Primaries and caucuses

WEBVTT
Kind: captions
Language: en

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Both of the major parties -- and we're talking about the United States here --

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hold a national convention during the summer before the actual general election.

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So the Republicans will hold their Republican national convention,

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and the Democrats will hold their Democratic national convention.

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And it's there that they will choose their official candidates

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that will run against each other in the general election.

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And a national convention for one of the parties

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will look something like this.

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This is the Democratic national convention in 2008.

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You have all the delegates over here,

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and everyone's all excited and they start to cheer lead for their party.

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and for their candidate the republican national convetion

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looks very similar

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And although there's a lot of energy here there actually isn't a lot of suspense

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Going into the convention we usually know already who

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the candidates for each of the parties are going to be

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And that's because each of the states have their own selection process

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for picking a candidate

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As we get the results from we know how many delegates

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they're going to send to the convention

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and who(m) they're going to vote for

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But there's two ways they can select those candidates

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or those delegates at the national convention

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They could either run a caucus

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or they could run a primary

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And I'll start with primary because that's a little more intuitive

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It's kind of like just a election that is based on party

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for whom do you want to be your nominee

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at coming out of the convention

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So for any given state they will have both a

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Democratic primary and a Republican primary

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And on the democratic primary let's say candidate A gets

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40% of the votes on that election

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Candidate B gets 30% of the votes

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and let's say candidate C gets another 30%

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What will happen is is that state's delegates on the democratic side

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So let's say that that state just for convenience

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Let's say they have ten delegates

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On the democratic side, that means that these delegates

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will go on to the national convention and represent

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the different candidates proportionally

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So out of these ten delegates 40% or four will represent candidate A

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Three will represent candidate B

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and three will represent candidate C when they go to the national convention

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On the republican side it's a little bit more nuance

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you could have similar results

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A gets 40%

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B gets 30% and C gets - now let me do different letters

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so these aren't the same candidates

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Let me do candidates D, E and F

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So you could have candidate D, candidate E, candidate F

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and let's say - let me do the percentages slightly different

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for fun

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So let's he has 45% over here

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let's say he has 25% over here

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and then let's say you have candidate F with 30% over here

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On the republican side it depends from state to state

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Some states will do it similar to the democrats

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where the delegates represent the candidates proportion to

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the votes they have

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While some other states have it 'winner take all'

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And so for example in a winner take all state, candidate D

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will get all 10 delegates

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And the reason why states do that is it's a stronger incentive for candidates

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to show up to that state if they feel like their in the running

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Because if they throw enough money and marketing in that state, that's a big deal to take all of the

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votes.

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On the other hand, if you're a smaller candidate and you don't think you

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can take it all, it may be a disincentive for you to even show up to that state

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and you might want to focus on the states where you can actually get

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some delegates

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So that's all the primary is.

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It's really a- you can kind of view it as an election

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That sell separately on the democratic side, separately on the republican side

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an those are used by the state's parties to decide which delegates go to the national party

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and whom those delegates are going to vote for

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A caucus, the point is the same thing

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To figure out who are your delegates that are going to go

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to the national convention and whom are they going to vote for

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but the process is a little bit different

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In a caucus, you essentially have- people get together

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in these events, these caucuses in different in these events,

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these caucuses in different precincts,

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and the most famous of these are the Iowa caucuses

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So in small precincts you'll have groups of fifty to a hundred

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people get together, and the different parties will have different

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ways of going about it

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but they have processes in place where people try to market for different candidates

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they campaign for different candidates

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and sometimes they'll have a cut-off that if one of the candidates

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at one of the precincts don't get at least 15% of the votes

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then those people who supported that candidate will have to give their

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support to another candidate they make sure that all of the delegates

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represent at least a certain threshold of voters but there's different

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processes in place

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But the bottom line is that at each of these pre-syncs they'll select delegates

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and then those delegates will then go on to the county conventions

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and then those delegates at the county conventions now these are

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representing more people

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will then pick delegates to the district conventions and then at the

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district conventions they will pick candidates to the state conventions

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and at the state conventions they will pick the final candidates

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that will go on to the national convention

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No the two most famous caucuses or primaries are the Iowa caucus

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which takes place in Iowa

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You have the New Hampshire primary which of course takes place in New Hampshire

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And they are important not because they pick so many delegates that those delegates

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will tip the balance necessarily

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These are small states they don't have that many delegates compared to

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California or Texas or Florida

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but what's important about both of them is that they happen

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very very very early on in the primary season

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and because they happen early on in the primary season

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the candidates that come off with the lead here it is easier for them to raise money

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they say 'Oh I want to give my money to a winner, you know I don't want to give

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it to a candidate who is just going to blow it and lose the money and lose the election

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regardless'

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So it gives you that. It also gives a big signal for who's a front runner because

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there tends to be dynamics for whoever wins or comes in in second place in the Iowa or

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New Hampshire primary that those are the people that everyone should pay attention to

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they get more fundraising it's kind of a self-fulfilling prophecy

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More people all of a sudden take a serious look at them

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Now the Iowa caucus just to be clear

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the primaries all happen in one day and you get the one, the polling results

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when people exit the polls and you also get the final result pretty quickly

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This caucus process actually takes place over many many months

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five months in the case of the Iowa caucus

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And the result, the thing that the press focuses on is not this final result,

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of who are the actual delegates that go to the national convention

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The thing that the press focuses on are the precinct convention where people get together

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Because coming out of those precinct conventions the state parties get the information

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on how many candidates each delegates won going into now the county convention

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And this, this is the indicator that the press and the media and everyone else likes to use

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to see who's a front runner in that specific party's primary

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And the reason why the Iowa caucus in particular gets so much importance is

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because it is the first caucus

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These results come out before anything else

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The New Hampshire primary this is the first time that you have direct voting for candidates

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so you're getting I guess getting a more direct number or your not having it

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distorted or maybe cleaned up depending on how you view it

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by all of the different processes that might take place within the precinct convention


Deflationary spiral

WEBVTT
Kind: captions
Language: en

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So in a normal economy
we know that employment

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will drive overall demand.

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If we have high employment
or low unemployment,

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then people are going
to have more jobs,

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and they're going to
have higher wages,

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and that will have
higher demand.

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Or if the other way goes
around, if they lose their jobs,

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demand is going to go down,
wages will start to go down,

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and people aren't going to
have money in their pockets.

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So employment drives demand.

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And we can view the
demand-- and I'm

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making a huge
simplification here--

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demand will drive production.

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Or maybe we could
think of it as supply.

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It'll drive supply, and it
can also be a driver of price.

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And of course, there is a little
bit of a negative feedback

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loop for both of these things.

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If the demand is high
and the price goes high,

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that might produce a little
bit of negative feedback

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on the demand.

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Instead of an arrow, this line
here means negative feedback.

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I'll put a little
negative sign here.

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And let's say the demand is high
and then the supply goes high.

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Well actually, the
supply going high

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would drive the
price going down.

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So maybe I should draw a
negative feedback like here.

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High supply would
mean lower price.

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But that's not what I want
to focus on in that video.

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And we could keep
adding more lines here.

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But this is roughly
simple take on it.

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But the general idea
is supply and price

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will then drive corporate
profits, or just profits

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in general, even for an
individual business owner.

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And then profits are
going to drive employment.

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Now, let's imagine a scenario.

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We are in a bad economy, maybe
a depression-like economy.

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So in that situation,
you could start really

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at any point in this circle.

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I'll just start at employment.

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So let's say employment
is really low.

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That's going to make
demand really low.

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And if demand is
really low, then supply

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is going to go down, and
price is going to go down.

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And then that's going
to make profits go down.

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And that's going to make
employment even lower.

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And so what we find ourselves
in this kind of recessionary

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or depression area
environment, this

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would be called a
deflationary spiral.

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And it's a spiral
because a bad economy

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is driving lower
prices, which is

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in turn driving a bad economy.

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And to make matters worse, if
this continues long enough,

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or if these price declines
are severe enough,

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you could imagine
people saying, look,

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I have this dollar in my pocket.

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I'm not going to spend
this dollar because, one, I

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might lose my job
at any moment, and I

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know that that dollar is
becoming more powerful,

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that I can buy more
every minute that I wait.

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So as the price goes down,
so as all of this scary stuff

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happens-- so the
employment is going down,

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profits are going down,
prices going down-- this

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makes people not
hoard goods the way

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that they would do in
an inflationary spiral.

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But it makes them hoard money.

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And why it's ultra scary
for central bankers

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or for governments
is they start to not

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have as much control
over the economy.

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They can't just run
the printing press

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and try to stimulate the
economy in this situation,

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because if they did people are
so conservative right now--

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You could imagine
maybe a depression

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is going on for years
and years and years.

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And let's say that they take
some type of a helicopter--

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And this isn't how you actually
distribute money to the money

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supply, but it's just to
show an extreme example.

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So they take a
helicopter, and they

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start dumping cash on people.

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They print cash, and they
start dumping it on people.

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So every man, woman, and child
in the country gets a $10 bill.

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Well, if people are really
scared and really afraid,

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they're just going
to take that $10 bill

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and stuff it into
their mattress,

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and it's not going
to change anything.

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That dollar isn't
going to actually enter

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into the money supply.

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The velocity on it will be 0.


Hyperinflation in a good economy

WEBVTT
Kind: captions
Language: en

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We now know a little bit
about inflation and deflation.

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And now I want to introduce
you to hyperinflation.

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And as the word implies,
it's inflation gone wild.

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How hyperinflation,
or at least the cases

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that we've seen in modern times,
how they've happened is you

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have some type of a
government just going wild

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with the printing press.

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They're just printing
a ton of money.

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So the general cycle
is they print money,

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they print like mad,
usually because they

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don't have any other
way of getting revenue.

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They print like mad.

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That leads to prices going up.

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And then because
prices go up, they

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have to print more
in order for them

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to be able to get the
same goods and services

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or pay the government
workers what they wanted

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to pay the government workers,
or pay the soldiers what

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they wanted to pay the soldiers.

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This by itself would probably
drive the hyperinflation

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in and of itself.

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But on top of this, we're used
to thinking high inflation is

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5% or 10%, but you
could imagine what

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happens when inflation
is 5% or 10% per hour.

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Because then
there's no incentive

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to be actually holding currency.

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Every second that
you hold currency it

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becomes worth less
and less and less.

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And so what happens in a
scenario like this is people

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want to hoard hard assets.

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So if the price of bread
is going up by the minute

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or by the hour, or
the price of shoes

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are going up by the
minute or by the hour,

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the increase in prices is going
to make people hoard things.

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Hoarding goes through the roof.

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And you can imagine if
hoarding goes through the roof,

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if the shoe seller doesn't
want to sell his shoes anymore,

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or he wants the hold
them a little bit longer,

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then the supply of shoes
are going to go down,

00:01:52.490 --> 00:01:54.710
and the prices are going
to go up even higher.

00:01:54.710 --> 00:01:58.080
So hoarding leads
even to higher prices.

00:01:58.080 --> 00:01:59.650
When people go to
the bread market,

00:01:59.650 --> 00:02:02.030
and there's five loaves of
bread, they buy all of them.

00:02:02.030 --> 00:02:03.520
And then the next
person can't buy any

00:02:03.520 --> 00:02:04.970
because they know that
the price of bread

00:02:04.970 --> 00:02:06.180
is going through the roof.

00:02:06.180 --> 00:02:09.100
So it just keeps
getting worse and worse.

00:02:09.100 --> 00:02:11.990
And it's all started
by the government just

00:02:11.990 --> 00:02:14.430
going nuts with
the printing press.

00:02:14.430 --> 00:02:17.430
Now, the three most
famous examples

00:02:17.430 --> 00:02:19.940
of this happening--
probably the most famous one

00:02:19.940 --> 00:02:22.640
is what happened
in Weimar Germany

00:02:22.640 --> 00:02:26.640
after World War I. They had
huge reparations to pay.

00:02:26.640 --> 00:02:28.430
That's what the
Weimar government

00:02:28.430 --> 00:02:30.600
would have argued
was their main cause.

00:02:30.600 --> 00:02:32.967
But they just printed
money like crazy.

00:02:32.967 --> 00:02:34.550
Some people said
that they were almost

00:02:34.550 --> 00:02:36.883
trying to destroy the economy
so that they wouldn't have

00:02:36.883 --> 00:02:40.540
to pay reparations for what
they did in World War I.

00:02:40.540 --> 00:02:43.270
But this just gives you a
sense of how crazy it was.

00:02:43.270 --> 00:02:46.560
Here's the end of World
War I. And they just

00:02:46.560 --> 00:02:47.710
printed money like mad.

00:02:50.860 --> 00:02:52.520
And isn't the rate of inflation.

00:02:52.520 --> 00:02:56.330
This is how much it was
relative to a gold mark.

00:02:56.330 --> 00:02:58.160
So this is one gold
mark over here.

00:02:58.160 --> 00:03:02.660
So only after about 2 and a
half years it was over tenfold.

00:03:02.660 --> 00:03:04.240
And this is a logarithmic scale.

00:03:04.240 --> 00:03:07.170
Each slash year, this
is a factor of 10.

00:03:07.170 --> 00:03:09.297
So after by the
end of 1923, you're

00:03:09.297 --> 00:03:10.380
looking at-- This is what?

00:03:10.380 --> 00:03:15.280
Not 100,000, not a
million, not a billion.

00:03:15.280 --> 00:03:16.260
This is a trillion.

00:03:16.260 --> 00:03:20.200
It had gone up a trillion fold
in the span of one, two, three,

00:03:20.200 --> 00:03:23.620
four, five, six years.

00:03:23.620 --> 00:03:26.000
The other famous
examples of this,

00:03:26.000 --> 00:03:29.230
Zimbabwe from 1980 until 2009.

00:03:29.230 --> 00:03:31.470
Once again, printing
money like mad.

00:03:31.470 --> 00:03:34.140
And some of their productive
capacity went away.

00:03:34.140 --> 00:03:39.760
This right here is a 100
trillion Zimbabwe dollar.

00:03:39.760 --> 00:03:43.020
And this shows you
the Zimbabwean dollar

00:03:43.020 --> 00:03:44.250
relative to the US dollar.

00:03:44.250 --> 00:03:46.070
And once again, is
a logarithmic scale.

00:03:46.070 --> 00:03:48.430
This is 10 to the 30th power.

00:03:48.430 --> 00:03:52.000
And then the largest or the
most extreme hyperinflation

00:03:52.000 --> 00:03:55.170
ever was Hungary
after World War II.

00:03:55.170 --> 00:03:57.170
And this right here
is a 10 million

00:03:57.170 --> 00:03:59.850
pengo note, just to give
you an idea of what people

00:03:59.850 --> 00:04:02.500
were carrying around
in their pockets.


Deflation despite increases in money supply

WEBVTT
Kind: captions
Language: en

00:00:00.523 --> 00:00:02.869
Let's revisit the island
or the universe that

00:00:02.869 --> 00:00:07.273
only has a farmer and a builder in it.

00:00:07.273 --> 00:00:09.333
Let's think about a different scenario.

00:00:09.333 --> 00:00:11.140
Let's think about a
scenario where they each

00:00:11.140 --> 00:00:13.353
start off with a lot of physical currency.

00:00:13.353 --> 00:00:14.998
We're in a universe that's
starts off with much

00:00:14.998 --> 00:00:16.736
more physical currency
than the last example.

00:00:16.736 --> 00:00:19.141
Where the universe had only 4 gold coins.

00:00:19.141 --> 00:00:21.935
Let's say that the farmer
right over here starts

00:00:21.935 --> 00:00:24.190
off with ... and I'll right down
the number instead of drawing

00:00:24.190 --> 00:00:27.066
the coins. Actually let
me draw the coins, that's

00:00:27.066 --> 00:00:29.799
kind of fun. Let's say
he starts off with 5

00:00:29.799 --> 00:00:33.689
gold coins, and the builder
also starts off with

00:00:33.689 --> 00:00:35.535
5 gold coins.

00:00:35.535 --> 00:00:38.067
Entering into this year,
the farmer is feeling

00:00:38.067 --> 00:00:41.190
pretty pessimistic. He
goes to the builder.

00:00:41.190 --> 00:00:44.796
He tells builder look I
just want the base level

00:00:44.796 --> 00:00:47.334
of construction or maintenance or whatever

00:00:47.334 --> 00:00:49.933
going on in my farm
today. I can only afford

00:00:49.933 --> 00:00:54.195
1 coin of business from
you, or what you can do

00:00:54.195 --> 00:00:57.418
for 1 coin. He gives
that coin to the builder.

00:00:57.418 --> 00:00:59.400
The builders feeling pretty pessimistic.

00:00:59.400 --> 00:01:01.424
Normally the farmer
starts off the year much

00:01:01.424 --> 00:01:03.266
better than that. He says
that this clearly going

00:01:03.266 --> 00:01:07.268
to be a bad year. I'm
only going to buy my base

00:01:07.268 --> 00:01:08.932
necessities for food.

00:01:08.932 --> 00:01:11.338
He goes to the farmer
and says look even though

00:01:11.338 --> 00:01:12.679
I have ... he's not
going to tell the farmer

00:01:12.679 --> 00:01:14.264
that he's hoarding all of his cash.

00:01:14.264 --> 00:01:16.601
He's going to say look
farmer, things are bad,

00:01:16.601 --> 00:01:18.800
business is bad, I'm
preparing for the worse.

00:01:18.800 --> 00:01:21.427
Just give me the base
minimum, cheapest, simplest,

00:01:21.427 --> 00:01:23.530
food you can that'll keep me alive.

00:01:23.530 --> 00:01:27.064
So, he only gives 1
coin back to the farmer.

00:01:27.064 --> 00:01:30.598
Imagine that the money
supply actually increases.

00:01:30.598 --> 00:01:32.532
For whatever reason the
farmer digs around in

00:01:32.532 --> 00:01:34.682
his backyard and finds some more gold.

00:01:34.682 --> 00:01:37.006
Then the builder, also,
while building a building

00:01:37.006 --> 00:01:40.530
actually discovers a
huge chest of gold right

00:01:40.530 --> 00:01:43.059
over here. Their still
feeling pretty pessimistic.

00:01:43.059 --> 00:01:45.096
Maybe their just pessimistic people.

00:01:45.096 --> 00:01:47.764
The farmer despite this
increase in the money

00:01:47.764 --> 00:01:49.536
supply, this gold that he discovers.

00:01:49.536 --> 00:01:52.138
He's like how frequently
am I going to discover

00:01:52.138 --> 00:01:54.599
gold like that. That
was just a one off thing

00:01:54.599 --> 00:01:56.867
a bonanza that I just
happened to run into.

00:01:56.867 --> 00:02:01.021
The business itself is
pretty bad. It was even

00:02:01.021 --> 00:02:03.521
worse last year then it normally is.

00:02:03.521 --> 00:02:05.274
I'm going to spend as little as possible.

00:02:05.274 --> 00:02:07.205
I'm going to go to the
builder, and I'm going

00:02:07.205 --> 00:02:09.735
to say look things seem
to only be getting worse.

00:02:09.735 --> 00:02:14.267
I can only afford half
a coin worth of what

00:02:14.267 --> 00:02:17.685
you have to offer, before
this base maintenance.

00:02:17.685 --> 00:02:19.799
The builders thinking
gee. That's even worse

00:02:19.799 --> 00:02:22.796
than last year, but I have
all this extra capacity

00:02:22.796 --> 00:02:25.262
I could be building so
much more. I have people

00:02:25.262 --> 00:02:28.662
who aren't working. Sure, I'll take it.

00:02:28.662 --> 00:02:30.468
I'll take your half coin,
and I'll deliver that

00:02:30.468 --> 00:02:34.803
same service for that half of a coin.

00:02:34.803 --> 00:02:38.202
He does it, and essentially,
his price had gone

00:02:38.202 --> 00:02:41.135
down despite the fact
there's more currency.

00:02:41.135 --> 00:02:43.199
The builder, even though
he dug around and found

00:02:43.199 --> 00:02:44.941
all this gold, he's feeling even worse.

00:02:44.941 --> 00:02:46.861
The price of what he's
offering has gone down.

00:02:46.861 --> 00:02:49.199
He's got even less revenue
in total in absolute

00:02:49.199 --> 00:02:51.864
gold coins now. When
he goes to the farmer.

00:02:51.864 --> 00:02:54.796
he's like, I have to buy that base level

00:02:54.796 --> 00:02:56.065
food. Otherwise, my
family's going to starve.

00:02:56.065 --> 00:02:58.465
Business is worse than
ever. I'm so pessimistic.

00:02:58.465 --> 00:03:00.198
He doesn't even tell the farmer that he

00:03:00.198 --> 00:03:01.534
discovered all of this. That he's hoarding

00:03:01.534 --> 00:03:04.359
all of this. So, he's
say farmer, i can just

00:03:04.359 --> 00:03:07.469
afford half a coin worth of stuff.

00:03:07.469 --> 00:03:10.265
The farmer says well I guess so, since the

00:03:10.265 --> 00:03:12.272
building prices have
gone down, and I can buy

00:03:12.272 --> 00:03:14.731
more with that half of
coin. I have all this

00:03:14.731 --> 00:03:17.199
surplus labor, and surplus
capacity on my farm.

00:03:17.199 --> 00:03:21.130
Sure, I will take a half
of coin for the same

00:03:21.130 --> 00:03:23.865
thing last year I took a full coin for.

00:03:23.865 --> 00:03:26.466
You see the situation where
deflation is occurring

00:03:26.466 --> 00:03:29.202
even though the money supply has increase.

00:03:29.202 --> 00:03:30.864
Of course, I'm exaggerating things.

00:03:30.864 --> 00:03:32.611
In normally if you have
this large of bonanza,

00:03:32.611 --> 00:03:34.693
and the money supply,
people would start to get

00:03:34.693 --> 00:03:36.361
optimistic and would start to spend money.

00:03:36.361 --> 00:03:38.135
It would probably lead to deflation.

00:03:38.135 --> 00:03:40.671
The main point here is
to realize that it isn't

00:03:40.671 --> 00:03:42.996
just driven by the
absolute quantity of the

00:03:42.996 --> 00:03:45.861
currency. That's important,
but just as important

00:03:45.861 --> 00:03:48.800
are confidence and what confidence drives,

00:03:48.800 --> 00:03:51.203
and that's specifically
the velocity of money.

00:03:51.203 --> 00:03:53.205
The transactions of money. The higher the

00:03:53.205 --> 00:03:57.695
velocity ... or quantity
matters. But quantity

00:03:57.695 --> 00:04:03.287
times velocity what really
drives the level of prices.


Velocity of money rather than quantity driving prices

WEBVTT
Kind: captions
Language: en

00:00:00.530 --> 00:00:03.340
It's a common misconception
that price levels

00:00:03.340 --> 00:00:06.412
are dictated purely by the
quantity of money out there.

00:00:06.412 --> 00:00:07.870
And to see why this
isn't the case,

00:00:07.870 --> 00:00:11.060
let's imagine an island
that has two players in it.

00:00:11.060 --> 00:00:15.460
So it has a farmer, who
obviously will produce food,

00:00:15.460 --> 00:00:20.730
and it also has a-- let's call
him a landlord-- landlord slash

00:00:20.730 --> 00:00:23.830
builder, who will either
rent out buildings

00:00:23.830 --> 00:00:26.740
or can build you more
buildings or build themselves

00:00:26.740 --> 00:00:28.560
more buildings to rent out.

00:00:28.560 --> 00:00:30.640
And we're living in a
reality where all you need

00:00:30.640 --> 00:00:32.570
is food and shelter.

00:00:32.570 --> 00:00:35.520
And let's imagine
one reality where

00:00:35.520 --> 00:00:38.610
this island, this country,
whatever you want to call it,

00:00:38.610 --> 00:00:40.470
they haven't discovered
a lot of currency.

00:00:40.470 --> 00:00:42.640
So they only have a
little bit of gold.

00:00:42.640 --> 00:00:46.010
So maybe the farmer only
has a couple of gold coins

00:00:46.010 --> 00:00:49.170
to start off with, and
the landlord slash builder

00:00:49.170 --> 00:00:52.390
also only has a couple of
gold coins to start off with.

00:00:52.390 --> 00:00:56.320
They're very currency poor,
only a little bit of gold.

00:00:56.320 --> 00:00:57.669
But they're very optimistic.

00:00:57.669 --> 00:01:00.210
The farmer says, hey, you know
what, things are looking good,

00:01:00.210 --> 00:01:01.010
landlord.

00:01:01.010 --> 00:01:05.790
I want to rent a nice building
from you for my family,

00:01:05.790 --> 00:01:07.830
and for you to build
more buildings.

00:01:07.830 --> 00:01:09.890
So here, take both
of these coins

00:01:09.890 --> 00:01:13.220
and build me or rent
me out something nice.

00:01:13.220 --> 00:01:15.830
And he gets both
coins over here.

00:01:15.830 --> 00:01:18.240
And then the landlord
says, wow, things are good.

00:01:18.240 --> 00:01:20.280
The farmer seems
pretty optimistic.

00:01:20.280 --> 00:01:25.270
Farmer, I want you to grow
me a ton of really good food,

00:01:25.270 --> 00:01:26.270
because things are good.

00:01:26.270 --> 00:01:32.900
So here, take four coins from
me and really grow me a ton

00:01:32.900 --> 00:01:37.970
of really nice food, the stuff
that's really hard to grow.

00:01:37.970 --> 00:01:40.990
So grow a ton of food for me.

00:01:40.990 --> 00:01:44.780
So he gets those four coins now.

00:01:44.780 --> 00:01:45.810
These are now gone.

00:01:45.810 --> 00:01:47.970
The farmer doesn't
have those anymore.

00:01:47.970 --> 00:01:51.027
Now the farmer's feeling really
great, really optimistic.

00:01:51.027 --> 00:01:52.860
And then, of course,
these are now gone now.

00:01:52.860 --> 00:01:54.810
The landlord has given
them to the farmer.

00:01:54.810 --> 00:01:56.435
The farmer's feeling
really optimistic.

00:01:56.435 --> 00:01:57.990
He says, landlord,
you know what,

00:01:57.990 --> 00:02:00.310
I'm feel even better
than I did before.

00:02:00.310 --> 00:02:02.710
Why don't you build me
even a few more buildings.

00:02:02.710 --> 00:02:04.955
I want to expand
my house even more.

00:02:04.955 --> 00:02:06.330
But now the
landlord's like, man,

00:02:06.330 --> 00:02:08.039
you've already given
me a lot of money,

00:02:08.039 --> 00:02:09.800
and I already have
a lot of work to do.

00:02:09.800 --> 00:02:12.300
You've got to pay me more if
you want me to work overtime,

00:02:12.300 --> 00:02:13.883
because that's going
to take time away

00:02:13.883 --> 00:02:15.620
from my family and all the rest.

00:02:15.620 --> 00:02:17.370
And the farmer says, sure.

00:02:17.370 --> 00:02:21.070
Last time I paid you two gold
coins for some buildings.

00:02:21.070 --> 00:02:22.860
I'll now pay you
three gold coins

00:02:22.860 --> 00:02:25.150
for the same number
of buildings.

00:02:25.150 --> 00:02:29.502
And so he gives
three gold coins.

00:02:29.502 --> 00:02:30.960
And all he's going
to get in return

00:02:30.960 --> 00:02:32.870
is what he used to get
for two gold coins.

00:02:32.870 --> 00:02:34.328
So if you think
about it, the price

00:02:34.328 --> 00:02:38.080
has gone up for whatever
service or product the builder

00:02:38.080 --> 00:02:38.900
is providing.

00:02:38.900 --> 00:02:41.040
And then he gives
those three gold coins

00:02:41.040 --> 00:02:43.090
to the landlord and the builder.

00:02:43.090 --> 00:02:45.174
And then the builder says,
things are really good.

00:02:45.174 --> 00:02:47.090
I'm getting a lot of
business from the farmer.

00:02:47.090 --> 00:02:48.814
I can get even more
food from the farmer.

00:02:48.814 --> 00:02:50.480
And he goes to the
farmer and says, hey,

00:02:50.480 --> 00:02:52.430
give me what you just gave
me that last time for two

00:02:52.430 --> 00:02:53.020
gold coins.

00:02:53.020 --> 00:02:54.560
The farmer says,
no, you know what?

00:02:54.560 --> 00:02:55.880
I'm really busy now.

00:02:55.880 --> 00:02:56.840
I'm almost tapped out.

00:02:56.840 --> 00:03:00.267
If you want me to work overtime
or expand my facilities,

00:03:00.267 --> 00:03:02.850
you've got to give me three gold
coins for what I gave before.

00:03:02.850 --> 00:03:05.370
And besides that, the
cost of buying houses

00:03:05.370 --> 00:03:07.154
has just gone up to
three gold coins,

00:03:07.154 --> 00:03:09.070
so you've got to give
me three gold coins now.

00:03:09.070 --> 00:03:10.486
And so the builder
says, oh, sure,

00:03:10.486 --> 00:03:11.940
I'll give you three gold coins.

00:03:11.940 --> 00:03:14.100
So the one thing I want
you to notice in this video

00:03:14.100 --> 00:03:17.220
is we only started off with
two gold coins for each

00:03:17.220 --> 00:03:18.134
of these players.

00:03:18.134 --> 00:03:20.300
But because they were really
confident, because they

00:03:20.300 --> 00:03:21.675
kept spending it
with each other,

00:03:21.675 --> 00:03:23.500
because there were a
lot of transactions,

00:03:23.500 --> 00:03:26.840
there was a high velocity
of the actual money

00:03:26.840 --> 00:03:30.196
that you actually had
an increase in prices.


Deflation

WEBVTT
Kind: captions
Language: en

00:00:00.850 --> 00:00:04.730
Deflation is literally
just a lowering of prices,

00:00:04.730 --> 00:00:06.980
or a general
decrease in the level

00:00:06.980 --> 00:00:08.759
of prices for
goods and services.

00:00:08.759 --> 00:00:10.800
Or another way to think
about it, since inflation

00:00:10.800 --> 00:00:13.030
is an increase in
the level of prices,

00:00:13.030 --> 00:00:18.690
you can just view it
as negative inflation.

00:00:18.690 --> 00:00:22.500
And so, let's say we're the
folks at the Bureau of Labor

00:00:22.500 --> 00:00:26.400
Statistics, and we're trying
to compute the CPI index.

00:00:26.400 --> 00:00:29.490
And in one period-- let's call
this period one over here--

00:00:29.490 --> 00:00:32.520
we have our CPI index
for urban consumers.

00:00:32.520 --> 00:00:34.416
And that's the one
that's quoted most often.

00:00:34.416 --> 00:00:35.790
And we have this
basket of goods.

00:00:35.790 --> 00:00:37.190
And it'll have housing in it.

00:00:40.660 --> 00:00:43.060
Let me write that a
little bit neater.

00:00:43.060 --> 00:00:44.440
It'll have housing in it.

00:00:44.440 --> 00:00:46.360
It'll have transportation in it.

00:00:46.360 --> 00:00:48.150
It'll have a fuel in it.

00:00:48.150 --> 00:00:50.800
It might have some
proxy for entertainment

00:00:50.800 --> 00:00:52.570
or whatever else inside of it.

00:00:52.570 --> 00:00:55.450
And that basket of goods,
let's say in period one--

00:00:55.450 --> 00:00:57.500
and this is a
simplification-- runs

00:00:57.500 --> 00:01:01.030
that urban consumer
on average $100.

00:01:01.030 --> 00:01:03.350
And then we go to
period two, and we

00:01:03.350 --> 00:01:05.330
look at that same
basket of goods.

00:01:05.330 --> 00:01:07.090
Maybe we're adjusting
certain things,

00:01:07.090 --> 00:01:08.770
maybe some products
have become obsolete

00:01:08.770 --> 00:01:10.650
and we have to
replace, or there has

00:01:10.650 --> 00:01:12.627
to be some adjustments
for technology.

00:01:12.627 --> 00:01:14.960
And that's all under debate,
how you should adjust them.

00:01:14.960 --> 00:01:17.330
But given that,
assuming everything else

00:01:17.330 --> 00:01:22.210
is equal, that same basket of
goods is now running at $98.

00:01:22.210 --> 00:01:25.070
And so the total cost
of goods and services

00:01:25.070 --> 00:01:30.330
for this kind of average
consumer has gone down by $2.

00:01:30.330 --> 00:01:32.540
Or we could say that
we've experienced

00:01:32.540 --> 00:01:36.720
negative 2% inflation,
which is really

00:01:36.720 --> 00:01:44.720
just another way of saying that
we have experienced deflation.

00:01:44.720 --> 00:01:47.220
Now, deflation is not
the norm, especially

00:01:47.220 --> 00:01:48.960
for growing economies,
the way that

00:01:48.960 --> 00:01:53.230
our current economic systems
runs, although it does happen.

00:01:53.230 --> 00:01:55.280
And Japan in
particular is probably

00:01:55.280 --> 00:01:59.100
the most recent, most
famous case of deflation.

00:01:59.100 --> 00:02:01.750
And the main reason
why economists really

00:02:01.750 --> 00:02:04.150
don't like deflation-- or
I should say in particular,

00:02:04.150 --> 00:02:07.560
while central bankers really
don't like deflation--

00:02:07.560 --> 00:02:10.400
is that it makes it much
harder to control the economy

00:02:10.400 --> 00:02:12.990
or to fuel the economy
with interest rates

00:02:12.990 --> 00:02:15.290
alone, or actually just
with printing money alone.

00:02:15.290 --> 00:02:16.956
And I'll go into a
little bit more depth

00:02:16.956 --> 00:02:18.456
with that in future videos.

00:02:18.456 --> 00:02:19.830
One thing I do
want to make clear

00:02:19.830 --> 00:02:21.730
is although deflation
isn't what we normally

00:02:21.730 --> 00:02:24.020
see in the broader
economy as a whole,

00:02:24.020 --> 00:02:27.480
it does happen very frequently
in specific sectors.

00:02:27.480 --> 00:02:29.750
And the most common one is
in the technology sector,

00:02:29.750 --> 00:02:31.810
specifically hardware.

00:02:31.810 --> 00:02:36.980
We've all experienced buying
a laptop at one period--

00:02:36.980 --> 00:02:42.050
so right now you buy the
laptop for maybe $1,000--

00:02:42.050 --> 00:02:45.450
and then six months
later you see

00:02:45.450 --> 00:02:49.041
that exact same laptop for $500.

00:02:49.041 --> 00:02:51.540
And that's just because the
rate of technological innovation

00:02:51.540 --> 00:02:53.280
is going so fast
that they can produce

00:02:53.280 --> 00:02:55.890
the same amount of memory
and processing power

00:02:55.890 --> 00:02:57.292
for a lot cheaper now.

00:02:57.292 --> 00:02:58.750
Or for the same
amount of money you

00:02:58.750 --> 00:03:01.140
can get much more memory
and processing power,

00:03:01.140 --> 00:03:02.640
and all of the rest.

00:03:02.640 --> 00:03:07.350
And you see this with laptops
and with a big screen TVs

00:03:07.350 --> 00:03:09.980
and phones and all the rest.


Use cases for credit default swaps

WEBVTT
Kind: captions
Language: en

00:00:00.442 --> 00:00:01.900
Let's think about
the different use

00:00:01.900 --> 00:00:03.820
cases for credit default swaps.

00:00:03.820 --> 00:00:06.330
So let's say that I have
some company over here,

00:00:06.330 --> 00:00:09.980
and it's given a
BB credit rating.

00:00:09.980 --> 00:00:12.820
And this rating, of course,
comes from a credit rating

00:00:12.820 --> 00:00:20.281
agency, sometimes called a
ratings agency or a rating

00:00:20.281 --> 00:00:20.780
agency.

00:00:20.780 --> 00:00:22.160
I've seen it every
different way.

00:00:22.160 --> 00:00:24.750
So this would be like Moody's or
Standard and Poor's or whatever

00:00:24.750 --> 00:00:25.110
else.

00:00:25.110 --> 00:00:27.630
And they look at this company,
and they look at its business,

00:00:27.630 --> 00:00:29.671
they look at its balance
sheet, and they say, OK,

00:00:29.671 --> 00:00:32.009
it's not super safe, but
it's not super risky either.

00:00:32.009 --> 00:00:33.710
We give it a BB rating.

00:00:33.710 --> 00:00:36.020
And let's say that there's
an investor over here who

00:00:36.020 --> 00:00:39.740
wants to lend money
to this company.

00:00:39.740 --> 00:00:41.880
So he might lend them
some money and get

00:00:41.880 --> 00:00:43.285
some interest in return.

00:00:46.520 --> 00:00:49.120
But this investor doesn't
like this level of safety.

00:00:49.120 --> 00:00:51.770
He wants to make sure
that he's made whole

00:00:51.770 --> 00:00:54.650
even if this company
goes out of business.

00:00:54.650 --> 00:00:57.430
So he can go to a writer
of a credit default swap,

00:00:57.430 --> 00:00:59.700
and the most famous of
those credit default

00:00:59.700 --> 00:01:03.564
swap writers is or was AIG.

00:01:03.564 --> 00:01:04.980
And he'll say,
hey, AIG, I'm going

00:01:04.980 --> 00:01:07.150
to pay you a little
bit every year.

00:01:07.150 --> 00:01:09.330
You could view that as
an insurance premium.

00:01:09.330 --> 00:01:11.460
And in exchange,
you are essentially

00:01:11.460 --> 00:01:18.349
going to ensure me in the case
of a default by this company.

00:01:18.349 --> 00:01:20.390
And what we already said,
it's a little bit shady

00:01:20.390 --> 00:01:22.760
because it was not
regulated like insurance.

00:01:22.760 --> 00:01:25.150
So AIG did not have
to set anything aside.

00:01:25.150 --> 00:01:27.110
And what was
powerful here for AIG

00:01:27.110 --> 00:01:29.800
is that the rating
agencies continued

00:01:29.800 --> 00:01:32.420
to give AIG a very high rating.

00:01:32.420 --> 00:01:34.486
So let's say it had a AA rating.

00:01:34.486 --> 00:01:36.110
So despite the fact
that it kept taking

00:01:36.110 --> 00:01:38.730
on all these liabilities,
the credit rating agency

00:01:38.730 --> 00:01:40.390
says, hey, we'll
still give you a AA.

00:01:40.390 --> 00:01:43.212
So they were able to use
this AA rating to keep

00:01:43.212 --> 00:01:45.295
writing these contracts,
to keep writing insurance

00:01:45.295 --> 00:01:48.300
and not setting anything aside,
and essentially just getting,

00:01:48.300 --> 00:01:49.800
almost you could
view it, free money

00:01:49.800 --> 00:01:53.660
with having to pay
the piper eventually.

00:01:53.660 --> 00:01:55.340
Now this is one scenario.

00:01:55.340 --> 00:01:58.340
Another scenario is
maybe an investment bank

00:01:58.340 --> 00:02:00.250
creates some type of
special purpose entity

00:02:00.250 --> 00:02:04.600
or some collateralized debt
obligation right over here.

00:02:04.600 --> 00:02:07.450
And they have their
different tranches.

00:02:07.450 --> 00:02:11.340
And maybe for the senior
tranche over here,

00:02:11.340 --> 00:02:14.720
just so that they can sell them
to pension funds who can only

00:02:14.720 --> 00:02:19.590
buy AA rated debt,
pension funds.

00:02:19.590 --> 00:02:23.310
The investment bank goes
to AIG and says, hey,

00:02:23.310 --> 00:02:28.220
can this entity right over
here buy credit default swaps?

00:02:28.220 --> 00:02:30.830
Can we enter into credit
default swap agreements

00:02:30.830 --> 00:02:34.440
on you, so that in case any
of this stuff were to default,

00:02:34.440 --> 00:02:36.090
you will also insure that?

00:02:36.090 --> 00:02:38.960
And once we do that,
then a rating agency.

00:02:38.960 --> 00:02:40.090
So this is a security.

00:02:40.090 --> 00:02:44.310
This is a senior tranche of a
collateralized debt obligation

00:02:44.310 --> 00:02:47.380
now, the senior tranche, and
now that that senior tranche

00:02:47.380 --> 00:02:52.760
is essentially insured by
AIG, a credit rating agency,

00:02:52.760 --> 00:02:56.030
once again, will assign
this a AA rating.

00:02:56.030 --> 00:02:57.950
Even though this
thing might be made up

00:02:57.950 --> 00:03:00.240
of a bunch of sub-prime
mortgages and all of the rest,

00:03:00.240 --> 00:03:03.710
although it is a senior tranche
so it'll be made whole first,

00:03:03.710 --> 00:03:06.630
but now pension funds can
buy this type of thing.

00:03:06.630 --> 00:03:13.970
The last use case is maybe you
have a hedge fund out here who

00:03:13.970 --> 00:03:15.990
doesn't want to lend
anybody any money,

00:03:15.990 --> 00:03:19.320
but is convinced that a whole
bunch of these companies, maybe

00:03:19.320 --> 00:03:23.930
this company over here or maybe
this company over here, that

00:03:23.930 --> 00:03:25.220
has some other rating.

00:03:25.220 --> 00:03:27.110
So this is another company.

00:03:27.110 --> 00:03:29.897
This hedge fund is convinced
that these companies are going

00:03:29.897 --> 00:03:31.480
to default on their
debt, that there's

00:03:31.480 --> 00:03:33.770
going to be a credit
crisis of some kind.

00:03:33.770 --> 00:03:36.440
Well, then this hedge fund can
enter into credit default swap

00:03:36.440 --> 00:03:41.360
agreements to essentially
get insurance,

00:03:41.360 --> 00:03:43.420
but not having
anything to insure.

00:03:43.420 --> 00:03:47.780
It's like getting car insurance
on someone else's driving

00:03:47.780 --> 00:03:49.530
or someone else's
car, and you kind of

00:03:49.530 --> 00:03:52.950
are starting to hope that they
have to have a car accident.

00:03:52.950 --> 00:03:54.890
Because now if this guy
has a credit default

00:03:54.890 --> 00:03:58.100
swap on this company
right over here,

00:03:58.100 --> 00:04:00.510
despite the fact that they
didn't lend out to them,

00:04:00.510 --> 00:04:02.801
the hedge funds is going to
pay a little bit every year

00:04:02.801 --> 00:04:04.120
and get the insurance.

00:04:04.120 --> 00:04:06.900
And they are essentially going
to hope that this company goes

00:04:06.900 --> 00:04:08.820
out of business,
because if it does,

00:04:08.820 --> 00:04:10.820
then they're going to get
the insurance payment.

00:04:10.820 --> 00:04:12.950
They're going to get the same
payment that this investor

00:04:12.950 --> 00:04:15.449
would have, but they would have
never had to lend the money.

00:04:15.449 --> 00:04:16.890
So you could use
it as a side bet,

00:04:16.890 --> 00:04:21.630
you could use it as a way of
making lower-rated securities

00:04:21.630 --> 00:04:23.720
all of a sudden acceptable
to pension funds,

00:04:23.720 --> 00:04:26.860
or you could use it as a
straight-up way of insuring

00:04:26.860 --> 00:04:30.410
debt that you're
lending to someone else.


Financial weapons of mass destruction

WEBVTT
Kind: captions
Language: en

00:00:00.499 --> 00:00:02.500
Let's think a
little bit about why

00:00:02.500 --> 00:00:04.250
credit default
swaps, or famously

00:00:04.250 --> 00:00:08.780
referred to by Warren
Buffett as financial weapons

00:00:08.780 --> 00:00:11.785
of mass destruction.

00:00:11.785 --> 00:00:13.160
At the center of
it-- and there's

00:00:13.160 --> 00:00:15.466
not just one credit
default swap writer,

00:00:15.466 --> 00:00:17.590
but I'll put one in the
middle because each of them

00:00:17.590 --> 00:00:20.210
are writing many, many
credit default swaps.

00:00:20.210 --> 00:00:21.880
AIG is the most famous.

00:00:21.880 --> 00:00:23.670
But you have some writer here.

00:00:23.670 --> 00:00:26.080
They're given some
good credit rating.

00:00:26.080 --> 00:00:27.580
Maybe in the past
that credit rating

00:00:27.580 --> 00:00:30.560
was actually earned by
a credit rating agency.

00:00:30.560 --> 00:00:32.460
And then frankly, the
credit rating agency

00:00:32.460 --> 00:00:35.970
got a little sloppy and really
wasn't willing to downgrade

00:00:35.970 --> 00:00:37.500
them given all of
the credit default

00:00:37.500 --> 00:00:41.420
swaps, all of the obligations
they are taking on.

00:00:41.420 --> 00:00:45.310
And as you could tell, I kind of
view these guys and these guys

00:00:45.310 --> 00:00:47.830
as the main culprits,
and maybe a little bit

00:00:47.830 --> 00:00:49.770
of the regulatory agencies
saying, hey, look,

00:00:49.770 --> 00:00:51.145
these guys are
writing insurance.

00:00:51.145 --> 00:00:53.090
Maybe we should
actually regulate them.

00:00:53.090 --> 00:00:56.060
But with that said, you
have companies over here.

00:00:56.060 --> 00:00:58.610
I'll do the companies
in this pink color.

00:00:58.610 --> 00:01:01.280
And they want to borrow
money from other parties,

00:01:01.280 --> 00:01:02.260
let's say, investors.

00:01:02.260 --> 00:01:05.880
I'll do the investors
in this orange color.

00:01:05.880 --> 00:01:08.300
So the investors are
lending them money.

00:01:08.300 --> 00:01:10.260
The companies give
them interest.

00:01:10.260 --> 00:01:13.370
So investors lending money,
giving interest, lending money,

00:01:13.370 --> 00:01:16.460
giving interest, lending
money, giving interest.

00:01:16.460 --> 00:01:18.880
And then these investors--
it seems pretty reasonable--

00:01:18.880 --> 00:01:21.230
say, hey, look, there's a
guy over here with a double A

00:01:21.230 --> 00:01:21.650
rating.

00:01:21.650 --> 00:01:24.233
The people that we're lending
to don't have a double A rating.

00:01:24.233 --> 00:01:28.040
Maybe this guy has a B, maybe
this guy has a double B,

00:01:28.040 --> 00:01:31.480
maybe this guy only has a
single A. And so he says, look,

00:01:31.480 --> 00:01:33.386
I want to be
completely safe here

00:01:33.386 --> 00:01:35.260
so I'm going to pay a
little bit of a premium

00:01:35.260 --> 00:01:39.760
to AIG or to the writer,
whoever the writer is,

00:01:39.760 --> 00:01:46.540
and in exchange I will get
insurance on this debt.

00:01:53.210 --> 00:01:55.460
And it seems pretty
reasonable except for the fact

00:01:55.460 --> 00:01:59.940
that this player right over here
did not put out any money aside

00:01:59.940 --> 00:02:01.860
or did not put the
appropriate amount of money

00:02:01.860 --> 00:02:06.210
aside to properly account for
all of these liabilities, all

00:02:06.210 --> 00:02:07.900
of this risk that its taking on.

00:02:07.900 --> 00:02:10.190
And also, all of these
risks are correlated.

00:02:10.190 --> 00:02:13.190
You can imagine a situation
where the economy goes bad.

00:02:13.190 --> 00:02:17.320
Now, all of a sudden
this company defaults

00:02:17.320 --> 00:02:19.840
on its debt and this company
defaults on its debt.

00:02:19.840 --> 00:02:21.330
In fact, when the
economy's good,

00:02:21.330 --> 00:02:22.930
it's likely that very
few of these companies

00:02:22.930 --> 00:02:25.055
are going to default and
when the economy goes bad,

00:02:25.055 --> 00:02:27.570
it's likely that many
of them will default.

00:02:27.570 --> 00:02:30.120
But the real problem is is as
soon as these defaults start

00:02:30.120 --> 00:02:32.850
happening, then the
credit default swap writer

00:02:32.850 --> 00:02:36.420
is going to have to actually
start paying for the defaults.

00:02:36.420 --> 00:02:38.420
They'll get the bad debt
and in exchange they'll

00:02:38.420 --> 00:02:40.910
make the other side
of the credit default

00:02:40.910 --> 00:02:44.820
swap, the holder of it, they
will pay to make them whole.

00:02:44.820 --> 00:02:47.600
And so this could take
them out of business.

00:02:47.600 --> 00:02:49.820
And all of a sudden,
the people over here

00:02:49.820 --> 00:02:53.030
who thought that they had
insurance no longer do.

00:02:53.030 --> 00:02:54.600
And they might
actually say, wait,

00:02:54.600 --> 00:02:57.570
I can only hold double A
debt and they might actually

00:02:57.570 --> 00:03:00.260
have to dump this
debt on to the market.

00:03:00.260 --> 00:03:04.620
Even worse, you have all
of the people over here

00:03:04.620 --> 00:03:06.404
who didn't lend any
money to anybody,

00:03:06.404 --> 00:03:08.320
but they really just
wanted to make side bets.

00:03:08.320 --> 00:03:10.890
Either the side bets might
have been pure directional bets

00:03:10.890 --> 00:03:12.348
on the state of
the economy saying,

00:03:12.348 --> 00:03:13.779
hey, I think a
bunch of companies

00:03:13.779 --> 00:03:15.320
or I think this
company in particular

00:03:15.320 --> 00:03:18.090
is going to default on
its debt, and they too

00:03:18.090 --> 00:03:21.420
could get credit default swaps
really as just side bets.

00:03:21.420 --> 00:03:26.260
So just for maybe this right
here is $1 billion in debt,

00:03:26.260 --> 00:03:30.630
maybe all of these parties
took side bets on this guy.

00:03:30.630 --> 00:03:33.260
So even though there's only
$1 billion of debt here,

00:03:33.260 --> 00:03:35.950
there might be $4
or $5 or $10 billion

00:03:35.950 --> 00:03:38.860
worth of insurance on
that $1 billion bet.

00:03:38.860 --> 00:03:41.000
So if all of a sudden
this one company

00:03:41.000 --> 00:03:43.920
can't pay its $1 billion,
now AIG is on the line

00:03:43.920 --> 00:03:47.070
not for $1 billion, but
for $4 or $5 or $6 billion,

00:03:47.070 --> 00:03:48.680
however much it insured it for.

00:03:48.680 --> 00:03:50.910
So it allows people
to insure for things

00:03:50.910 --> 00:03:54.920
that they don't have the
offsetting liability for.

00:03:54.920 --> 00:03:57.490
And so you can imagine,
some of these people--

00:03:57.490 --> 00:04:00.749
if this guy fails will just take
a loss and that's bad and all

00:04:00.749 --> 00:04:02.790
of the rest because they
were expecting that they

00:04:02.790 --> 00:04:05.280
wouldn't-- but some of
these players might have had

00:04:05.280 --> 00:04:06.700
offsetting hedges.

00:04:06.700 --> 00:04:09.120
The only reason why they
might have felt comfortable

00:04:09.120 --> 00:04:10.870
taking on some
other liability is

00:04:10.870 --> 00:04:14.420
they said, look, if the
economy goes really bad,

00:04:14.420 --> 00:04:16.529
I have this insurance over here.

00:04:16.529 --> 00:04:19.920
And they did that transaction
with another third party.

00:04:19.920 --> 00:04:23.130
Now all of a sudden,
if the economy goes bad

00:04:23.130 --> 00:04:25.480
and these guys say, hey,
look, I'm in a lot of trouble.

00:04:25.480 --> 00:04:27.020
Good thing I have this
credit default swap,

00:04:27.020 --> 00:04:29.603
but then it turns out that they
don't because the counterparty

00:04:29.603 --> 00:04:32.080
here fails, the credit
default swap writer,

00:04:32.080 --> 00:04:34.240
now all of a sudden this
guy becomes insolvent.

00:04:34.240 --> 00:04:36.359
But this guy was dependent
on this guy paying

00:04:36.359 --> 00:04:38.400
and he thought he was good
because he even looked

00:04:38.400 --> 00:04:41.020
at this guy's books and said
this guy had offsetting hedges,

00:04:41.020 --> 00:04:42.770
and now this guy might fail.

00:04:42.770 --> 00:04:44.550
And so you could have
this entire cascade

00:04:44.550 --> 00:04:47.590
through the entire
financial system.


Inflation data

WEBVTT
Kind: captions
Language: en

00:00:00.700 --> 00:00:03.870
In the last video, we talked a
little bit about what inflation

00:00:03.870 --> 00:00:05.382
is, and the Consumer
Price Index.

00:00:05.382 --> 00:00:07.340
And so I thought I would
actually show you data

00:00:07.340 --> 00:00:09.530
and maybe point out a
few interesting things

00:00:09.530 --> 00:00:10.860
right over here.

00:00:10.860 --> 00:00:13.165
So this right over here is
the monthly press release,

00:00:13.165 --> 00:00:15.900
or it's the table from the
monthly press release, issued

00:00:15.900 --> 00:00:18.000
by the Bureau of
Labor Statistics.

00:00:18.000 --> 00:00:19.660
And this is Table
A, which is really

00:00:19.660 --> 00:00:21.320
a summary of all the
important things.

00:00:21.320 --> 00:00:25.140
It's the percent changes in
CPI for all urban consumers,

00:00:25.140 --> 00:00:29.530
the CPI-U. And they do it for
non or urban consumers and all

00:00:29.530 --> 00:00:30.030
the rest.

00:00:30.030 --> 00:00:32.299
But the CPI that is
quoted is the one

00:00:32.299 --> 00:00:35.677
for urban consumers,
the US City Average.

00:00:35.677 --> 00:00:38.010
And what I always find is
that the details are much more

00:00:38.010 --> 00:00:39.970
interesting than what
you hear just on the news

00:00:39.970 --> 00:00:44.244
when people say, oh,
the CPI changed by 0.5%.

00:00:44.244 --> 00:00:45.660
And one thing I
do want to point--

00:00:45.660 --> 00:00:48.662
and this is true of the CPI,
this is true of all government

00:00:48.662 --> 00:00:50.620
statistics; in fact, this
is true of any report

00:00:50.620 --> 00:00:52.380
that any company
gives you-- it's

00:00:52.380 --> 00:00:54.846
very important to keep
in mind whether they're

00:00:54.846 --> 00:00:56.720
giving a sequential
change or whether they're

00:00:56.720 --> 00:00:58.800
giving a year-over-year change.

00:00:58.800 --> 00:01:04.019
So for example, there might be
a press release like this one,

00:01:04.019 --> 00:01:06.300
and the text of it, or
maybe the headline number

00:01:06.300 --> 00:01:08.840
when you look at your local
newspaper or your news report,

00:01:08.840 --> 00:01:13.990
will say, look in June 2011
inflation on all items,

00:01:13.990 --> 00:01:19.950
on the entire basket of
goods, went down by 0.2%.

00:01:19.950 --> 00:01:22.290
And you might say, oh wow,
look, there's no inflation.

00:01:22.290 --> 00:01:24.070
In fact, prices are going down.

00:01:24.070 --> 00:01:25.832
This would be minor deflation.

00:01:25.832 --> 00:01:27.790
But it's important to
realize that this is only

00:01:27.790 --> 00:01:32.987
the seasonally adjusted
prices from May to June.

00:01:32.987 --> 00:01:34.820
Now, when I talk about
seasonally adjusted--

00:01:34.820 --> 00:01:37.120
and traditionally, maybe
people use a different amount

00:01:37.120 --> 00:01:40.460
of energy, a different amount
of gasoline from May to June.

00:01:40.460 --> 00:01:43.290
And they try to factor
that in when they compare

00:01:43.290 --> 00:01:45.690
the basket of good, the
price of the basket of good,

00:01:45.690 --> 00:01:46.830
from May to June.

00:01:46.830 --> 00:01:49.020
So that's what they talk
about seasonally adjusting.

00:01:49.020 --> 00:01:50.780
But if you look over
here, the prices

00:01:50.780 --> 00:01:52.470
went down for May
to June according

00:01:52.470 --> 00:01:55.880
to adjusting it for the season.

00:01:55.880 --> 00:01:59.280
But they year-over-year
changes are still up.

00:01:59.280 --> 00:02:06.264
If you compare June 2011 to June
2010, it is still up by 3.6%.

00:02:06.264 --> 00:02:07.680
And in general,
the monthly things

00:02:07.680 --> 00:02:09.199
are going to be a little
bit more volatile.

00:02:09.199 --> 00:02:10.680
Obviously, you have the
seasonal adjustments.

00:02:10.680 --> 00:02:13.200
You have other short-term
factors that might change it.

00:02:13.200 --> 00:02:16.780
But the year-over-year
one is a stronger signal

00:02:16.780 --> 00:02:18.877
for what is actually
happening for inflation.

00:02:18.877 --> 00:02:20.710
Although someone might
want to pay attention

00:02:20.710 --> 00:02:23.670
to the monthly one, because
that's obviously giving you

00:02:23.670 --> 00:02:26.770
the most up to date of
what's happening now.

00:02:26.770 --> 00:02:28.510
And what you'll
often see is, they'll

00:02:28.510 --> 00:02:30.570
give an inflation
number for everything,

00:02:30.570 --> 00:02:33.630
and then they'll subtract
out food and energy.

00:02:33.630 --> 00:02:36.634
So this is all items
less food and energy.

00:02:36.634 --> 00:02:38.300
And that's because
food and energy, they

00:02:38.300 --> 00:02:40.047
represent a good
bit of the basket,

00:02:40.047 --> 00:02:41.380
but they're very, very volatile.

00:02:41.380 --> 00:02:43.560
You can see it right
here in this report,

00:02:43.560 --> 00:02:49.270
year-over-year energy has
gone up double digits, 20%

00:02:49.270 --> 00:02:52.370
for energy generally.

00:02:52.370 --> 00:02:55.780
If you look at fuel oil,
35.6%, at least on this report.

00:02:55.780 --> 00:02:57.280
It's been coming
down more recently.

00:02:57.280 --> 00:02:59.950
But year-over-year it's
been up a huge amount.

00:02:59.950 --> 00:03:03.860
And so that's actually the main
driving factor for this 3.6%.

00:03:03.860 --> 00:03:06.520
If you take food and
energy out of the equation,

00:03:06.520 --> 00:03:08.750
if you compare the basket
of goods minus that,

00:03:08.750 --> 00:03:11.272
inflation was only up 1.6%.

00:03:11.272 --> 00:03:11.980
It's interesting.

00:03:11.980 --> 00:03:15.620
Even within that, you can look
at which parts of the economy,

00:03:15.620 --> 00:03:17.412
or which products and
services, are getting

00:03:17.412 --> 00:03:19.745
a lot more expensive and which
ones are getting cheaper.

00:03:19.745 --> 00:03:22.030
It's actually interesting
that used cars and trucks

00:03:22.030 --> 00:03:24.190
are up 5.1%.

00:03:24.190 --> 00:03:29.500
That seems like a pretty strong
price increase for used things.


What is inflation?

WEBVTT
Kind: captions
Language: en

00:00:01.649 --> 00:00:07.036
Inflation - and when most people talk about inflation, they talk

00:00:07.036 --> 00:00:11.703
about price inflation. And that's just the increase in general level of prices for goods and services.

00:00:11.703 --> 00:00:15.395
And you probably have a sense of that. That every year in kind of a normal

00:00:15.395 --> 00:00:18.228
economy things seem to a little bit more expensive, although not

00:00:18.228 --> 00:00:20.944
everything does. Especially if you look at something like

00:00:20.944 --> 00:00:25.403
healthcare, cost of education, you definitely see things getting

00:00:25.403 --> 00:00:29.443
more expensive. One interesting question is how do you

00:00:29.443 --> 00:00:33.692
measure it? How do you measure inflation? And what the

00:00:33.692 --> 00:00:37.082
Bureau of Labor Statistics does - this is actually the most used

00:00:37.082 --> 00:00:39.288
measurement of inflation. They create something called a

00:00:39.288 --> 00:00:43.003
Consumer Price Index. And the way they do it is they define a

00:00:43.003 --> 00:00:46.858
basket of goods - actually a basket of goods and services.

00:00:46.858 --> 00:00:49.946
So what they do is go and look at the average urban consumer

00:00:49.946 --> 00:00:53.731
and they say "what do they need in their life?". "They may need some

00:00:53.731 --> 00:00:58.073
housing, they might need some fuel - natural gas for their home

00:00:58.073 --> 00:01:03.205
they need gasoline for their cars, energy in other ways. They might need

00:01:03.205 --> 00:01:09.265
some type of services - they might need transportation". And they try to come up

00:01:09.265 --> 00:01:14.211
with a basket of all of the things that the average consumer in

00:01:14.211 --> 00:01:17.926
an urban environment might need. And they figure out how much

00:01:17.926 --> 00:01:21.734
that would cost them in year One. And let's say that in year One,

00:01:21.734 --> 00:01:26.076
that it costs them a hundred dollars - the actual basket CPI constructs would not

00:01:26.076 --> 00:01:29.258
cost a hundred dollars. But I am going to do this for the sake of

00:01:29.258 --> 00:01:33.019
simplicity. And they will weight these based on how much - what percentage they think

00:01:33.019 --> 00:01:35.457
people spend on housing vs. fuel vs. services vs. transportation.

00:01:35.457 --> 00:01:40.728
Then, they will look at the same basket each year after that.

00:01:40.728 --> 00:01:43.886
So then they will do the same things - Housing, fuel, services,

00:01:43.886 --> 00:01:50.527
transportation. And this will be in year Two now. And let's say

00:01:50.527 --> 00:01:55.775
the same basket costs one hundred and two dollars. Well, then they

00:01:55.775 --> 00:01:59.374
will say the general level of price and services for this consumer

00:01:59.374 --> 00:02:02.207
went up by two dollars or went up by more important

00:02:02.207 --> 00:02:06.874
thing is by the percentage - by two percent. So, based on this

00:02:06.874 --> 00:02:12.098
measure, based on this basket of goods, prices went up by two percent.

00:02:12.098 --> 00:02:15.117
Or you'll hear the people on news say this "Inflation rate went

00:02:15.117 --> 00:02:21.293
up by two percent". Now, I want to clarify - what inflation - sometimes talks to inflation

00:02:21.293 --> 00:02:24.916
in the money supply. People talk about there's more money being

00:02:24.916 --> 00:02:28.538
printed. And often increase in money supply is one of the factors

00:02:28.538 --> 00:02:33.020
that is driving price inflation. When most people talk

00:02:33.020 --> 00:02:35.876
about inflation, they are talking about price inflation. They are

00:02:35.876 --> 00:02:40.009
talking about increase in prices. They are not directly talking about

00:02:40.009 --> 00:02:43.538
the increase in the money supply. Now this seems like a pretty

00:02:43.538 --> 00:02:46.232
simple thing to do - but it is not as simple as you might first

00:02:46.232 --> 00:02:51.340
think. Because think about something like TV sets or especially anything

00:02:51.340 --> 00:02:57.052
that is technological. Do you look at the same TV set that is getting probably cheaper every year or do you look at the average

00:02:57.052 --> 00:02:59.351
TV Set that the American household is having. Do you look

00:02:59.351 --> 00:03:03.484
at the same computer that is getting significantly cheaper every

00:03:03.484 --> 00:03:06.874
year or you look at the average computer every year? Then you

00:03:06.874 --> 00:03:09.475
would actually be looking at a different product. So there's actually a lot

00:03:09.475 --> 00:03:11.866
of things to think about and a lot of things how can weight this.

00:03:11.866 --> 00:03:16.023
And there's been a lot of controversy in when the weightings

00:03:16.023 --> 00:03:18.577
change in different periods of time. But this is the general idea

00:03:18.577 --> 00:03:22.199
and it is really just the best attempt to figure out on average

00:03:22.199 --> 00:03:27.192
how much more expensive or how much purchasing power are

00:03:27.192 --> 99:59:59.999
we loosing from one year to the next.


Moderate inflation in a good economy

WEBVTT
Kind: captions
Language: en

00:00:00.627 --> 00:00:03.088
Any economy is a super complicated thing

00:00:03.088 --> 00:00:04.203
So what I am going to do in this video

00:00:04.203 --> 00:00:05.735
is a super over simplification.

00:00:05.735 --> 00:00:07.732
But it is just a way of thinking about things.

00:00:07.732 --> 00:00:09.218
In particular, I want to think about

00:00:09.218 --> 00:00:12.005
why good economies tend to be associated

00:00:12.005 --> 00:00:14.884
with a moderate level of inflation.

00:00:14.884 --> 00:00:16.370
And that will also help inform us

00:00:16.370 --> 00:00:17.670
when we are thinking about Stagflation

00:00:17.670 --> 00:00:19.808
when we have inflation with a bad economy.

00:00:19.900 --> 00:00:22.732
So, a good economy, employment is up

00:00:22.732 --> 00:00:24.218
And because employment is up,

00:00:24.218 --> 00:00:26.633
employees have more negotiating power

00:00:26.633 --> 00:00:28.305
There's more people who want to hire them,

00:00:28.305 --> 00:00:30.302
there is fewer people who wants their jobs,

00:00:30.302 --> 00:00:32.673
And so wages will go up.

00:00:33.181 --> 00:00:35.225
And since you have more people with jobs,

00:00:35.225 --> 00:00:36.943
And those who have jobs are being paid more,

00:00:36.943 --> 00:00:39.404
You can imagine that demand will also go up.

00:00:39.404 --> 00:00:42.051
There is more people that have money in their pockets.

00:00:43.220 --> 00:00:44.466
And if demand goes up,

00:00:44.466 --> 00:00:48.228
Then companies, or you can think of them as factories,

00:00:48.228 --> 00:00:49.714
But it can also be services,

00:00:49.714 --> 00:00:52.593
Then everything will be utilized more.

00:00:52.593 --> 00:00:53.801
And if things are utilized more,

00:00:53.801 --> 00:00:56.959
Then the companies or those factories

00:00:56.959 --> 00:00:58.120
or whatever you want to think of them,

00:00:58.120 --> 00:01:00.999
They are going to have more profit.

00:01:00.999 --> 00:01:05.411
On top of that, if they get close to fully utilization,

00:01:05.411 --> 00:01:07.361
Or if they see that fully utilization is down the road,

00:01:07.361 --> 00:01:09.869
They are going to want to invest more.

00:01:09.869 --> 00:01:11.866
And, they could actually push off that

00:01:11.866 --> 00:01:13.956
utilization and get more profit,

00:01:13.956 --> 00:01:17.485
by maybe raising prices.

00:01:17.485 --> 00:01:19.668
So this is where that moderate of inflation,

00:01:19.668 --> 00:01:21.572
really shows up.

00:01:21.572 --> 00:01:23.058
The fact that there is more demand,

00:01:23.058 --> 00:01:24.312
the fact that you can produce a little bit more,

00:01:24.312 --> 00:01:26.401
and it could raise prices a little bit more.

00:01:26.401 --> 00:01:28.073
So this is where,

00:01:28.073 --> 00:01:30.024
the moderate level of inflation shows up.

00:01:30.024 --> 00:01:31.742
And there is a little bit of a negative feedback,

00:01:31.742 --> 00:01:33.182
if price goes up.

00:01:33.182 --> 00:01:36.575
It will inhibit demand a little bit.

00:01:36.852 --> 00:01:38.522
And that is why it is moderate inflation,

00:01:38.522 --> 00:01:41.013
not some type of crazy inflationary spiral here.

00:01:41.013 --> 00:01:43.840
But the net effect of more utilization,

00:01:43.840 --> 00:01:45.651
and more investment

00:01:45.651 --> 00:01:48.484
is going to be an increase in supply.

00:01:48.576 --> 00:01:51.456
is going to be an increase in supply.

00:01:51.656 --> 00:01:52.497
And once again,

00:01:52.497 --> 00:01:54.799
And this is kind of e-con 101,

00:01:54.799 --> 00:01:58.218
If supply goes up, price will also have an

00:01:59.526 --> 00:02:03.293
inhibitory impact on price.

00:02:03.739 --> 00:02:07.036
So let me draw, so we get all the feedback loops here.

00:02:07.036 --> 00:02:09.683
So this is negative feedback right over there.

00:02:09.683 --> 00:02:12.002
But to complete the loop, if we are investing more,

00:02:12.140 --> 00:02:14.653
we are going to build more factories.

00:02:14.653 --> 00:02:17.253
or some more capacity to do services or whatever else.

00:02:17.253 --> 00:02:20.225
That is going to increase employment.

00:02:20.225 --> 00:02:21.479
If we have more profit,

00:02:21.479 --> 00:02:23.894
Then a company feels better about growing,

00:02:23.894 --> 00:02:25.458
It feels more like it have a cushion,

00:02:25.458 --> 00:02:27.238
and feels more optimistic about the future,

00:02:27.238 --> 00:02:28.863
that is going to help employment.

00:02:28.863 --> 00:02:31.185
And obviously, utilization itself

00:02:31.185 --> 00:02:33.507
if we want to run the factory lines longer,

00:02:33.507 --> 00:02:35.179
we are going to need more people to run those lines.

00:02:35.179 --> 00:02:38.244
So that will also increase employment.

00:02:38.244 --> 00:02:40.659
This is like the general feedback loop

00:02:40.659 --> 00:02:44.513
you can add little nuanced twists to this,

00:02:44.513 --> 00:02:47.811
but this is the general idea of a why a moderate level of inflation is

00:02:47.811 --> 00:02:52.037
kind of associated with this virtuous cycle

00:02:52.037 --> 99:59:59.999
you normally see in a good economy.


Stagflation

WEBVTT
Kind: captions
Language: en

00:00:00.700 --> 00:00:03.060
We've learned that a
moderate level of inflation

00:00:03.060 --> 00:00:05.350
is normally associated
with a good economy.

00:00:05.350 --> 00:00:08.150
But what we saw-- in particular,
we saw in the early '70s,

00:00:08.150 --> 00:00:11.010
in 1973, when the
oil embargo hit--

00:00:11.010 --> 00:00:13.920
is that we started to experience
something called stagflation,

00:00:13.920 --> 00:00:17.500
or something that was
labeled stagflation.

00:00:17.500 --> 00:00:19.290
It's this weird,
bizarre circumstance

00:00:19.290 --> 00:00:22.430
where you have inflation
at the same time

00:00:22.430 --> 00:00:25.120
as the stagnation
in the economy.

00:00:25.120 --> 00:00:27.630
So that's where they get
this kind of combination

00:00:27.630 --> 00:00:29.084
of words, of stagflation.

00:00:29.084 --> 00:00:30.750
Let's think about how
that would happen.

00:00:30.750 --> 00:00:32.250
In particular, let's
think about how

00:00:32.250 --> 00:00:34.189
that would happen due
to a supply shock.

00:00:34.189 --> 00:00:36.230
There's other ways that
you could get stagflation

00:00:36.230 --> 00:00:40.020
if you have strange
regulations, over-regulation,

00:00:40.020 --> 00:00:42.250
if the government
does weird things.

00:00:42.250 --> 00:00:44.869
But the classic example
is a supply shock.

00:00:44.869 --> 00:00:47.410
When we say supply shock, it's
something like an oil embargo,

00:00:47.410 --> 00:00:50.730
where all of a sudden
the supply of oil,

00:00:50.730 --> 00:00:56.480
the supply of something,
just goes down dramatically.

00:00:56.480 --> 00:00:58.660
And it could be because
of some type of emergency,

00:00:58.660 --> 00:01:00.830
or it could be literally
because of an embargo.

00:01:00.830 --> 00:01:03.450
And just think
about how that would

00:01:03.450 --> 00:01:05.260
affect the rest of this chain.

00:01:05.260 --> 00:01:08.440
So if the supply of something
dramatically goes down--

00:01:08.440 --> 00:01:11.250
We know that supply has
an inverse relationship

00:01:11.250 --> 00:01:11.920
with price.

00:01:11.920 --> 00:01:14.420
So if supply goes down,
then, bam, right there,

00:01:14.420 --> 00:01:17.319
you see price would
immediately go up.

00:01:17.319 --> 00:01:19.110
And when we think about
something like oil,

00:01:19.110 --> 00:01:22.100
you might say, hey, oil is
only the part of my pocketbook

00:01:22.100 --> 00:01:23.070
where I drive around.

00:01:23.070 --> 00:01:25.080
But it's not, because
even when you buy a fruit,

00:01:25.080 --> 00:01:27.121
you're really paying for
the transportation cost.

00:01:27.121 --> 00:01:30.060
So the price of oil affects
fruit, affects food,

00:01:30.060 --> 00:01:31.697
affects any good in services.

00:01:31.697 --> 00:01:34.280
It's one of these things that's
pervasive through the economy.

00:01:34.280 --> 00:01:38.330
So the prices of a bunch of
things could generally go up.

00:01:38.330 --> 00:01:40.830
Well, if the price of a bunch
of things generally go up,

00:01:40.830 --> 00:01:42.205
what's going to
happen to demand?

00:01:42.205 --> 00:01:44.740
Once again, inverse
relationship right over here.

00:01:44.740 --> 00:01:49.700
Demand is going to plummet.

00:01:49.700 --> 00:01:55.400
If demand plummets, utilization
plummets, investment plummets,

00:01:55.400 --> 00:01:57.910
and profit is going to plummet.

00:01:57.910 --> 00:01:59.620
And profit's going
to plummet now

00:01:59.620 --> 00:02:01.550
because, one, utilization
is going down,

00:02:01.550 --> 00:02:03.090
and price has gone up.

00:02:03.090 --> 00:02:05.330
But it's not the price that
they can sell things at.

00:02:05.330 --> 00:02:09.120
Now price is fundamentally
a big cost for-- especially

00:02:09.120 --> 00:02:12.450
if you think of it from a
US-centric point of view,

00:02:12.450 --> 00:02:18.820
if oil is an import, as in the
case of the early '70s, then

00:02:18.820 --> 00:02:21.860
price going up is
going to have, I

00:02:21.860 --> 00:02:23.855
guess they have an
inverse relationship.

00:02:23.855 --> 00:02:24.730
So the price goes up.

00:02:24.730 --> 00:02:26.438
It's really going to
be on the cost side.

00:02:26.438 --> 00:02:28.350
So once again,
hitting profits hard.

00:02:28.350 --> 00:02:30.260
And if all of these
things go down,

00:02:30.260 --> 00:02:34.000
that's just going to kill
employment, kill wages,

00:02:34.000 --> 00:02:36.770
and then further make
demand even worse.

00:02:36.770 --> 00:02:38.890
So stagflation is
that situation where

00:02:38.890 --> 00:02:41.660
you have some type of
shock to the system, where

00:02:41.660 --> 00:02:45.380
in the classic scenario
it hits supply so hard

00:02:45.380 --> 00:02:48.247
it causes a massive inflation
in one part of the economy,

00:02:48.247 --> 00:02:49.830
and as is the case
of oil, a part that

00:02:49.830 --> 00:02:51.440
affects other parts
of the economy.

00:02:51.440 --> 00:02:53.590
And then all of that kind
of throws a monkey wrench

00:02:53.590 --> 00:02:55.790
in everything else.


Calculating real return in last year dollars

WEBVTT
Kind: captions
Language: en

00:00:00.322 --> 00:00:01.701
Male voice: In the last
video, we were able

00:00:01.701 --> 00:00:04.401
to calculate the real
return by putting everything

00:00:04.401 --> 00:00:06.934
in today's dollars. Put
that $100 we invested

00:00:06.934 --> 00:00:08.685
a year ago in today's dollars, figure out

00:00:08.685 --> 00:00:12.267
what our actual return
was, our dollar return

00:00:12.267 --> 00:00:14.874
is in today dollars, then
we got our real return.

00:00:14.874 --> 00:00:16.344
What I want to think about in this video

00:00:16.344 --> 00:00:17.855
is how we can do it another way.

00:00:17.855 --> 00:00:19.872
We can actually put everything in last

00:00:19.872 --> 00:00:25.768
year's money. We got $110. Let's put $110,

00:00:25.768 --> 00:00:35.771
of today's money in last year's money.

00:00:35.771 --> 00:00:37.663
To think about this, we could do a little

00:00:37.663 --> 00:00:39.198
algebra, or you don't have to do algebra,

00:00:39.198 --> 00:00:40.968
but maybe that makes it a
little bit more intuitive.

00:00:40.968 --> 00:00:43.326
There's some amount of money last year,

00:00:43.326 --> 00:00:46.017
there's some amount of
money, let's call that X,

00:00:46.017 --> 00:00:51.525
that if we multiply it by the
inflation rate, so if we grow it by 2%,

00:00:51.525 --> 00:00:58.222
that's going to be worth $110 today.

00:00:58.222 --> 00:01:00.146
Or, to just solve for X, you divide both

00:01:00.146 --> 00:01:05.398
sides by 1.02 and we
get the amount of money

00:01:05.398 --> 00:01:07.152
that if you grow it by
inflation, or that had

00:01:07.152 --> 00:01:10.062
the same amount of purchasing
power as $110 today,

00:01:10.062 --> 00:01:13.333
would be 110 divided by 1.02 which is,

00:01:13.333 --> 00:01:16.066
let me move over to the
right at little bit,

00:01:16.066 --> 00:01:23.590
this would be 110 divided by 1.02.

00:01:23.590 --> 00:01:28.727
This would be equal to
$107.8 just roughly,

00:01:28.727 --> 00:01:33.536
just to round it. This is equal to $107.8.

00:01:33.536 --> 00:01:38.727
So $110 today buys us
the exact same thing,

00:01:38.727 --> 00:01:40.477
if you believe the whole CPI Index,

00:01:40.477 --> 00:01:45.926
as $107.80, maybe I can
even add another digit,

00:01:45.926 --> 00:01:51.229
84 cents, would have bought us last year.

00:01:51.229 --> 00:01:55.488
What is our dollar return
in last year's money?

00:01:55.488 --> 00:02:02.343
Dollar return in last year's money.

00:02:02.343 --> 00:02:05.153
Last year's money.

00:02:05.153 --> 00:02:11.005
Well, we ended up with
$107.84 in last year's money.

00:02:11.005 --> 00:02:15.653
So 107.84, or $107.84. We had originally

00:02:15.653 --> 00:02:19.143
invested, in last year's money, $100.

00:02:19.143 --> 00:02:21.674
We had originally invested $100.

00:02:21.674 --> 00:02:27.190
So our dollar return is
$7.84, or if you want

00:02:27.190 --> 00:02:30.847
to calculate the real return, how much did

00:02:30.847 --> 00:02:32.846
our actual purchasing power increase?

00:02:32.846 --> 00:02:39.084
Well, we got a $7.84 return
off of a $100 investment,

00:02:39.084 --> 00:02:41.176
so this is pretty easy to calculate.

00:02:41.176 --> 00:02:45.176
We once again get to the same
7.8% for the real return.


Real and nominal return

WEBVTT
Kind: captions
Language: en

00:00:00.730 --> 00:00:05.950
Let's say last year I put $100
into some type savings account

00:00:05.950 --> 00:00:06.960
in a bank.

00:00:06.960 --> 00:00:09.670
So this is a year ago.

00:00:09.670 --> 00:00:14.620
And that now today, exactly
one year later, that $100

00:00:14.620 --> 00:00:17.330
has grown to $110.

00:00:17.330 --> 00:00:19.143
So this is now.

00:00:19.143 --> 00:00:23.340
So if you look at things just
in the absolute dollar terms,

00:00:23.340 --> 00:00:25.210
things have grown by $10.

00:00:25.210 --> 00:00:32.070
So I made $10 off of an
original $100 investment.

00:00:32.070 --> 00:00:35.410
So I got a 10% return.

00:00:35.410 --> 00:00:38.070
But what I want to think
about is does this really

00:00:38.070 --> 00:00:41.670
capture how much more I
can buy with this $110

00:00:41.670 --> 00:00:43.850
than I could buy with
that $100 before.

00:00:43.850 --> 00:00:47.540
Can I really by 10% more
goods and services today

00:00:47.540 --> 00:00:49.320
than I could a year ago?

00:00:49.320 --> 00:00:50.820
And to think about
that, let's think

00:00:50.820 --> 00:00:53.880
about a hypothetical
inflation rate from last year

00:00:53.880 --> 00:00:54.560
to this year.

00:00:54.560 --> 00:00:59.200
So let's say that the
inflation ended up

00:00:59.200 --> 00:01:02.600
being 2% between a
year ago and today.

00:01:02.600 --> 00:01:08.530
If that's the case, what is $100
a year ago in today's money?

00:01:11.990 --> 00:01:15.970
Well, if inflation was
2%, then $100 a year

00:01:15.970 --> 00:01:21.490
ago would buy you the same stuff
that $102 would buy you today.

00:01:21.490 --> 00:01:24.140
So it would be $102.

00:01:24.140 --> 00:01:35.750
So what is the dollar
return in today's money,

00:01:35.750 --> 00:01:37.910
the current purchasing power?

00:01:37.910 --> 00:01:42.100
Well, we're getting $110.

00:01:42.100 --> 00:01:46.310
And we invested in
today's money $102.

00:01:46.310 --> 00:01:47.850
If we look at it
from today's terms,

00:01:47.850 --> 00:01:50.141
we invested something that
gives us the same purchasing

00:01:50.141 --> 00:01:52.190
power as $102 today.

00:01:52.190 --> 00:01:55.890
And now it's giving us a
purchasing power of $110.

00:01:55.890 --> 00:01:59.450
So we've gotten $8 more
of purchasing power

00:01:59.450 --> 00:02:01.140
in today's money.

00:02:01.140 --> 00:02:04.705
So what is the
actual real return?

00:02:08.560 --> 00:02:10.380
And we can do it
in today's money.

00:02:10.380 --> 00:02:11.760
And you could do it either way.

00:02:11.760 --> 00:02:15.080
You could discount the 110
back to a year ago money

00:02:15.080 --> 00:02:17.390
and figure out the real
return there, and figure out

00:02:17.390 --> 00:02:20.820
the product actual dollar
return, and do the calculation.

00:02:20.820 --> 00:02:23.010
Or you can do it
in today's money.

00:02:23.010 --> 00:02:25.660
And maybe I'll do it the
previous way in the next video.

00:02:25.660 --> 00:02:30.910
But the real return is we made
$8 over the course of the year

00:02:30.910 --> 00:02:32.170
in today's money.

00:02:32.170 --> 00:02:38.120
And what we originally invested
in today's money was $102.

00:02:38.120 --> 00:02:40.340
And so we get our
calculator out.

00:02:40.340 --> 00:02:47.020
8 divided by 102 is 7.8%.

00:02:47.020 --> 00:02:48.812
So this is equal to 7.8%.

00:02:51.380 --> 00:02:55.510
So even though the
nominal return, if we just

00:02:55.510 --> 00:02:59.040
look at what we got in
exchange for what we invested,

00:02:59.040 --> 00:03:01.980
even though the
nominal return was 10%,

00:03:01.980 --> 00:03:06.210
because there was 2% inflation
our actual purchasing power

00:03:06.210 --> 00:03:09.183
only increased by 7.8%.


Relation between nominal and real returns and inflation

WEBVTT
Kind: captions
Language: en

00:00:00.620 --> 00:00:02.720
Let's generalize the
mathematics that we've

00:00:02.720 --> 00:00:04.100
been doing in the
last few videos

00:00:04.100 --> 00:00:05.590
to calculate the real return.

00:00:05.590 --> 00:00:07.910
And maybe we'll come up with
some interesting formulas

00:00:07.910 --> 00:00:10.395
or some simple approximations.

00:00:10.395 --> 00:00:12.020
So what we've been
doing is we've been,

00:00:12.020 --> 00:00:14.186
at least in the first video,
we converted everything

00:00:14.186 --> 00:00:15.420
to today's dollars.

00:00:15.420 --> 00:00:18.260
So the actual dollar
return in today's dollars

00:00:18.260 --> 00:00:22.870
is the amount that we got
or the net dollar return.

00:00:22.870 --> 00:00:25.190
And the net dollar
return is the amount

00:00:25.190 --> 00:00:28.360
that we originally
invested compounded

00:00:28.360 --> 00:00:29.862
by the nominal interest rate.

00:00:29.862 --> 00:00:32.320
And here we're assuming that
we're writing it as a decimal.

00:00:32.320 --> 00:00:34.810
So in the example we've
been using it was 10%.

00:00:34.810 --> 00:00:38.060
And so this is going to be 0.10.

00:00:38.060 --> 00:00:41.662
Or this whole value
is going to be 1.10.

00:00:41.662 --> 00:00:43.120
And so this is how
much we're going

00:00:43.120 --> 00:00:46.390
to get after a year has passed.

00:00:46.390 --> 00:00:48.760
So in our example,
this was the $110.

00:00:48.760 --> 00:00:52.030
$100 compounded by 1.1.

00:00:52.030 --> 00:00:53.810
And then from that,
you want to subtract

00:00:53.810 --> 00:00:57.010
how much we invested
in today's dollars.

00:00:57.010 --> 00:01:00.510
Well, we originally invested
P dollars a year ago.

00:01:00.510 --> 00:01:02.010
And in today's
dollars, we just need

00:01:02.010 --> 00:01:04.690
to grow it by the
rate of inflation.

00:01:04.690 --> 00:01:06.190
And in the examples
we've been doing

00:01:06.190 --> 00:01:08.410
we assume that the rate
of inflation is 2%.

00:01:08.410 --> 00:01:11.030
So that would be 0.02.

00:01:11.030 --> 00:01:13.280
So this expression
right over here

00:01:13.280 --> 00:01:17.590
is actually the dollar
return in today's dollars.

00:01:17.590 --> 00:01:19.060
It's this value
right here that we

00:01:19.060 --> 00:01:20.790
calculated in the first video.

00:01:20.790 --> 00:01:23.010
And to calculate the real
return we want the dollar

00:01:23.010 --> 00:01:26.810
return in today's dollars
divided by the investment

00:01:26.810 --> 00:01:28.230
in today's dollars.

00:01:28.230 --> 00:01:31.100
And once again, this is the
investment in today's dollars.

00:01:31.100 --> 00:01:36.050
It's the amount we invested
originally grown by inflation.

00:01:38.870 --> 00:01:43.770
And this right over here
gives us the real return.

00:01:43.770 --> 00:01:45.480
Now one thing we can
do right off the bat

00:01:45.480 --> 00:01:48.194
to simplify this is that we
have everything in the numerator

00:01:48.194 --> 00:01:50.360
and everything in the
denominator is divisible by P.

00:01:50.360 --> 00:01:52.401
So let's divide the
numerator and the denominator

00:01:52.401 --> 00:01:55.730
by P. Simplify it a little bit.

00:01:55.730 --> 00:01:57.340
Just like that.

00:01:57.340 --> 00:02:00.140
And then we get
in the numerator,

00:02:00.140 --> 00:02:07.420
we get 1 plus N minus 1 plus I.
I'll write it like that still.

00:02:07.420 --> 00:02:15.310
All of that over 1
plus I is equal to R.

00:02:15.310 --> 00:02:18.200
And I'm giving some space here
because one simplification I

00:02:18.200 --> 00:02:22.540
can do here is I can add 1 to
both sides of this equation.

00:02:22.540 --> 00:02:25.360
So if I add a 1 on the right
hand side, I have to add a 1

00:02:25.360 --> 00:02:26.680
on the left hand side.

00:02:26.680 --> 00:02:32.450
But a 1 is the same thing as
a 1 plus I over a 1 plus I.

00:02:32.450 --> 00:02:35.080
This is completely
identical because this

00:02:35.080 --> 00:02:37.720
is dividing the same
thing by itself.

00:02:37.720 --> 00:02:38.890
So this is going to be a 1.

00:02:38.890 --> 00:02:40.400
So we're adding a 1 on the left.

00:02:40.400 --> 00:02:42.848
We're adding a 1 on the right.

00:02:42.848 --> 00:02:44.306
And the reason why
I did that is it

00:02:44.306 --> 00:02:46.139
comes up with an
interesting simplification.

00:02:46.139 --> 00:02:47.630
We have the same
denominator here.

00:02:47.630 --> 00:02:51.840
If I add the numerators, 1
plus I plus 1 plus N minus 1

00:02:51.840 --> 00:02:56.340
plus I. So this and this
are going to cancel out.

00:02:56.340 --> 00:02:58.790
And we're going to be left
with, in the numerator,

00:02:58.790 --> 00:03:02.190
we're just left with a 1 plus
the nominal interest rate.

00:03:02.190 --> 00:03:08.080
In the denominator, we just have
a 1 plus the rate of inflation

00:03:08.080 --> 00:03:12.320
is equal to 1 plus the
real interest rate.

00:03:12.320 --> 00:03:14.670
And then we can multiply
both sides times the 1

00:03:14.670 --> 00:03:21.800
plus I. Multiply both
sides times 1 plus I.

00:03:21.800 --> 00:03:23.150
And we get interesting result.

00:03:23.150 --> 00:03:25.650
And to some degree, this
is a common sense result.

00:03:25.650 --> 00:03:26.740
And I want to show you
that it's completely

00:03:26.740 --> 00:03:28.865
consistent with everything
we've been doing so far.

00:03:28.865 --> 00:03:30.400
These guys cancel out.

00:03:30.400 --> 00:03:33.780
And when you compounded by
the nominal interest rate,

00:03:33.780 --> 00:03:37.310
that's the same thing as
growing the real growth,

00:03:37.310 --> 00:03:41.170
and then that compounded by
the rate of inflation, which

00:03:41.170 --> 00:03:44.390
actually makes a ton of sense.