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.