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taking stock

A real estate agent sits next to a board displaying prices for residential apartments in central Beijing. Home prices are falling in the Asian nation.David Gray/Reuters

A little more than an hour after arriving on a flight from London, Albert Edwards cheerfully launches into the bleak vision he has encapsulated in a chart book handed out to a rapt investment audience in mid-town Toronto. The headline on page 2 reads: The Ice Age is Back.

It's a term the notoriously bearish British economist has used for some time to describe a period of little or no inflation, accompanied by a wide-ranging reduction of financial leverage, sliding bond yields and more volatile and vulnerable markets and economies. If you think times are tough now, they are about to get worse, as China's "classic credit bubble" bursts, the euro zone comes unglued and the U.S. slides back into recession. And if that isn't enough reason to lock up the sharp objects, double-digit inflation lurks down the road.

Nothing should worry market players or policy makers more – or seems to bother them less – than China, says Mr. Edwards, who has 20 per cent of his personal assets in gold, "not to get rich … just to make sure I don't get poor."

The latest data from the Asian nation ought to raise some red flags, he says. Home prices are falling, auto inventories are rising and the broadest measure of money supply growth is shrinking faster than in Spain. Industrial production rose 9.3 per cent in April, the lowest in three years. "There is no doubt that the level of activity growth in April is significantly below the government's comfort zone," Goldman Sachs's China watchers said in a report.

"China will end in a very hard landing, which will surprise investors," Mr. Edwards says flatly. The slowdown will hammer commodities, drive equities below levels reached at the market nadir in the first quarter of 2009, and could pose serious geopolitical risks.

Yet many investors remain focused on the Greek soap opera and the latest stumbles of European policy makers, while giving the Chinese authorities virtually a free ride.

"When you stand back and look at it from the macro level, it is so clear," Mr. Edwards says later between sips of beer. "It's the classic behavioural finance thing: It's overconfidence in a good growth story. It produces the wrong valuations, the wrong credit structures. Of course, these things can carry on for longer than you assume."

The London-based strategist with Société Générale stands out in the dark-suited crowd in his untucked blue print shirt and khaki trousers. But then why dress up for the apocalypse.

What he finds particularly puzzling about the Chinese story is how so many investors steeped in free-market ideology could have so much faith in the couple of dozen policy makers at the helm of the nation's economy. The primary goal of China's leaders is to preserve their lucrative perks and the unchallenged power of the ruling Communists and who have already made some serious blunders. Why should they prove any more adept than Western leaders at engineering a soft landing?

If there's one positive it's that these same officials are plainly worried. And they never donned rose-coloured glasses, unlike their counterparts in Europe and the U.S. Who could forget Fed chief Ben Bernanke's assurance in 2007 that sub-prime mortgages didn't seem to be affecting the broader mortgage market?

Certainly not Mr. Edwards, who has nothing good to say about any leading central banker. If it were up to him, they would be dragged to the nearest city square and locked in public stocks, where people could throw rotten fruit at them. A former Bank of England economist, Mr. Edwards started an online petition earlier this year to have the central bank's current governor, Mervyn King, stripped of his knighthood.

As for the Chinese, "they really look as if they are starting to lose control. The next stage will be when they pull the levers, but nothing happens economically." A decision to restart the pump-priming could trigger a short-term market rally. But once it becomes clear that the policies aren't having much of an impact, confidence will fly out the window, much as it did in the U.S. in 2008.

"Unfortunately, the world has seemed so reliant on China as a growth engine, I think this will accentuate the disappointment even more when it hard lands."

Ironically, a Chinese slump – and we're still talking about annual growth of 5 or 6 per cent – could help the embattled euro zone. "Maybe the best thing for the euro would be if China hard landed and Germany [whose export boom has been powered by Chinese demand]went into a deep recession," Mr. Edwards muses. "Then they might be far more accommodative or far more reasonable about forgoing austerity."

But any substantial Chinese slowdown would cause considerable pain for resource producers such as Canada and Brazil and absolutely devastate the Australian economy, whose continuing health depends not only on strong exports to China and other emerging Asian markets but Chinese investment dollars flowing the other way.

Once the bubble bursts, "Canada might be a lightly done muffin, but Australia will be absolutely toast."