as devastating. Getting rid of a worker without “just cause” can result in a fine of 4% of the total amount the worker has ever earned. The employee’s incompetence or the bankruptcy of the company are not considered just cause. Like Brazil, India’s infamous inflexible labor codes have made it impossible to take advantage of its inexpensive labor.

 Revenue for the state usually in the form of taxes is a necessity, but how it is collected makes a big difference. In China since all land belongs to the state, so with a few experimental exceptions, there aren’t any real estate taxes. This makes the governments dependent on sales of land (actually sale of long term leases of up to 70 years) to developers for up to 40% of their revenue. Local governments also use the land as collateral for loans from state owned banks. This system worked well as long as the money kept flowing and the prices kept rising. When Beijing restricted real estate sales and tightened lending, the real estate bubble started to collapse with potentially devastating consequences.

 Subsidies, inflexible labor markets, and poorly designed tax codes are just the tip of an enormous iceberg. To these problems you could add protectionist policies, failure to protect property rights especially intellectual property rights, slow or corrupt judiciary and transparent markets.

All of these problems have to do with laws. Laws can be changed at no cost. Reforming these laws and policies could be an enormous stimulus for any economy, but changing them is almost impossible. Every law creates systems of economic winners and losers. As Mancur Olson freerider thesis predicted, those who benefit are willing to fight tooth and nail to protect what they consider their property interests even if it means economic suffering for all of their fellow citizens. So without real reform, a global recovery is nowhere in sight.

Like most investors I spent most of last week addicted to news about the crisis in the Eurozone. I have assiduously followed the progress of the European summit together with the market reaction. After extensive emersion in every newspaper, magazine, radio program and television show my conclusion is that I have totally wasted a week. Little if anything was accomplished. The reason is quite simple. The Europeans are trying to solve the wrong problem. What they should do is to learn from US history. They didn’t and it will cost them and everyone else.

 The most recent agreement is based on the idea that fiscal malfeasance is the origin of the crisis. The thesis goes something like this. Wicked spendthrift governments mostly in Europe’s periphery borrowed a lot of money and blew it on social programs. Now they can’t pay the money back.

 To solve this problem the summit decreed penitence. All Eurozone countries would be forced to adopt budgetary discipline through a “fiscal compact”. They would also pass ‘golden rules’ to ensure balanced budgets. If the rules were broken, they would be punished with automatic penalties. They also added a few Euros to the bailout fund, but much of the fund depends on leverage and anyway it wasn’t enough.

 This approach was politically acceptable but has some definite problems. The first is that a recession is the wrong time to adopt an austerity package. Austerity creates a vicious circle of economic decline. It reduces domestic demand which raises unemployment and lowers revenues from taxes. This in turn creates larger deficits which lessens confidence in banks and shaky sovereign debt. Besides it isn’t the problem.

 Before the crisis Spain, Estonia and Ireland had much better control of their deficits than Germany, Austria or France. They were in fact running a surplus. As a result of their fiscal discipline Estonia, Ireland and Spain has much better control of their public debt than Germany and France. Although Greece and Italy’s public debt is over 100% of their GDP, Spain’s debt is only slightly more that Germany or Austria’s. Estonia and Finland have surpluses.

 The real problem was competitiveness. The Eurozone countries that got into trouble, Estonia, Portugal, Greece, Spain, Ireland and Italy were all running substantial trade deficits. Estonia’s current account deficit was over 10% of GDP. So when the crisis hit in 2008 and private financing of the external imbalance dried up, the countries were in deep trouble.

 Estonia is sort of the poster child for the problems of the lack of competitiveness and what to do about it. Estonia is a tiny country and its banking system is owned by foreign firms, mostly from Sweden. During a construction boom, Estonia’s growth was at double digits. After the crash it fell by 14%. The result was pain. Employment rocketed to 18%.

 One tried and tested way to increase competitiveness is to devalue your currency. The Chinese are especially good at keeping the yuan low in order to insure their competitiveness. But since Estonia like Italy and Greece is a member of the Eurozone, this option was not available. Instead they went through an internal devaluation, which included slashing 9% of GDP from their budget and big cuts in nominal wages. The medicine worked. Estonia now has surpluses and its growth rate at 8.5% is the highest in Europe.

But Estonia had something else that was very important. It had a regulatory framework that encouraged business and was fairly clean. On the Doing Business Index and Corruption Index it scores slightly below Germany. In contrast Italy’s business climate is worse than Mongolia’s and Greece is worse than Yemen. As to corruption both countries are worse than Rwanda.

 One thing that the Eurozone could do would be to create a form of joint liability like Eurobonds. These could be adopted with a credible sanction. Any country that spent too much couldn’t use them.

 The success of this method was proved over 200 years ago in the United States. In 1790 the recently created country had a massive war debt of $54 million or about $4 trillion in today’s money. The problem was that the debt was very unequal. Some states like New York were deeply in debt, while others like Virginia were almost debt free. One of the country’s “founding fathers”, Alexander Hamilton had an idea. The new United States federal government would assume all the debt and create joint liability of US bonds.

 Hamilton’s plan was an incredible success, but sadly no such solution was agreed to by the European summit. This desire to punish rather than cooperate insures that the ongoing crisis continues and continues to get worse. Credit remains tight, capital flight from the Eurozone is becoming a real problem and Standard and Poor’s will most likely downgrade several member states. So don’t expect a happy New Year anywhere.  

Governments purport to act for the benefit of their citizens. Their laws, regulations and policies are supposed to protect them. They also like to pretend that they can protect them from markets. Usually it is the other way around. Markets operate for the benefit of citizens and markets need protection from governments. Often government policies, implemented with the best intentions, backfire. The policies can create a bubble. Although these bubbles victimize the very citizens the government is trying to protect, they can be very profitable for investors. One of the most egregious recent examples has to do with rice.

Rice is the staple crop for half the world’s population. The world grows about 450 million tons annually, but the amount available for international trade is only about 7% of the total crop. This is tiny compared with 20% or so of the world’s wheat crop available for sale. So little reaches the market because it is considered a strategic food in many countries. Governments consider it so vital to their survival that they make sure that it under their control. Domestic markets are heavily regulated and protected in order to encourage self sufficiency. The world’s largest producer is China, but its 130 million ton crop is not for sale. The top exporters are Thailand and Vietnam, but together they export only about 17 million tons. India grew about 95 million tons in 2010-2011, but exported only slightly less than 4 million.

In 2007 the price of wheat started rising. For most of the decade it sold for about $200 a metric ton, but by September it was over $300. Countries started to panic. To maintain low prices for domestic supply, they restricted exports and lowered tariffs for imports. With the restricted supply the price rose further and hit an all time high of over $ 439 a metric ton in February of 2008. Since one bubble wasn’t enough, government thought they would create another.

When wheat became too expensive the Indian government decided to purchase more rice for its food programs. In October 2007, it banned the export of rice. At the time rice was plentiful. Farmers around the world were harvesting record crops, but because of the restrictions much of this crop was not available for global markets. So the price rose.

As the price rose, so did the panic and restrictive government policies. Egypt, Pakistan, and most importantly Vietnam joined India and restricted the export of rice. From a price of about $300 a metric ton in 2006, the price soared to over $1000. The panic then hit consumers. In Vietnam rice markets and supermarkets were cleaned out. Even in the US stores Walmart limited rice to 4 20 pound bags per customer. The insanity was due only to governments. There was still plenty of rice sometimes in the strangest places.

As a result of a trade dispute between Japan and the US, there were over a million tons of American rice sitting in Japanese warehouses. Like other Asian nations, Japan protects its rice farmers. They had no interest in using the rice domestically. They imported it only because the World Trade Organization told them to. Thanks to some lobbying by a US economist and a rice trader, the US and Japan agreed to release some of the rice onto the market in mid-May of 2008. The announcement of the release was sufficient to prick the bubble.

Fast forward to 2011. India and Pakistan are having a good year. Both countries have large surpluses, so good in fact that India in September agreed to lift the export ban. This was fortunate because droughts in the US and floods in Thailand have hit both countries exports, but these problems won’t help Indian farmers and traders. The traders were so afraid that the Indian ban would be reinstated that they sold their rice at rock bottom prices a month before the Thai floods drove the price up.

The implications of this story for investors are enormous. This isn’t just the story of the disastrous unintended consequences of a few well meaning, but incompetent Indian babus. Economists, financial analysts, and money managers all assume that prices and markets are driven by market forces like supply and demand. The reality is that these forces may be irrelevant in the short term. During the 2008 food crisis, the papers were filled with stories about shifts in global demand due to a wealthier Asia. The reality was something simpler and less profound.   

The good intentions of government bureaucrats are heavily implicated in the massive distortions and volatility of all market categories over the past five years. One policy creates a bubble and another attempts to ameliorate the effects, each one making the gyrations worse. For investors the profit comes from understanding these mistakes and not economic forecasts.

What words strikes fear and dread in the hearts of every investor? The words that signal a severe economic contraction? The words that insure bad choices and losses in each and every market? Some would suggest a panic or a depression. Certainly panics and business depressions, especially the present one, are very difficult, but they are foreseeable. Expansions especially those fueled by irrational exuberance and government policy distortions always end the same way. Absurd expectations are easy to spot. The trick is not to get carried along with the crowd and take an early exit. No, none of these things are either unusual or unexpected. The worst words are a deliberate falsehood, misleading, disingenuous and deceptive. The hideous words are ‘soft landing’.

 The words ‘soft landing’ are certainly beloved by central bankers, politicians and (ahem) financial writers. When an economy is slowing, it is always nice to provide a little cheer for investors. After all we don’t want them act like rational creatures and try to protect their investments by selling all at once? Our leaders want us to believe that the situation is under control. They want us to believe that the wise and good in charge of the economy with a few tweaks to interest rates, reserve requirements, fiscal stimulus, taxes and industrial policies can easily engineer a slow down or a ‘soft landing’.

The whole idea is absurd, a financial fantasy, an economic delusion. The concept assumes that policy makers understand the economy and markets, that their models and theories can predict the future and that they are supplied with timely, complete and accurate information. They don’t. So they can’t ‘fine tune’ an economy into a ‘soft landing’.

 Even if policy makers did have the right tools, their efforts would be a thimble full of water fighting the raging current of the markets. One of the most powerful forces in markets is momentum. Once the urge of investors to follow the herd starts, it is almost impossible to stop. The enthusiasm driven by Keynesian animal spirits is not something that can be turned on and off like a light switch by making a few adjustments. In order to slow an economy that is out of control means that prices drop. Dropping prices mean that any person or firm that is overleveraged, and there are many, gets wiped out. Insolvent firms mean that lenders don’t get repaid. The trust that prices are rising, loans are secure and money is to be made disappears almost overnight. Once extinguished, the fire cannot be easily reignited.

Yet examples of the illusion of a soft landing exist are everywhere. For example, when housing prices started to drop in the US, most forecasters believed that housing prices would have a ‘soft landing’ in that they would stagnate and rather than experience substantial declines.

Ben Bernanke is a famous ‘soft landing’ proponent. The recession in the US officially started in December of 2007, but in April of 2008 Mr. Bernanke was predicting that it appeared “likely that real gross domestic product will not grow much, if at all, over the first half of 2008 and could even contract slightly”. Two months later in June he stated that “the risk of a nasty economic downturn had fallen and he promised that the Fed would “strongly resist” any rise in people's expectations of future inflation.”

In fact the main feature of the US recession, a collapse in housing prices, was clear a year earlier. In August 2007 the number of sales of homes, property transactions, in the Los Angeles area had dropped 35% from a year earlier and 31% in San Francisco.

 There is another place where property transactions are falling, China. Last week it was just reported that property transactions fell 39% year-on-year in China’s 15 biggest cities. They fell 11.6% in October alone accelerating from a 7 %. This is a problem.

In the US and Europe construction usually makes up only 5% of GDP. At the top of the construction boom in the US it made up 8% of GDP. In China it makes up 14% of output. Such numbers are reflected in the amount of lending. Much of the lending by Chinese banks during the stimulus of 2009-2010 went to local government who lent 42% of that to developers. A contraction in construction would have domino effect all through the economy.

 Yet such is the faith in China’s technocrats that even my favorite columnist, John Authers of the Financial Times believes that “China may, just may, have engineered a “soft landing”, bringing inflation under control before its economy tanks”.  Such illusions are what disasters are made of.