TAWOMG - Sleepless in Uppsala

Dear Friends,

When I was a child I used to sleep a lot. I also used to go to bed very early. When I wanted to stay awaken later, it was rather difficult. At that time I was very frustrated with it. When my parents went out at night I usually wanted to wait till they came back home, but never could. I fell asleep long before they arrived. I don't remember when, I don't know why, but one day it all changed: it started become difficult to fall asleep.

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When I came to Uppsala the first time, many nights I couldn't sleep well. Summer 1989 was an exceptionally nice and warm one in Scandinavia. Everybody talked about it. The student room where I lodged was very warm. This, combined with the long Scandinavian summer days, was a bad mixture. Quite often I woke up around 03:00 a.m. and just couldn't fall asleep again. That year I had a hired bike. When I couldn't sleep I rode my bike around Uppsala. This is one of the best memories that I have from that summer: the dim northern light, the fresh air, the absence of wind, the deep silence and the empty streets of Uppsala. I was almost glad for being unable to sleep.

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During the past four weeks in Uppsala sometimes I had trouble to sleep. However, it was nothing comparable to last night. Maybe it was because during the weekend I spent a lot of time reading the news and some reports about the world economy. I also called a few friends in different countries and asked for their opinion and what to expect next. I must admit that the resulting picture was rather scaring! At night I couldn't help thinking about how the economy is developing this year.

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Before coming to Sweden I organised some papers at home. I realized that since 2003 I had collected several articles published by "The Economist" about the house price bubble in America, Britain and other countries. Since 2005 I thought that the Spanish housing market was about to halt. If there is anything surprising about the current economic mess, it actually is that it took that long to happen. However, since last August the storm is building up and it is getting pretty ugly out there. The bad news is that, although some economies have already been hard hit by the crisis, we are still just at the early moments of it. The worst has still to come!

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At the end of last year I was convinced that the American economy would fall into recession at the first half of this year. Resilient consumption and growing exports, plus a huge tax stimulus by the American government, made it possible to avoid it. However, considering all the woes of the American economy, recession may well turn to be unavoidable:

- The house prices in he US have fallen by the fastest and greatest pace since depression in the 1930's. The bad news is that there are no indications that they will stop to fall in the near future. As long as house prices decline, there is no way out of the crisis. It could well be that the prices do not stop falling before the end of 2008.

- As conditions worsen, so do default rates in mortgages and foreclosures. This has already led to multibillion losses for the lenders and probably a lot more is to come.

- The building industry is already in recession. As fewer units are sold, the inventory of empty houses on the market grows and makes matters worse. It will be years before the housing industry peaks again. Fewer houses built and sold mean less jobs and also less taxes collected by local governments. This in turn means that they will be able to spend less.

- The banking sector in America is in very bad shape. This week many big banks will publish their results for the second quarter. Nobody is expecting good news. The bad results have already been discounted in the share prices. However, worse than expected news could drive share prices further down.

- Jobs were lost in America every single month since January. The stock exchange is operating in a bearish mood - most stock exchanges around the world fell by more than 20% in the year. How long will consumption be immune to all those bad news? The feeling is that since last month the perspectives have deteriorated substantially. It could well happen that in the next few months consumer good manufacturers start to issue profit warnings, knocking their share prices down. If consumption tumbles, then recession will be around the corner - maybe it is already there!

- High oil and food prices are putting pressure on inflation. As inflation soars central banks will find it difficult to avoid interest rate increases. On the other hand, the credit crush will continue to undermine the economy growth.

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America is the biggest world economy. Can the rest of the world decouple from an American recession? Some European economies, like the British, Irish and Spanish are heading straight to it. At best the whole EU economy will be flat for the next year and a half or so. Same applies for Japan. It is very difficult to think that the emerging economies will run into recession, but a slow down cannot be discarded. If it happens the commodity prices may start to fall, impacting all the economies that grew in the past years thanks to high commodity prices and strong demand.

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All this seems like the economic version of an Ingmar Bergman's film. You watch it and feel depressed. It could well be that very soon we will be reminded that in capitalism the economic cycle still holds and prosperity cannot last for ever. After years of strong growth, that will not be a nice remind.

Wish you enjoy the week and the remaining months before it gets nasty out there!

Maurício