'Lejos de una recession?' Dream on, Espanya.

Recessions rarely announce themselves. And the Spanish economy is a house of cards, propelled by an unsustainable real estate boom. As interest rates continue their vertiginous climb and out-of-pocket monthly mortgage expenses eat away at a population long ago endeudados hasta las cejas, a Panglossian blush across the land can quickly turn to blight. But let's see what real economists (and economic history) show... (gimme a day to retrieve these bits, please)

The most credible scenario about how Spain will fall from grace (and its ridiculously overprice housing market along with it) comes from Financial Times columnist Wolfgang Munchau today. In a nutshell, a sustained Euro-USD exchange rate in the 1.40-1.45 range along with a flailing US economy export recession to Europe and beyond. I've tried my best to edit down his comments, taking out some of the more wonkish stuff, but only reluctantly!

Brace for Act II when the crisis goes global
By Wolfgang Munchau
Published: September 16 2007 17:13
There has been some good news in the past week and a lot more bad news. The good news consisted of tentative signs that the credit markets were stabilising. Conditions in the asset-backed commercial paper market also appeared to improve. The bad news was the shocking bail-out of Northern Rock, a UK mortgage bank.

I would nevertheless suspect that within a few months, the banking sector will have absorbed most of the horrible real estate investments and the financial markets will be celebrating an end to the crisis.

Unfortunately, I fear this is only going to be the end of Act I. Act II plays out in the real world. Act II begins with a sharp slowdown in US economic growth. The two obvious questions that arise from this scenario are: how bad will the US downturn be and how contagious will it be? It looks as though it will be bad. Some optimists had hoped that the rest of the world could easily withstand a US recession and invented the infamous de-coupling theory. What they did not count on was the rapid decline of the US currency as expectations of a US recession were rising. A weak dollar is going to be the main global transmission mechanism.

Some market observers are now preparing for the bilateral exchange rate to move into the $1.40-$1.45 range. Short spikes in an exchange rate do not have much economic effect, but if the exchange rate were to remain in the $1.40-$1.45 trading range for a long period, it would no doubt affect eurozone exports and growth. Add to this the more direct effects of the credit crisis plus the global cyclical slowdown that has already started and you have the ingredients for a sharp downturn. If the US economy tanks, the rest of the world will follow with some delay. Act II of the crisis is therefore the transmission from the US to the global economy.

By the end of Act II, there is a reasonable chance that global imbalances will have unwound. US imports will have fallen. Exports will rise, as will the savings rate.

Will there be an Act III? Quite possibly. Moody’s, the rating agency, has predicted that a US recession could see a rise in corporate default rates from 1.4 per cent of rated companies last year to about 12 per cent – a level last seen during the early 1990s and after the dotcom crash. When that happens, it will be interesting to see how the credit markets will cope. The subprime glitch may soon be over. But the credit and global adjustment crises have only just begun.