Economics Update

It's Purim, so let's lead off with currency.

First, the dollar is a bit stronger vs the yen, but I think that the trend, and the underlying fundamentals, are in the other direction. No secrets here, just the combined federal and balance of payments deficit, along with the rise of the Euro as a reserve currency (brief primer here on what a reserve currency is), will push the dollar down.

There is an article in CNN Money about why there will be no bailout of the greenback by other nations central banks, but it misses an important point, that this bailout has been ongoing for over a decade.

The dollar is now falling in spite of the best efforts of the central bankers.

And in the "economists are always late to the game" news, the Economic Cycle Research Institute (ECRI) says that we are definitely in a recession.

Not to worry though, as majority of Americans think economy will turn around in 2009. I expect that the predictive powers of the American public will not be as good as mine.

We are looking at a deep and long recession, as credit contracts, and the stagnant wages of the past 30 years catches up with us. This will be worse than 1982, when unemployment broke 10% (Ronnie added the military to the count to keep the number below 10%), and real (i.e. subtracting inflation) interest rates in excess of 6%.

I think that it will be worse.

In the short term, the Visa IPO that I erroneously derided seems to have given a lot of banks some breathing room. It's generated a significant amount of cash, which should help with upcoming liquidity issues....for a while, at least.

Still, banks will be leery of making loans even to exemplary credit risks, for some time to come.

In the world of companies in trouble, S&P is considering downgrades to Goldman and Lehman, and it has downgraded National City's outlook rating.

However, this is all pretty mild compared to where Thornburg Mortgage which, in order to prevent margin calls (people demanding their loans be paid back now) for the next year, gave its creditors the following:

• To generate liquidity, it will issue "convertible bonds paying 12 percent annual interest".
• The bonds can be converted to stock at about $0.72/share.
• This means that existing stockholders will have their equity diluted by a factor of 9.
• Without conversion, the interest rate would be in the 25% range (!!!)
• The assets that it is protecting through these bonds yield somewhere around 6%, but they cannot be sold now. They hope that the market will improve in a year.