How and why Greece would leave the Euro (part 3)

WEBVTT
Kind: captions
Language: en

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Now that we have a reasonable understanding of why austerity is very difficult.

00:00:04.930 --> 00:00:07.275
1) There probably isn't the political will to do it.

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And even more, it might drive Greece into a bigger recession.

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And we also understand why defaulting isn't an option for Greece

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and we understand what a monetarily independent Greece would have done.

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We can now get a good sense of what Greece is likely to do, outside any other intervention,

00:00:26.179 --> 00:00:28.844
outside any help from other Euro Zone members.

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In future videos, we will talk about why other Euro Zone members do have some incentive to try and stop Greece from doing what I'm about to articulate.

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So in an ideal world, Greece, if it had its own currency, would just print away and be able to inflate away its obligations.

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Also, if it had its own currency, and this is not necessarily a good thing to do,

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because it will undermine investor trust going forward,

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but even defaulting would be an option, because they would still have access to their own currency

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and then they could just keep printing and then lending to that government,

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then the government could continue to pay the nominal obligations,

00:01:04.730 --> 00:01:09.066
but since they're getting inflated away, in real terms they would become lower and lower.

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So what Greece, if it doesn't get any help from other Euro Zone members,

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if it does not get bailed out in some way, what is likely to happen is that Greece leaves the Euro.

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And the actual mechanics of that, and it will probably go back to a new form of the drachma.

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And the way that that would actually happen mechanically is that they would declare a banking holiday.

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And it sounds like a very nice thing like everything which had a world "holiday" in it

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but a banking holiday is essentially a forced shut down of all of the banks for some period of time,

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over which they can do transition into the new currency.

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And so, entering into the banking holiday the Euro was the currency,

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and the money you had in your bank was denominated in Euro,

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but exiting the banking holiday the drachma will be the currency,

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and the money that you have in the bank will be the drachma.

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And what the government will essentially do is set some type of conversion rate over that banking holiday.

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They'll maybe say every one Euro you have will be converted into one drachma.

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And then just the exchange markets will determine

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what the actual exchange between a euro and a drachma is going forward.

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And so then everybody would buy and sell in drachma.

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And the government would also say all of our obligations are now in drachma.

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Which would essentially be a default because if they told to their debtors

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that "we no longer owe you....[where is the number?] 356 billion euros",

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or actually close to 400 billion or whatever the number is,

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"we do not longer owe you 400 billion euros",

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they are now going to say "we owe you 400 billion drachma."

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Or they can even say, we're only going to pay you 200 billion drachma,

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or a 100 billion drachma. But no matter what they say,

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even if they say they are going to give you a trillion drachma, that would still be a default on the debt

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because these debtors, in order to fulfill these obligations, they were expecting euro.

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And if you give them anything other than euro,

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if you give them strawberries or bananas or drachma, that is a default.

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So no matter how many drachma they say they're going to give,

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this would constitute a default on their debt.

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But the Greek people could actually then move on with their lives.

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And there's all sorts of crazy things that would happen,

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but at least now the government would be able to print its own money and use

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it to buy government debt, and continue to fund government spending

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and eventually inflate away its obligations.

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You could imagine a situation that, right now,

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its real GDP is, let's say it's the equivalent of 100 drachma.

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And then by just keep printing drachma, the actual productivity of the economy doesn't change.

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It actually might improve if money is printed, but you don't get to hyper inflation.

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Let's say over the next 10 years that the real GDP doesn't change,

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but the nominal GDP, due to inflation over the next 10 years, becomes 500.

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Prices in general, ...so inflation, you had 5x inflation.

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Things become worth 5 times as much, you produce the same goods and services,

00:05:11.009 --> 00:05:16.033
they are now worth 5x as much. But now, that debt that you have,

00:05:16.033 --> 00:05:19.978
your taxes are going to grow with inflation because they are a % of your GDP

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but your actual debt obligations won't change.

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So in real terms, they'll be 1/5 as much, which all of a sudden, makes them sustainable.

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Now, as I said, this is not a simple thing to do. And not a painless to do.

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And we haven't even started talking about the repercussions for the rest of Europe, and why this might be scary,

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and make other people suspicious of countries like Spain and Italy, etc.

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And even in Greece this would be painful. Because you can imagine,

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you can imagine, we're already starting to see this in May of 2012.

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The government will say every euro in your bank account will now be a drachma,

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but the people there they know better than just believing that a drachma is going to be worth the same as a euro.

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They're going to know that as soon as the drachma starts exchanging on foreign exchange markets,

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that the actual reality is 1 drachma is going to be worth something closer to maybe .6 of a euro.

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Or .7 of a euro.

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Let's say it's .7 of a euro.

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So essentially by this happening, everyone's savings and deposits,

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in real terms, in terms of their global buying power is going to go down by 30% overnight.

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And the Greek people are already seeing that.

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They are seeing the possibility of a banking holiday, and a conversion to the drachma.

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And so that's why you have people waiting in line before this happens and trying to withdraw their euros.

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So people are starting to withdraw their euros,

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and if they have a Swiss bank account they can deposit it there

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or they can just take the euros and stash in their mattresses.

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And that by itself is a little bit scary. The bank's deposits are depleted.

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But remember, they have a fractional reserve banking system.

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They do not expect everyone to show up on one day and expect all of their deposits to be accessible.

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So this is essentially going to lead to a run on banks.

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And you're already starting to see this in Greece, and it is actually rational behaviour.

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If you think that 30% of your savings is about to swiped away because of this thing right here,

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I'm going to give you .7 of a euro for every euro you have,

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you would rationally go to the bank and get your deposit back.

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But because everyone is going to start doing that, the banks won't have their reserves.

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The Greeks don't have their own central bank that can back up the banking system there.

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So this might lead to massive bank failures.

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And essentially, the entire Greek banking sector could go down because of this.

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And they don't have an independent central bank, independent of the European central bank,

00:08:04.243 --> 00:08:08.398
to kind of fight the fires the way that the Fed would in the US.

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So this is not a clean situation; it is not a painless situation.

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But, outside any help, it seems like the only option that Greece has at this point.


Greek Financial Crisis (part 2)

WEBVTT
Kind: captions
Language: en

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So let's review
the situation that

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has been emerging in Greece.

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And then dig a little bit
deeper as to their options.

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So as we saw on the
last video, Greece

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was spending a lot more
than it was bringing it

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in tax revenues.

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So it was running
these deficits.

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And year after year, these
deficits we're piling up.

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And the national
debt was increasing.

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And to make matters
worse, Greece actually

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tried to cover this up for
many years with some accounting

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shenanigans because there were
some European Central Bank

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rules about how much
debt you could take on.

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And so it was trying to not
trigger those rules while still

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being able to take on more
debt so that it could fund

00:00:45.750 --> 00:00:47.990
this spending right over here.

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But then, in the last few
years, it became clear.

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The shenanigans were cleared up.

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And when they were
cleared up, one, it

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made people realize,
wow, that was

00:00:55.950 --> 00:00:57.320
kind of shady what they did.

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But on top of that, they
had a much larger government

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public debt burden
than people thought.

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And the combination of
the two-- the combination

00:01:08.870 --> 00:01:12.650
that this country was
actively trying to not make

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its obligations to be
transparent to the markets,

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and on top of that, that
this debt burden was so huge,

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it made people wary of whether
the country would actually

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be able to fulfill
its obligations.

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So trust.

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Investor trust.

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When I talk about
investors, I'm talking

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about the people who would
invest in Greek bonds.

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So, essentially, the
lenders to Greece.

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Their trust went down and
they expected higher interest.

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So they expected higher interest
from the Greek government.

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And that made things worse.

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Now, not only did
they have to keep

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spending on all of their
entitlements, but now the cost

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of funding that existing
debt that they already

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and any new debt that they
had to do to keep spending

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at that rate, the cost of
that debt itself went up.

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And that only added fuel to
this ballooning debt problem.

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Now the last video, we
explored a couple of options.

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In particular, we said,
what about austerity?

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What about the situation
where you just really,

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mainly, you could try to
increase your revenues

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or slash spending.

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But people really try to
focus on the spending side.

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What if we really
just try to slash

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the spending in a
very severe way?

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Really just cut
straight to the bone?

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Well, there's a
couple of problems

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there we thought about.

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One problem was that
it's not popular at all.

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It's not popular at all.

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And then the bigger
problem was, is

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you're already in a recession.

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You're already in a recession.

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And this could make the
recession more severe.

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And frankly, it was not popular.

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It's never popular.

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But it became-- even as
we move now in 2012--

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it's even less popular
because Greece has already

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gone through a couple of
rounds of this austerity.

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This is not a new problem.

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They've been bailed
out in small ways.

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And I'll talk more
about what a bailout is.

00:03:03.350 --> 00:03:05.004
But as part of that
package, the people

00:03:05.004 --> 00:03:06.670
who've been billing
them out says, look,

00:03:06.670 --> 00:03:07.910
if we're going to
give you something.

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If we're going to use some
of our own taxpayer money

00:03:10.120 --> 00:03:12.800
to help you out, you've
got to cut your spending.

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But what's happened in every
round of austerity so far,

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is that helped slow the
economy even further.

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That recession kept
deepening and deepening.

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And it's comments
sense that it would.

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If the government stop
spending in a big way,

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it slows down an
already slow economy.

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Now, the other
thing that you might

00:03:29.630 --> 00:03:33.700
be saying, why doesn't Greece
just stop paying its debt?

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Why doesn't it just
default on its debt?

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So why doesn't it just default?

00:03:39.877 --> 00:03:40.960
Say, hey, we're a country.

00:03:40.960 --> 00:03:43.251
I'm sorry, investors, that
you had to take a loss here.

00:03:43.251 --> 00:03:44.960
But we're just not
paying any more.

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Well, the problem is,
it has a situation where

00:03:47.910 --> 00:03:50.190
it's spending more
than it's bringing in.

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And its obligations
are all in the Euro.

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It does not have
its own currency.

00:03:56.670 --> 00:04:00.027
And so, if they were to default
on their debt-- obviously,

00:04:00.027 --> 00:04:02.110
the people who lent the
money will be very upset--

00:04:02.110 --> 00:04:03.651
and there's no way
that they're going

00:04:03.651 --> 00:04:05.430
to lend more money to Greece.

00:04:05.430 --> 00:04:08.830
And if they don't lend
more money to Greece--

00:04:08.830 --> 00:04:10.511
if they don't lend
more Euros to Greece,

00:04:10.511 --> 00:04:12.260
Greece is not going
to be able to continue

00:04:12.260 --> 00:04:13.880
spending Euros the way it has.

00:04:13.880 --> 00:04:17.572
It's promising all of
the pension, retirees,

00:04:17.572 --> 00:04:19.620
the unemployed
insurance-- it's paying

00:04:19.620 --> 00:04:21.089
all those obligations in Euros.

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And if they default,
they're not going

00:04:22.672 --> 00:04:25.320
to be able to borrow more
Euros to do those obligations.

00:04:25.320 --> 00:04:29.410
And, once again, it'll be a
very fast and violent austerity

00:04:29.410 --> 00:04:31.730
because there wouldn't even
be the money to fund that.

00:04:31.730 --> 00:04:34.570
You would have this
very drastic, almost,

00:04:34.570 --> 00:04:36.390
shut down of the government.

00:04:36.390 --> 00:04:39.260
So this right over here
is not a good option.

00:04:39.260 --> 00:04:41.410
Now to start exploring
the third option,

00:04:41.410 --> 00:04:43.750
and this is the option
that it seems likely

00:04:43.750 --> 00:04:46.050
that Greece might have
to go in, let's think

00:04:46.050 --> 00:04:47.900
about what Greece
could have done

00:04:47.900 --> 00:04:50.590
if it had monetary independence.

00:04:50.590 --> 00:04:53.000
If it had its own currency.

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So just remember, this is
completely hypothetical.

00:04:56.310 --> 00:04:58.600
Greece did have its own
currency, the Drachma,

00:04:58.600 --> 00:05:00.270
before it joined the Euro.

00:05:00.270 --> 00:05:01.890
But let's think
about what it could

00:05:01.890 --> 00:05:05.610
have done in this
situation, if it actually

00:05:05.610 --> 00:05:07.240
did have its own currency.

00:05:07.240 --> 00:05:09.700
It's not cut and dry here
because Greece was actually

00:05:09.700 --> 00:05:12.250
able to, and historically,
borrowed very cheap rates

00:05:12.250 --> 00:05:14.470
because it was part
of this Eurozone.

00:05:14.470 --> 00:05:15.970
But let's just think
about it, if it

00:05:15.970 --> 00:05:18.540
was in this situation,
what it could have done

00:05:18.540 --> 00:05:21.050
if it had its own central bank.

00:05:21.050 --> 00:05:24.497
So this is some of the
stats from our last video.

00:05:24.497 --> 00:05:26.330
And if it had its own
central bank-- and let

00:05:26.330 --> 00:05:27.330
me make this very clear.

00:05:27.330 --> 00:05:29.700
This is all hypothetical.

00:05:29.700 --> 00:05:32.460
Greece does not have its
own central bank right now.

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All of the Eurozone
countries-- the Euro

00:05:34.790 --> 00:05:37.520
is printed by the
European Central Bank.

00:05:37.520 --> 00:05:39.640
It's not by any one country.

00:05:39.640 --> 00:05:42.050
But, hypothetically,
let's say that Greece

00:05:42.050 --> 00:05:43.420
does have a central bank.

00:05:43.420 --> 00:05:49.620
So Greek Central Bank
that prints it's own--

00:05:49.620 --> 00:05:51.700
let's call it the New Drachma.

00:05:51.700 --> 00:05:54.890
And so that Greek Central Bank,
in this type of a situation,

00:05:54.890 --> 00:05:56.610
could just start
printing Drachma.

00:05:59.380 --> 00:06:01.330
And, essentially,
use that Drachma

00:06:01.330 --> 00:06:03.160
to buy government bonds.

00:06:03.160 --> 00:06:04.870
So it could buy
government bonds.

00:06:04.870 --> 00:06:06.140
So it's, essentially,
printing that money.

00:06:06.140 --> 00:06:07.640
And when it buys
government bonds,

00:06:07.640 --> 00:06:09.710
its lending it to
the government.

00:06:09.710 --> 00:06:11.930
It lends to the government.

00:06:11.930 --> 00:06:14.130
And so the government could
spend on entitlements.

00:06:14.130 --> 00:06:19.500
Government could spend on all
of its various obligations.

00:06:19.500 --> 00:06:21.094
Now that might seem
very convenient.

00:06:21.094 --> 00:06:22.760
Essentially, one part
of the government,

00:06:22.760 --> 00:06:25.060
or something pseudo associated
with the government,

00:06:25.060 --> 00:06:28.060
prints money, essentially lends
it to the government, funds

00:06:28.060 --> 00:06:28.960
its obligation.

00:06:28.960 --> 00:06:30.793
But the immediate thing
you might say, well,

00:06:30.793 --> 00:06:33.370
if you just print currency
like this Willy-nilly,

00:06:33.370 --> 00:06:38.033
won't this right over
here lead to inflation?

00:06:40.970 --> 00:06:43.630
And the simple answer
is, it probably will.

00:06:43.630 --> 00:06:45.980
But that actually
might be the solution

00:06:45.980 --> 00:06:49.230
if you're in a conundrum
like what Greece is in.

00:06:49.230 --> 00:06:52.090
First of all, inflation
might not be so bad.

00:06:52.090 --> 00:06:53.966
Right now, the country's
in a deep recession.

00:06:53.966 --> 00:06:55.423
So there's all this
extra capacity.

00:06:55.423 --> 00:06:57.880
So you might even have a
little bit of a price cushion.

00:06:57.880 --> 00:07:00.750
And, just in general,
the inflation rates

00:07:00.750 --> 00:07:02.130
aren't alter dramatic.

00:07:02.130 --> 00:07:05.050
They're not super low, but
they're not super high either.

00:07:05.050 --> 00:07:09.609
So you might have to worry about
a hyper-inflationary situation.

00:07:09.609 --> 00:07:11.400
But on top of that,
the government probably

00:07:11.400 --> 00:07:13.960
wants a respectable
amount of inflation.

00:07:13.960 --> 00:07:16.640
It might not want
100%, 1000% inflation.

00:07:16.640 --> 00:07:20.650
But it might like 10, 20,
or 30% year inflation.

00:07:20.650 --> 00:07:22.820
And to think about that,
think about the idea,

00:07:22.820 --> 00:07:25.530
in this hypothetical Greece,
all of its obligations

00:07:25.530 --> 00:07:27.910
would not be in
Euro, its obligations

00:07:27.910 --> 00:07:29.950
would be in the Drachma.

00:07:29.950 --> 00:07:31.242
And so you can imagine a world.

00:07:31.242 --> 00:07:32.908
So let's think of a
hypothetical Greece.

00:07:32.908 --> 00:07:34.860
And I'm going to use
hypothetical numbers just

00:07:34.860 --> 00:07:37.890
to make things more simple
to understand or to do

00:07:37.890 --> 00:07:38.649
in our heads.

00:07:38.649 --> 00:07:40.190
Let's take this
hypothetical Greece--

00:07:40.190 --> 00:07:42.260
it could be Greece or
really any country.

00:07:42.260 --> 00:07:51.530
And let's say it has a
GDP of-- let's call it

00:07:51.530 --> 00:07:54.540
100 of its currency.

00:07:54.540 --> 00:07:57.420
Let's say 100
Drachma as its GDP.

00:07:57.420 --> 00:08:06.380
And let's say it has
entitlement obligations--

00:08:06.380 --> 00:08:09.380
and this is all on an annual
basis-- of, let's say,

00:08:09.380 --> 00:08:12.432
10 billion of its
currency, of its Drachma.

00:08:12.432 --> 00:08:13.890
This isn't the
situation in Greece.

00:08:13.890 --> 00:08:16.680
All of its obligations
are in Euros.

00:08:16.680 --> 00:08:18.510
But let's just think
about the situation.

00:08:18.510 --> 00:08:21.480
And let's say that
on top of that,

00:08:21.480 --> 00:08:23.950
it has debt obligations--
so the total debt.

00:08:23.950 --> 00:08:26.030
The total value of debt.

00:08:26.030 --> 00:08:30.920
Let's say that it was-- I don't
know-- another 150 billion

00:08:30.920 --> 00:08:32.084
of its currency.

00:08:32.084 --> 00:08:33.500
If you were to
inflate-- let's say

00:08:33.500 --> 00:08:35.480
you inflate over
a couple of years.

00:08:35.480 --> 00:08:37.190
So inflation occurs.

00:08:37.190 --> 00:08:41.320
And let's say you have 100%
inflation over a few years.

00:08:41.320 --> 00:08:43.470
But in real terms, your
GDP doesn't change.

00:08:43.470 --> 00:08:45.690
This is really just more
of a thought experiment.

00:08:45.690 --> 00:08:48.010
So then, in real terms,
if you have 100% inflation

00:08:48.010 --> 00:08:50.100
but you're producing
the same amount,

00:08:50.100 --> 00:08:55.499
the nominal value of your
GDP will now be 200 billion.

00:08:55.499 --> 00:08:57.290
It's the same amount
of goods and services,

00:08:57.290 --> 00:08:59.500
but everything now
costs twice as much.

00:08:59.500 --> 00:09:01.210
So you would value
it at 200 billion.

00:09:01.210 --> 00:09:04.530
If you're inflation adjusted, it
would still be at 100 billion.

00:09:04.530 --> 00:09:06.530
The good thing--
and it's very seldom

00:09:06.530 --> 00:09:08.250
the use inflation
in a good context--

00:09:08.250 --> 00:09:10.500
but what would be good about
Greece in this situation,

00:09:10.500 --> 00:09:12.490
is that these
entitlement obligations,

00:09:12.490 --> 00:09:15.310
they would still be 10 billion.

00:09:15.310 --> 00:09:16.810
You're still going
to say, I'm still

00:09:16.810 --> 00:09:17.750
going to pay you 10 billion.

00:09:17.750 --> 00:09:19.833
Even though that 10 billion
is going to buy people

00:09:19.833 --> 00:09:21.126
half is much.

00:09:21.126 --> 00:09:23.500
That is much easier to do
politically than telling people

00:09:23.500 --> 00:09:27.090
overnight that I'm going to
reduce your pension by half.

00:09:27.090 --> 00:09:28.710
That's political suicide.

00:09:28.710 --> 00:09:30.700
But to inflate away
the obligations,

00:09:30.700 --> 00:09:32.950
nominally it looks like
you're paying the same thing.

00:09:32.950 --> 00:09:34.170
But just buying less.

00:09:34.170 --> 00:09:36.250
It's a little bit
more viable to do.

00:09:36.250 --> 00:09:38.650
And the same thing is true
of your debt obligations.

00:09:38.650 --> 00:09:40.990
Your debt obligations
won't adjust to inflation.

00:09:40.990 --> 00:09:44.050
And so you would
still owe 150 billion.

00:09:44.050 --> 00:09:46.100
But as a percentage
of GDP, you've

00:09:46.100 --> 00:09:49.480
now halved how big that debt is.

00:09:49.480 --> 00:09:52.410
You've halved how big the
entitlement obligations are.

00:09:52.410 --> 00:09:54.422
So that's actually
a viable solution.

00:09:54.422 --> 00:09:55.880
And in this
hypothetical situation,

00:09:55.880 --> 00:09:58.700
it's probably the best
solution for government

00:09:58.700 --> 00:10:04.800
to, essentially, inflate
away its obligations.

00:10:04.800 --> 00:10:06.770
So I'll leave you with that.

00:10:06.770 --> 00:10:08.540
Something for you
to think about.

00:10:08.540 --> 00:10:11.000
And then we could think about
what could Greece actually

00:10:11.000 --> 00:10:12.350
do in this direction.

00:10:12.350 --> 00:10:14.150
But more importantly,
let's think about--

00:10:14.150 --> 00:10:15.440
and you could start
to think about-- why

00:10:15.440 --> 00:10:16.740
is the whole world so scared?

00:10:16.740 --> 00:10:17.700
All of this is Greece.

00:10:17.700 --> 00:10:19.360
It's a relatively small country.

00:10:19.360 --> 00:10:21.820
Why is the whole
Eurozone so scared?

00:10:21.820 --> 00:10:25.410
Why are people thinking about
bailing out Greece in some way

00:10:25.410 --> 00:10:27.880
to prevent all of this
craziness from happening?

00:10:27.880 --> 00:10:31.680
And what are the repercussions
in the larger, global market?

00:10:31.680 --> 00:10:33.230
But I'll leave you
there and leave

00:10:33.230 --> 00:10:35.790
you to think about
all this stuff.


Greek Debt Recession and Austerity (part 1)

WEBVTT
Kind: captions
Language: en

00:00:00.353 --> 00:00:04.328
Greece and the crisis in the European Union has been in the news for some time now,

00:00:04.328 --> 00:00:07.471
so it's long past due that I did a video on it

00:00:07.471 --> 00:00:12.141
and just so we have a time context that you might be watching this video far in the future.

00:00:12.141 --> 00:00:14.622
This video is being done in May, 2012.

00:00:14.622 --> 00:00:17.241
So we really don't know how all this is going to play out,

00:00:17.241 --> 00:00:23.845
but I hope over the next few videos to lay out the potential scenarios and what might be the risks and drawbacks,

00:00:23.845 --> 00:00:26.355
uh, drawbacks of each of them.

00:00:26.355 --> 00:00:29.998
So this right over here, that is Greece.

00:00:29.998 --> 00:00:33.372
And so let's just think about it on a very high level,

00:00:33.372 --> 00:00:36.672
what the situation that they find themselves in.

00:00:36.672 --> 00:00:38.386
So when you look at this chart right over here

00:00:38.386 --> 00:00:41.752
the most obvious thing and it actually pops out from this top line right here,

00:00:41.752 --> 00:00:44.821
their public debt is growing at a dramatic level

00:00:44.821 --> 00:00:47.664
and their debt to GDP...this is actually the more relevant thing

00:00:47.664 --> 00:00:49.586
because you might have a huge amount of debt

00:00:49.586 --> 00:00:52.295
but if your GDP, if the productivity of the country is high,

00:00:52.295 --> 00:00:54.163
that might not be that big of a problem.

00:00:54.163 --> 00:00:58.400
What matters is how much you owe relative to how much that you can actually produce.

00:00:58.400 --> 00:01:01.534
And we see right over here the debt to GDP ratio is a percentage

00:01:01.534 --> 00:01:05.620
so this debt is a percentage of GDP , it's well over 100%.

00:01:05.620 --> 00:01:09.165
It is well over 100% for Greece.

00:01:09.165 --> 00:01:11.835
And you can see a large part of that is because

00:01:11.835 --> 00:01:14.902
the public revenue, the taxes that the Greek government gets

00:01:14.902 --> 00:01:18.272
is consistently lower than their public expenditures.

00:01:18.272 --> 00:01:19.772
So let me write this down.

00:01:19.772 --> 00:01:26.903
So you have taxes. Taxes are less than spending

00:01:26.903 --> 00:01:31.721
which lead to deficits...deficit is how much you couldn't afford,

00:01:31.721 --> 00:01:36.044
or how much, how much spending you have above and beyond your revenues in a given year.

00:01:36.044 --> 00:01:40.822
And so they have deficit spending on a year by year basis which increases their debt.

00:01:40.822 --> 00:01:43.386
The debt is the total amount of money that they owe,

00:01:43.386 --> 00:01:45.517
that's this top line right over here.

00:01:45.517 --> 00:01:53.259
So this leads to increasing debt, increasing debt right over here.

00:01:53.259 --> 00:01:55.039
But that's not the only problem.

00:01:55.039 --> 00:01:57.520
Because as their debt keeps increasing,

00:01:57.520 --> 00:02:00.856
people start to become more and more suspicious of

00:02:00.856 --> 00:02:05.245
whether the government is actually good for their I.O.U.'s,

00:02:05.245 --> 00:02:07.730
whether the government will actually pay back that debt.

00:02:07.730 --> 00:02:11.643
And so as the government's debt becomes riskier and riskier,

00:02:11.643 --> 00:02:14.738
people start demanding higher and higher interest rate.

00:02:14.738 --> 00:02:17.523
So the debt goes up. And as the debt goes up,

00:02:17.523 --> 00:02:20.791
people think that they're not a good borrower.

00:02:20.791 --> 00:02:25.374
So they want higher interest, interest goes up.

00:02:25.374 --> 00:02:27.348
But now that makes things even worse,

00:02:27.348 --> 00:02:29.299
because we were already running deficits,

00:02:29.299 --> 00:02:31.855
we were already spending more than we were bringing in taxes,

00:02:31.855 --> 00:02:35.488
now we have to spend even more on the interest on our debt.

00:02:35.488 --> 00:02:38.398
So if you were spending 10% on your interest in one year,

00:02:38.398 --> 00:02:41.904
so if you had $100 billion dollars, you just spend $10 billion,

00:02:41.904 --> 00:02:45.611
now if the interest rates go to 15%, you have to spend$15 billion on that.

00:02:45.611 --> 00:02:48.108
So that's going to make your spending on interest go up,

00:02:48.108 --> 00:02:51.115
so that's going to make the debt go up even more.

00:02:51.115 --> 00:02:54.477
So Greece finds itself in a situation like this.

00:02:54.477 --> 00:02:56.144
So you might immediately say "well, you know

00:02:56.144 --> 00:02:59.231
there's seems to be a fairly straight forward solution here.

00:02:59.231 --> 00:03:04.728
Why don't they do some combination of increasing taxes?"

00:03:04.728 --> 00:03:08.594
So why don't they increase taxes?

00:03:08.594 --> 00:03:11.934
"And maybe even more importantly, why don't they decrease spending? "

00:03:11.934 --> 00:03:17.831
Why don't they decrease spending?

00:03:17.831 --> 00:03:20.290
Now the first cut is a political situation.

00:03:20.290 --> 00:03:22.489
Because this spending right over here,

00:03:22.489 --> 00:03:24.857
these are for the most part, these are promises to people,

00:03:24.857 --> 00:03:27.870
these might be government obligations, these might be pensions,

00:03:27.870 --> 00:03:30.529
there might be retirees that are dependent on this,

00:03:30.529 --> 00:03:32.866
there could be other types of government programs.

00:03:32.866 --> 00:03:34.593
So if you decrease that spending,

00:03:34.593 --> 00:03:38.593
the people who are losing out on those entitlements,

00:03:38.593 --> 00:03:40.278
they are not going to be too pleased with you.

00:03:40.278 --> 00:03:42.700
So politically that's probably not the best thing to do.

00:03:42.700 --> 00:03:46.247
But there might be a brave Greek leader that say

00:03:46.247 --> 00:03:48.408
"well no, this is what we have to do to save the country,

00:03:48.408 --> 00:03:50.238
we're willing to cut that spending."

00:03:50.238 --> 00:03:52.914
But that by itself, even if someone was willing to do it,

00:03:52.914 --> 00:03:54.980
it still isn't clear whether it's a good idea.

00:03:54.980 --> 00:03:57.775
Because you might have noticed this other line right over here.

00:03:57.775 --> 00:04:01.017
This other line, "Real GDP Growth" .

00:04:01.017 --> 00:04:05.782
Greece right over here is in a fairly severe recession.

00:04:05.782 --> 00:04:07.097
They have a lot of unemployment,

00:04:07.097 --> 00:04:11.693
clearly factories aren't producing at the levels that they could actually produce.

00:04:11.693 --> 00:04:15.863
So if you either do some combination of increasing your taxes,

00:04:15.863 --> 00:04:18.660
increasing the government revenue, and decreasing spending,

00:04:18.660 --> 00:04:22.940
that actually will suck air out of the economy.

00:04:22.940 --> 00:04:26.063
So this combination of things, and you've probably heard this word a lot,

00:04:26.063 --> 00:04:27.895
this combination of things,

00:04:27.895 --> 00:04:32.128
and it tends to focus on the decreasing spending in a very significant way,

00:04:32.128 --> 00:04:37.041
this is referred to as "Austerity."

00:04:37.041 --> 00:04:40.418
The word "Austere" just generally means someone who doesn't have a lot of frills,

00:04:40.418 --> 00:04:43.435
they just deal with the most bare necessities

00:04:43.435 --> 00:04:45.671
they really kind of cut things to the bone.

00:04:45.671 --> 00:04:49.129
And so when a lot of people say "Hey Greece you have to do Austerity measures"

00:04:49.129 --> 00:04:51.926
--and there's actually already been a couple of rounds of austerity measures.

00:04:51.926 --> 00:04:54.510
"you need to decrease your spending in a big way."

00:04:54.510 --> 00:04:58.488
But the problem is Austerity sucks money out of the economy,

00:04:58.488 --> 00:05:07.068
and so Austerity leads to the economy slowing further,

00:05:07.068 --> 00:05:10.829
and if the economy slows further, that actually going to hurt your taxes.

00:05:10.829 --> 00:05:19.847
So the economy slowing makes your taxes, your actual revenue that you're getting, go down,

00:05:19.847 --> 00:05:24.608
and that can actually make your deficits even worse!

00:05:24.608 --> 00:05:27.256
Because now people say "oh my God, their economy is bad,

00:05:27.256 --> 00:05:28.586
they're even less likely to be able to pay."

00:05:28.586 --> 00:05:33.039
Interest rates go up, and since the tax revenue goes down,

00:05:33.039 --> 00:05:35.090
and a lot of the spending isn't tied to the economy,

00:05:35.090 --> 00:05:37.297
a lot of the spending actually goes up with the economy.

00:05:37.297 --> 00:05:41.135
It might be unemployment insurance, it might be people retiring, pensions,

00:05:41.135 --> 00:05:42.953
and so that can actually make things worse.

00:05:42.953 --> 00:05:46.005
And that's actually what has happened over the last few years.

00:05:46.005 --> 00:05:48.311
Because, and we'll talk more about this,

00:05:48.311 --> 00:05:53.469
the Greek's were given some help from the rest of the European Union.

00:05:53.469 --> 00:05:55.720
In exchange, the rest of the European Union said

00:05:55.720 --> 00:05:59.566
"well, if we're going to help you, you gotta take some pain.

00:05:59.566 --> 00:06:03.579
And the pain that you had to take were these Austerity measures right over here."

00:06:03.579 --> 00:06:07.348
But these Austerity measures actually made the economy do even worse,

00:06:07.348 --> 00:06:10.980
which made debt as a percentage of GDP even higher,

00:06:10.980 --> 00:06:15.685
because now the GDP itself was shrinking at a even larger and larger rate.

00:06:15.685 --> 00:06:20.202
So if you think, just all of these aspects, there was no obvious answer here.

00:06:20.202 --> 00:06:24.999
You do Austerity, it's kind of a bad situation because that's going to hurt the economy,

00:06:24.999 --> 00:06:28.698
you're going to become even less productive, at least in the short term.

00:06:28.698 --> 00:06:32.840
And on top of that it's hugely politically unpopular,

00:06:32.840 --> 00:06:38.115
to the point to where we have such high unemployment that it's becoming politically unstable.

00:06:38.115 --> 00:06:41.399
So I'll leave you there, I'll let you mull over this situation,

00:06:41.399 --> 00:06:46.067
and in the next video I'll talk about what a normal, independent country,

00:06:46.067 --> 00:06:49.784
truly independent, both fiscally and monetarily independent country,

00:06:49.784 --> 00:06:53.440
would do in a situation like this, given Greece's situation.

00:06:53.440 --> 00:06:58.447
And then we'll talk about why Greece kind of can't do it in its current context.


Math mechanics of Thai banking crisis

WEBVTT
Kind: captions
Language: en

00:00:00.422 --> 00:00:01.693
- [Voiceover] What I want
to do in this video is

00:00:01.693 --> 00:00:03.931
make a little bit of what I
talked about in the last video,

00:00:03.931 --> 00:00:05.777
a little bit more concrete.

00:00:05.777 --> 00:00:08.844
So, let's say that the year is,

00:00:08.844 --> 00:00:12.246
for the sake of simplicity,
let's say it's 1996

00:00:12.246 --> 00:00:16.618
1996, and the current interest rates,

00:00:16.618 --> 00:00:18.395
and I'm just going to
use round numbers here,

00:00:18.395 --> 00:00:19.138
they don't have to be exact,

00:00:19.138 --> 00:00:21.158
as long as you get the general idea.

00:00:21.158 --> 00:00:24.451
Let's say the current interest
rates in the United States

00:00:24.451 --> 00:00:26.114
are 8%,

00:00:26.114 --> 00:00:28.245
8% interest rates in the United States,

00:00:28.245 --> 00:00:30.387
and let's say that in Thailand,

00:00:30.387 --> 00:00:32.599
in Thailand, let's say,

00:00:33.814 --> 00:00:38.774
Thailand, let's say that
the interest rates are

00:00:39.888 --> 00:00:41.438
12%.

00:00:41.438 --> 00:00:42.893
So, the last video we talked about

00:00:42.893 --> 00:00:45.621
that you have this
interest rate discrepancy,

00:00:45.621 --> 00:00:47.797
their exchange rate is being pegged

00:00:47.797 --> 00:00:49.503
by the Thai Central Bank,

00:00:49.503 --> 00:00:51.564
it's being managed,

00:00:51.564 --> 00:00:54.606
this could be a tempting way to make money

00:00:54.606 --> 00:00:57.091
for a Thai financial institution.

00:00:57.091 --> 00:00:58.206
So, let's say it's 1996,

00:00:58.206 --> 00:00:59.961
you're a Thai financial institution,

00:00:59.961 --> 00:01:02.083
you borrow a million dollars,

00:01:02.083 --> 00:01:05.729
so you borrow, you
borrow 1 million dollars,

00:01:05.729 --> 00:01:06.908
and this is the part where
we're going to make it

00:01:06.908 --> 00:01:08.330
a little bit more concrete,

00:01:08.330 --> 00:01:10.854
and in 1996 the exchange rate,

00:01:10.854 --> 00:01:14.203
let's say it's 25 Baht per dollar.

00:01:14.203 --> 00:01:15.777
So, then you convert that,

00:01:15.777 --> 00:01:17.374
you convert that into,

00:01:17.374 --> 00:01:18.797
and you're borrowing one million dollars,

00:01:18.797 --> 00:01:20.832
let's say you're borrowing it at 8%,

00:01:20.832 --> 00:01:24.524
and then you convert
that to 25 million baht.

00:01:24.524 --> 00:01:29.035
So, this gets turned into 25 million

00:01:29.035 --> 00:01:31.079
25 million baht,

00:01:31.079 --> 00:01:33.157
that you then lend at 12%,

00:01:33.157 --> 00:01:36.710
That you just then lend at 12%.

00:01:36.710 --> 00:01:38.569
Now, let's just say for
the sake of simplicity,

00:01:38.569 --> 00:01:39.828
this is an interest only loan,

00:01:39.828 --> 00:01:42.540
and that the principal
is due in two years.

00:01:42.540 --> 00:01:44.786
So, we're going to call
this a two year loan.

00:01:44.786 --> 00:01:48.192
So, this is a two year loan.

00:01:48.192 --> 00:01:49.336
So, let's think about what happens,

00:01:49.336 --> 00:01:51.257
how you can make money
as long as the currency

00:01:51.257 --> 00:01:52.186
stay stable,

00:01:52.186 --> 00:01:55.053
and how this loan will really burn you

00:01:55.053 --> 00:01:57.161
if something happens with the currency.

00:01:57.161 --> 00:01:59.669
Especially if the Baht were to devalue

00:01:59.669 --> 00:02:01.853
relative to the US Dollar.

00:02:01.853 --> 00:02:03.929
So, while the two currencies are stable,

00:02:03.929 --> 00:02:05.885
every year you're going to make 12%

00:02:05.885 --> 00:02:09.206
on the 25 million baht that you lent,

00:02:09.206 --> 00:02:10.309
and that is what?

00:02:10.309 --> 00:02:14.036
12% of 25 million,
that's going to be what?

00:02:14.036 --> 00:02:15.505
Four million a year?

00:02:15.505 --> 00:02:18.356
And I'll get the calculator out
just to verify that for you.

00:02:18.356 --> 00:02:21.686
So, if I have 25 times

00:02:21.686 --> 00:02:23.306
so this gonna be in millions,

00:02:23.306 --> 00:02:27.217
so, 25 times 12%, it gets us,

00:02:27.217 --> 00:02:28.402
oh sorry, three million,

00:02:28.402 --> 00:02:30.117
I was doing my mental map incorrectly.

00:02:30.117 --> 00:02:32.286
So, that gives you three
million baht a year,

00:02:32.286 --> 00:02:34.494
you're going to make in interest.

00:02:34.494 --> 00:02:37.112
So, this is going to be three million,

00:02:37.112 --> 00:02:38.595
so, you're going to
get three million baht,

00:02:38.595 --> 00:02:41.584
it's going to come from
whoever borrowed that money,

00:02:41.584 --> 00:02:44.802
three million baht,

00:02:44.802 --> 00:02:47.548
and then to pay the interest that you owe

00:02:47.548 --> 00:02:48.624
on that dollar loan,

00:02:48.624 --> 00:02:50.428
you can then convert that into,

00:02:50.428 --> 00:02:52.036
you're going to get 25,

00:02:52.036 --> 00:02:54.603
you're going to have 25 baht per dollar,

00:02:54.603 --> 00:02:56.774
so let's convert that into dollars,

00:02:56.774 --> 00:02:58.591
so three million baht,

00:02:58.591 --> 00:03:01.003
if you divide it by 25,

00:03:01.003 --> 00:03:02.443
is going to be,

00:03:02.443 --> 00:03:04.105
so this is in millions,

00:03:04.105 --> 00:03:07.222
so this is $120,000.

00:03:07.222 --> 00:03:11.076
So you convert this into $120,000,

00:03:11.076 --> 00:03:14.764
so it becomes $120,000,

00:03:14.764 --> 00:03:16.633
and how much interest do you have to pay?

00:03:16.633 --> 00:03:19.206
Well, you have to pay 8% on the million,

00:03:19.206 --> 00:03:21.430
which is $80,000.

00:03:21.430 --> 00:03:24.221
So, you subtract out
the 80,000 in interest,

00:03:24.221 --> 00:03:26.706
minus 80k interest,

00:03:26.706 --> 00:03:30.705
and you're left with $40,000 per year.

00:03:30.705 --> 00:03:33.590
$40,000 per year profit.

00:03:33.590 --> 00:03:34.751
40 per year,

00:03:34.751 --> 00:03:36.332
and this is just off of a million dollars,

00:03:36.332 --> 00:03:37.823
you can imagine if you did
this with a billion dollars,

00:03:37.823 --> 00:03:38.666
or any amount of money,

00:03:38.666 --> 00:03:39.618
you're just getting this

00:03:39.618 --> 00:03:43.321
what seems like an
almost risk free profit.

00:03:43.321 --> 00:03:45.237
The reason why I say it's
almost is that this is all

00:03:45.237 --> 00:03:49.750
contingent upon this
exchange rate staying stable.

00:03:49.750 --> 00:03:53.065
Now let's see how you get
burned when you have this

00:03:53.065 --> 00:03:55.203
devaluation of the baht.

00:03:55.203 --> 00:03:57.432
And the first place it'll
just become much harder

00:03:57.432 --> 00:03:59.057
for you to do this interest.

00:03:59.057 --> 00:04:01.601
So, now all of a sudden the currency's,

00:04:01.601 --> 00:04:04.103
the baht devalues and you go to,

00:04:04.103 --> 00:04:05.501
let's say you go to,

00:04:05.501 --> 00:04:07.843
I'll just pick an arbitrary
point right over here,

00:04:07.843 --> 00:04:12.273
you get to a situation where
you're at 45 baht per dollar.

00:04:12.273 --> 00:04:13.115
So, let me write this,

00:04:13.115 --> 00:04:14.693
so you have devaluation,

00:04:14.693 --> 00:04:17.165
devaluation,

00:04:17.165 --> 00:04:19.470
and now you have 45,

00:04:19.470 --> 00:04:22.805
45 baht per US dollar.

00:04:22.805 --> 00:04:27.805
Up here it was 25 baht per US dollar.

00:04:28.024 --> 00:04:29.234
So, let's say this is happening,

00:04:29.234 --> 00:04:31.591
this is 1997 that we're talking about.

00:04:31.591 --> 00:04:33.675
Now, how'd the dynamics play out?

00:04:33.675 --> 00:04:35.939
Well, now your three
million baht in interest,

00:04:35.939 --> 00:04:37.996
'cause remember you lent this in baht,

00:04:37.996 --> 00:04:39.429
your three million baht,

00:04:40.579 --> 00:04:41.607
let me write this down,

00:04:41.607 --> 00:04:43.476
are going to be how many dollars?

00:04:43.476 --> 00:04:44.684
Let's get our calculator out,

00:04:44.684 --> 00:04:46.792
so now you're going to have three million,

00:04:46.792 --> 00:04:49.422
and you're going to
have 45 baht per dollar,

00:04:49.422 --> 00:04:52.623
so divided by 45, you get

00:04:52.623 --> 00:04:55.994
this is going to be about $67,000.

00:04:55.994 --> 00:04:58.217
So, this right over here is going to be

00:04:58.217 --> 00:05:00.273
equivalent to at this new exchange rate

00:05:00.273 --> 00:05:03.605
$67,000.

00:05:03.605 --> 00:05:06.277
But your interest that
you owe on the dollar loan

00:05:06.277 --> 00:05:08.523
is $80,000.

00:05:08.523 --> 00:05:11.112
$80,000 in interest,

00:05:11.112 --> 00:05:15.161
and so you actually have
this $13,000 deficit

00:05:15.161 --> 00:05:16.273
that you're going to have to pay

00:05:16.273 --> 00:05:17.210
out of your pocket.

00:05:17.210 --> 00:05:20.321
So, now your little attempted arbitrage

00:05:20.321 --> 00:05:21.656
is working against you.

00:05:21.656 --> 00:05:23.328
But that's not the horrible part,

00:05:23.328 --> 00:05:24.710
you might be able to still

00:05:24.710 --> 00:05:26.973
dig up some money to pay this off.

00:05:26.973 --> 00:05:29.105
But the horrible part is
what happens when you have to

00:05:29.105 --> 00:05:30.335
pay off the principal,

00:05:30.335 --> 00:05:31.566
this was a two year loan.

00:05:31.566 --> 00:05:33.754
So, in 1998 you're going
to have to pay back

00:05:33.754 --> 00:05:35.183
the million dollars.

00:05:35.183 --> 00:05:36.735
Well, if everything worked out,

00:05:36.735 --> 00:05:38.876
if the exchange rate had stayed stable,

00:05:38.876 --> 00:05:40.505
the people you lent the money to

00:05:40.505 --> 00:05:42.432
would give you 25 million baht,

00:05:42.432 --> 00:05:44.417
you would be able to convert
that into a million dollars

00:05:44.417 --> 00:05:45.400
and pay off the loan.

00:05:45.400 --> 00:05:48.145
But now that there's
been this devaluation,

00:05:48.145 --> 00:05:50.339
in 1998,

00:05:50.339 --> 00:05:54.124
in 1998, so 1998,

00:05:54.124 --> 00:05:55.709
the people you lent the money to,

00:05:55.709 --> 00:05:57.488
assuming you lent it responsibly,

00:05:57.488 --> 00:05:58.329
and even that's in question,

00:05:58.329 --> 00:05:59.780
because the whole country was entering in

00:05:59.780 --> 00:06:01.499
something of a bubble,

00:06:01.499 --> 00:06:03.580
but you're going to get 25 million,

00:06:03.580 --> 00:06:06.237
you're going to get 25 million Thai Baht,

00:06:06.237 --> 00:06:07.308
but you're not going to
be able to convert it

00:06:07.308 --> 00:06:08.573
into a million dollars anymore.

00:06:08.573 --> 00:06:11.969
We're going to have to
divide this number by 45.

00:06:11.969 --> 00:06:14.059
So you divide 25,

00:06:14.059 --> 00:06:16.056
divided by 45,

00:06:16.056 --> 00:06:18.117
you're going to be able
to convert it to about

00:06:18.117 --> 00:06:20.932
$556,000.

00:06:20.932 --> 00:06:25.796
So, $556,000, which is too bad

00:06:25.796 --> 00:06:27.846
because you owe a million dollars.

00:06:27.846 --> 00:06:30.702
You're going to be nearly $450,000 short,

00:06:30.702 --> 00:06:33.448
you're going to take a
huge hit on this trade

00:06:33.448 --> 00:06:35.817
that you were doing just
to make $40,000 here,

00:06:35.817 --> 00:06:37.947
because the baht devalued.

00:06:37.947 --> 00:06:38.964
And you can imagine,

00:06:38.964 --> 00:06:40.119
as people saw this coming,

00:06:40.119 --> 00:06:43.016
so for whatever reason
people started to get afraid,

00:06:43.016 --> 00:06:45.025
they started to convert out of the baht,

00:06:45.025 --> 00:06:47.609
stop investing in Thailand as much,

00:06:47.609 --> 00:06:49.420
they started to realize that
some of those investments

00:06:49.420 --> 00:06:51.007
made in those earlier years
might have been going into

00:06:51.007 --> 00:06:52.672
kind of a speculative bubble.

00:06:52.672 --> 00:06:54.535
But then when this becomes apparent

00:06:54.535 --> 00:06:57.079
that there might actually be
a banking crisis going on,

00:06:57.079 --> 00:06:58.594
because all of these
banks were doing this,

00:06:58.594 --> 00:07:00.242
all of these actually formal banks

00:07:00.242 --> 00:07:02.564
or even informal financial institutions

00:07:02.564 --> 00:07:03.772
were doing this trade,

00:07:03.772 --> 00:07:06.164
and it could bring down the
entire Thai financial system,

00:07:06.164 --> 00:07:09.826
it became even a more
self-fulfilling prophesy.

00:07:09.826 --> 00:07:12.289
Because now investors
were even more afraid

00:07:12.289 --> 00:07:13.194
to invest in Thailand,

00:07:13.194 --> 00:07:14.645
even more people were to pull out,

00:07:14.645 --> 00:07:17.873
and that would deplete the
Thai Central Bank's reserves

00:07:17.873 --> 00:07:18.637
even more,

00:07:18.637 --> 00:07:19.280
and then on top of that,

00:07:19.280 --> 00:07:20.423
even Thai citizens would become

00:07:20.423 --> 00:07:21.955
afraid of the banking sector,

00:07:21.955 --> 00:07:23.217
they would go to their banks,

00:07:23.217 --> 00:07:25.911
they want their demand deposits back,

00:07:25.911 --> 00:07:28.587
and we all know how a
fractional reserve system works,

00:07:28.587 --> 00:07:30.474
that by itself is a bank run,

00:07:30.474 --> 00:07:32.276
and so the banks wouldn't even
have the reserves to pay it.

00:07:32.276 --> 00:07:36.064
So, even before the
banks take the hit here,

00:07:36.064 --> 00:07:37.214
when people see it coming,

00:07:37.214 --> 00:07:39.617
it could bring down the entire system.


Financial crisis in Thailand caused by speculative attack

WEBVTT
Kind: captions
Language: en

00:00:00.472 --> 00:00:03.974
What I want to do in this video is show you that some of the things that we've been talking about

00:00:03.974 --> 00:00:13.236
in the last few videos actually do happen. In particular, talk about how one of these speculative attacks on accuracy can turn into a banking crisis.

00:00:13.236 --> 00:00:24.570
So, this right over here, this is a chart from Oxford economics and it's a chart of two things of Thailand's exchange rate in short term interest rates from the early 90's until the present.

00:00:24.570 --> 00:00:27.805
And so there's a couple of interesting things that you might see over here.

00:00:27.805 --> 00:00:36.903
The first is the exchange rate. You see from the early nineties all the way to the late nineties the exchange rate was relatively fixed

00:00:36.903 --> 00:00:45.223
and, just so you understand what this chart is, this is the number of the Thai (I believe their currency is a Thai baht) relative to the US dollars.

00:00:45.223 --> 00:00:55.139
So it looks like it was right around 25 or 26 of the Thai currency per US dollars. It was pretty much pegged to it. We talked about how a central bank can peg a currency

00:00:55.139 --> 00:01:04.903
by buying and selling reserves of US dollars. But then, all of a sudden, you see right over here in 1997 there was a devaluation.

00:01:04.903 --> 00:01:11.570
All of a sudden you had many more Thai bahts per US dollar that it started floating and no longer had a direct peg.

00:01:11.570 --> 00:01:16.839
And that's because it experienced some of the dimanics that we saw in the last few videos.

00:01:16.839 --> 00:01:27.503
Now, what I want to talk about in this video is that, okay, you might think that's bad. Speculative attack on a currency, imports are going to be more expensive, it's going to raise the cost of

00:01:27.503 --> 00:01:35.307
living for people in that country... But why is it so, so bad? In this video I want to give you an example of why it can be so, so bad

00:01:35.307 --> 00:01:42.806
that a speculative attack on a currency or a massive devaluation of a currency can lead to an actual banking crisis.

00:01:42.806 --> 00:01:47.642
So let's go back to the early nineties. (So, let me write this down).

00:01:47.642 --> 00:01:58.106
And you see here that Thailand had a pretty high short term interest rate. That's this blue line right over here (let me underline).

00:01:58.106 --> 00:02:07.472
If we go to 1992 we have a short term interest rate that it looks like it's in the low teens, it's about 11, 12 % right over there.

00:02:07.472 --> 00:02:16.237
And so you can see the currency had a nice peg versus the dollar, people recognised the thailands seemed to had a pretty healthy economy

00:02:16.237 --> 00:02:21.569
and investors said "well, I can go to Thailand and get pretty high interest rates". And you could imagine a Thai bank say:

00:02:21.569 --> 00:02:31.639
"Well, look! All these people want to invest in Thailand instead of me trying to borrow money from, maybe, depositors in Thailand, why don't I borrow it from abroad

00:02:31.639 --> 00:02:40.389
and invest it in Thailand?" Let's just think about this. Think of it in terms of US investors, but it was investors from all over the world.

00:02:40.389 --> 00:02:50.837
So that's the US and this is Thailand right over here. And I have a look at the exact interest rates of the US but let's just say for the sake of arguments it was somewhat lower

00:02:50.837 --> 00:03:02.723
in the early 90's. So I'll just pick up a number. Let's just say it was 7% and in Thailand, for the sake of argument, let's say it was 11%.

00:03:02.723 --> 00:03:15.572
So you could imagine if you were an enterprising thai bank (I'll draw the bank right over here). You would say, well, why don't I go to the US, borrow dollars at 7%

00:03:15.572 --> 00:03:28.836
and then I can bring it to Thailand, I convert it to the Thai baht, I'll get 25 thai baht for every one of these dollars

00:03:28.836 --> 00:03:45.102
and then I can lend it out at 11%? So I'm pretty much going to be getting this 4% spread.

00:03:45.102 --> 00:03:50.836
And what are the risks here? What are the risks of borrowing in a foreing currency and then lending in your own?

00:03:50.836 --> 00:03:58.723
Well, the real risk is if the foreign currency would appreaciate dramaticaly relative to your own. But if you're a thai bank in the early nineties

00:03:58.723 --> 00:04:13.306
you're like "this is huge demand of other people wanting to convert their currency into the thai bank". And in order to maintain the spec the thai central bank is printing money and buying those dollars.

00:04:13.306 --> 00:04:17.640
It's trying to soak it up so the thai central bank is building this huge reserve of dollars.

00:04:17.640 --> 00:04:20.438
So if for whatever reason if those investors were ever to try to pull out,

00:04:20.438 --> 00:04:24.171
the thai central bank could still attempt to keep the currency pegged.

00:04:24.171 --> 00:04:30.306
So you tell this is a pretty stable thing and I could just make this thing. The spread is 4% spread. Easy money.

00:04:30.306 --> 00:04:35.903
But as we know it's not always that easy and risks that you're not aware of can very easily crop up

00:04:35.903 --> 00:04:40.237
and so when you go to 1997 that's exactly what happened

00:04:40.237 --> 00:04:45.103
All of a sudden, people realised that there was all this boom went on in Thailand

00:04:45.103 --> 00:04:47.101
there's all the lending going on in Thailand.

00:04:47.101 --> 00:04:53.169
but maybe that lending wasn't going on in the best possible places, and in particular it was going on in real state in the very speculative way

00:04:53.169 --> 00:04:58.139
and we all know now that real state is a good source of speculative bubbles

00:04:58.139 --> 00:05:02.642
and investors started to get scared and they started wanting to pull out.

00:05:02.642 --> 00:05:15.902
and we saw in the last videos they might naturally get scared, then you might have a speculative attack, you might have currency speculers saying "I want to start borrowing in Thailand

00:05:15.902 --> 00:05:23.104
and then I'm going to convert that to dollars and then invested in the US" hoping that this devaluation will occur

00:05:23.104 --> 00:05:26.436
and knowing that if enough people kind of jump on the bandwagon,

00:05:26.436 --> 00:05:32.973
the thai central bank would literally run out of reserves. And the reason why this is risky once they do run out of reserves

00:05:32.973 --> 00:05:40.504
what's going to happen to this person who had borrowed in dollars and then lend in Thailand?

00:05:40.504 --> 00:05:46.171
Well, over here you see that there's a massive devaluation that overnight the value of the thai baht

00:05:46.171 --> 00:05:50.903
relative to the dollar almost when in half. so all the sudden you borrowed in this currency

00:05:50.903 --> 00:05:58.972
and that currency is becoming worth twice as much as you thought it was relative to your own currency,

00:05:58.972 --> 00:06:03.170
relative to this inbound payments that you're getting right over there.

00:06:03.170 --> 00:06:06.571
and so, all of a sudden, if your debts are doubled because

00:06:06.571 --> 00:06:10.973
the currency you borrowed in doubled relative to your own currency you now own twice as much

00:06:10.973 --> 00:06:19.237
and given that banks like to have a good bit, you're probably going to go out of the business.

00:06:19.237 --> 00:06:23.569
and this was happening on a massive scale, it was happening throughout the thai financial sector

00:06:23.569 --> 00:06:27.903
the entire banking sector. And so it wasn't just a matter of imports getting expensive

00:06:27.903 --> 00:06:31.903
it was a matter of the entire financial system collapsing.


Speculative attack on a currency

WEBVTT
Kind: captions
Language: en

00:00:00.571 --> 00:00:03.050
Voiceover: Let's revisit
the scenario where everyone

00:00:03.050 --> 00:00:05.849
is trying to exit country B's currency

00:00:05.849 --> 00:00:08.601
and convert it back into country A.

00:00:08.601 --> 00:00:11.569
We saw in the last video that if,

00:00:11.569 --> 00:00:13.473
just left to its own devices,

00:00:13.473 --> 00:00:14.886
if this were to happen,

00:00:14.886 --> 00:00:18.169
if lot of Bs wanted to
converted into currency A

00:00:18.169 --> 00:00:22.401
and because everyone is
afraid to convert into B now

00:00:22.401 --> 00:00:24.010
because they think for whatever reason

00:00:24.010 --> 00:00:26.321
the country B is in bad shape,

00:00:26.321 --> 00:00:28.010
then you have this imbalance

00:00:28.010 --> 00:00:29.337
and if you left it to its own devices,

00:00:29.337 --> 00:00:32.637
country B's currency
would become devalued.

00:00:32.637 --> 00:00:37.994
You would need more Bs to trade for an A,

00:00:40.486 --> 00:00:47.239
which is just another way to
say B's value would go down,

00:00:47.239 --> 00:00:48.516
and that could be a bad thing,

00:00:48.516 --> 00:00:50.735
especially if it's a pretty steep decline.

00:00:50.735 --> 00:00:52.348
Maybe it's a country that needs

00:00:52.348 --> 00:00:54.309
to import fuel from the rest of the world.

00:00:54.309 --> 00:00:56.509
Maybe they need to import food
from the rest of the world,

00:00:56.509 --> 00:00:58.861
and if their currency were
to devalue dramatically,

00:00:58.861 --> 00:01:01.958
then imports could become
very, very, very expensive

00:01:01.958 --> 00:01:03.269
and so people in that country might have

00:01:03.269 --> 00:01:04.925
to pay double for gas and double

00:01:04.925 --> 00:01:08.285
for basic necessities like
food and whatever else.

00:01:08.285 --> 00:01:11.068
So we played out a scenario
where the central bank

00:01:11.083 --> 00:01:13.395
of country B actively tries to intervene

00:01:13.395 --> 00:01:15.154
to keep this from happening,

00:01:15.154 --> 00:01:17.075
to keep the exchange rate stable,

00:01:17.075 --> 00:01:22.874
and so what they do is
they could use reserves,

00:01:22.874 --> 00:01:25.155
and I'll do this in blue for country B,

00:01:25.155 --> 00:01:29.507
so they could use reserves of
A that they have accumulated

00:01:29.507 --> 00:01:36.027
during better times or in previous videos,

00:01:36.027 --> 00:01:37.603
depending on how you want to view them,

00:01:37.603 --> 00:01:39.770
and they try to balance
out the supply of A's

00:01:39.770 --> 00:01:43.624
with the supply of B's by selling

00:01:43.624 --> 00:01:45.674
their reserves and buying B's.

00:01:45.674 --> 00:01:47.842
So one way to think of it,
they're adding supply of A's

00:01:47.842 --> 00:01:52.026
and they're also adding demand for B's.

00:01:52.026 --> 00:01:53.178
They're going to sell their reserves

00:01:53.178 --> 00:01:56.203
of A and buy their own currency.

00:01:56.203 --> 00:01:58.714
And that would work as
long as they have reserves.

00:01:58.714 --> 00:02:00.434
They're going to be
able to stabilize things

00:02:00.434 --> 00:02:03.274
so that this situation doesn't happen.

00:02:03.274 --> 00:02:04.850
But the problem was,

00:02:04.850 --> 00:02:06.435
and we talked about it at
the end of the last video

00:02:06.435 --> 00:02:08.236
is that they can run out here.

00:02:08.236 --> 00:02:10.314
It's not like they can print

00:02:10.314 --> 00:02:13.657
another country's currency forever.

00:02:13.657 --> 00:02:14.794
They can't print it at all.

00:02:14.794 --> 00:02:16.554
They have to accumulate this.

00:02:16.554 --> 00:02:18.075
This isn't their own currency.

00:02:18.075 --> 00:02:19.747
So they have a finite amount of this.

00:02:19.747 --> 00:02:21.347
They could eventually run out.

00:02:21.347 --> 00:02:23.641
What is often the case is,

00:02:23.641 --> 00:02:25.282
currency speculators see this

00:02:25.282 --> 00:02:27.022
and they begin to smell blood.

00:02:27.022 --> 00:02:28.314
They see, okay look,

00:02:28.314 --> 00:02:29.450
people are trying to exit this currency.

00:02:29.450 --> 00:02:32.426
It would devalue if it was
left to its own devices,

00:02:32.426 --> 00:02:37.835
but the central bank of
country B is trying to keep it

00:02:37.835 --> 00:02:39.538
from devaluing by depleting

00:02:39.538 --> 00:02:42.418
its finite reserves of currency A.

00:02:42.418 --> 00:02:45.154
So what currency speculators
will start to do is,

00:02:45.154 --> 00:02:48.881
well I can go into country
B and I can borrow B's.

00:02:48.881 --> 00:02:51.466
So I could literally go
to a bank in country B

00:02:51.466 --> 00:02:55.154
and borrow some of the B currency,

00:02:55.154 --> 00:02:57.377
and then I could go to
the exchange markets

00:02:57.377 --> 00:03:04.581
and try to convert it into A's.

00:03:04.642 --> 00:03:06.947
Just off of looking at that superficially,

00:03:06.947 --> 00:03:08.340
what's that going to do?

00:03:08.340 --> 00:03:09.604
Well this is going to make the situation

00:03:09.604 --> 00:03:11.506
even worse for the central bank,

00:03:11.506 --> 00:03:12.962
because now you have people actively

00:03:12.962 --> 00:03:14.731
that don't even hold B's before

00:03:14.731 --> 00:03:16.042
they're going to be borrowing B's

00:03:16.042 --> 00:03:17.531
and converting them into A's.

00:03:17.531 --> 00:03:19.915
So it's going to create
an even larger supply

00:03:19.915 --> 00:03:24.083
of B's and even more demand
for the finite number

00:03:24.083 --> 00:03:27.155
of A's that are willing to go this way.

00:03:27.155 --> 00:03:28.785
And why is the speculator doing this?

00:03:28.785 --> 00:03:30.987
Well think about the
two situations for them.

00:03:30.987 --> 00:03:34.587
Let me draw the two scenarios.

00:03:34.587 --> 00:03:39.622
Scenario one is that for
whatever reason the central bank

00:03:39.622 --> 00:03:42.109
of B is able to keep
the currency stabilized.

00:03:42.109 --> 00:03:48.893
So currency stays stable.

00:03:48.893 --> 00:03:51.101
And the other scenario is that

00:03:51.101 --> 00:03:53.141
the central bank runs out of reserves,

00:03:53.141 --> 00:03:55.916
and they have to essentially
just let the currencies float,

00:03:55.916 --> 00:03:58.509
and B gets devalued.

00:03:58.509 --> 00:04:04.746
So central bank out of reserves,

00:04:05.745 --> 00:04:08.007
which would mean that the currencies

00:04:08.007 --> 00:04:16.528
would float and B would devalue.

00:04:16.528 --> 00:04:18.616
Well if this first scenario happens,

00:04:18.616 --> 00:04:21.712
and it's happens, and it's going to become

00:04:21.712 --> 00:04:24.054
less and less likely as
more and more people pile on

00:04:24.054 --> 00:04:25.951
this strategy and more and more people try

00:04:25.951 --> 00:04:29.784
to run out of B's or try
to exit B's currency.

00:04:29.784 --> 00:04:31.936
But even if this situation were to happen,

00:04:31.936 --> 00:04:33.711
the speculator says okay,

00:04:33.711 --> 00:04:35.672
the currency ended up being stable.

00:04:35.672 --> 00:04:36.783
I'll just unwind this.

00:04:36.783 --> 00:04:39.183
I'll take my A's, when I have
to pay off my debt in B's,

00:04:39.183 --> 00:04:40.078
I'll take my A's, convert them

00:04:40.078 --> 00:04:42.124
into B's and pay off my debt.

00:04:42.124 --> 00:04:44.122
And so depending what the interest rates

00:04:44.122 --> 00:04:45.123
and all of that were,

00:04:45.123 --> 00:04:50.168
not a big loss or maybe
even a minimal loss,

00:04:50.183 --> 00:04:51.780
and only if there's a kind of differential

00:04:51.780 --> 00:04:53.364
with interest rates or things like that,

00:04:53.364 --> 00:04:57.488
minimal to no loss.

00:04:57.488 --> 00:04:59.811
But what happens if the central
bank runs out of reserves?

00:04:59.811 --> 00:05:01.618
Remember just the fact
that the speculators

00:05:01.618 --> 00:05:03.306
are doing this speculative attack,

00:05:03.306 --> 00:05:07.986
they're borrowing in country
B and converting to A,

00:05:07.986 --> 00:05:09.541
that's making the central bank

00:05:09.541 --> 00:05:11.467
run out of reserves even faster.

00:05:11.467 --> 00:05:13.098
It's going to deplete their reserves.

00:05:13.098 --> 00:05:14.554
Essentially when they do this,

00:05:14.554 --> 00:05:16.242
it's the central bank of country B

00:05:16.242 --> 00:05:17.450
that's going to be giving them,

00:05:17.450 --> 00:05:19.209
is going to be allowing them to convert.

00:05:19.209 --> 00:05:20.402
They don't know who they're

00:05:20.402 --> 00:05:23.986
buying these B's from with
this A currency they have.

00:05:23.986 --> 00:05:25.610
So if this happens,

00:05:25.610 --> 00:05:27.194
if the central bank runs out of reserves,

00:05:27.194 --> 00:05:28.939
it floats, and then B devalues,

00:05:28.939 --> 00:05:30.754
then those currency speculators

00:05:30.754 --> 00:05:32.466
make a pretty good buck.

00:05:32.466 --> 00:05:34.177
and just to see how that could work,

00:05:34.177 --> 00:05:39.961
imagine that they borrow 100 B's,

00:05:39.976 --> 00:05:43.570
so this is what they borrow,

00:05:43.570 --> 00:05:47.643
and while the currency is
being actively intervened

00:05:47.643 --> 00:05:48.987
with by the central bank,

00:05:48.987 --> 00:05:50.715
they're trying to keep it from devaluing,

00:05:50.715 --> 00:05:56.226
the exchange rate is one A for one B,

00:05:56.226 --> 00:06:03.187
so they convert on the open market,

00:06:03.187 --> 00:06:04.556
and the only reason this is able to happen

00:06:04.556 --> 00:06:07.002
at this exchange rate is
because B's central bank

00:06:07.002 --> 00:06:08.619
is actively selling A's,

00:06:08.619 --> 00:06:13.740
they're able to convert to 100 A's.

00:06:13.740 --> 00:06:15.443
Now let's say that they're able to do this

00:06:15.443 --> 00:06:18.116
and the central bank runs out of A's

00:06:18.116 --> 00:06:20.092
and then a devaluation occurs.

00:06:20.092 --> 00:06:26.412
So this is happening at a
conversion of one A equals one B.

00:06:26.412 --> 00:06:29.379
But let's say that these guys,
they run out of reserves.

00:06:29.379 --> 00:06:30.691
The things devalue.

00:06:30.691 --> 00:06:32.507
B becomes worth a lot less,

00:06:32.507 --> 00:06:34.364
and then we go to a future state

00:06:34.364 --> 00:06:38.019
where one A is now equal to two B's.

00:06:38.019 --> 00:06:39.308
Well as soon as this happens,

00:06:39.308 --> 00:06:41.276
and remember this is this
scenario right over here

00:06:41.276 --> 00:06:42.781
that we're thinking about right over here,

00:06:42.781 --> 00:06:44.844
this is what the currency
speculators want to happen.

00:06:44.844 --> 00:06:47.028
If one A all of a sudden equals two B's

00:06:47.028 --> 00:06:49.700
because the central bank
can't intervene any more,

00:06:49.700 --> 00:06:52.684
they are floating, B gets devalued.

00:06:52.684 --> 00:06:53.916
Then what's going to happen?

00:06:53.916 --> 00:06:55.740
These guys can take their 100 A's.

00:06:55.740 --> 00:07:00.132
Convert it back once things are floating.

00:07:00.132 --> 00:07:03.251
So now they're going to convert
back into this direction.

00:07:03.251 --> 00:07:05.427
And how many B's can they convert it into?

00:07:05.427 --> 00:07:11.383
Well now they can convert it into 200 B's.

00:07:11.383 --> 00:07:13.628
They can pay off their debt

00:07:13.628 --> 00:07:15.037
because they borrowed the 100 B's,

00:07:15.037 --> 00:07:20.620
so minus 100 B's to pay debt,

00:07:20.620 --> 00:07:23.491
and then they make a
pretty sizable profit.

00:07:23.491 --> 00:07:27.291
They make a profit of 100 B's.

00:07:27.291 --> 00:07:29.236
That's exactly what they're hoping for,

00:07:29.236 --> 00:07:31.476
and so you can imagine
this is one of those trades

00:07:31.476 --> 00:07:32.513
that they're going to try to get more

00:07:32.513 --> 00:07:33.927
and more people to do,

00:07:33.927 --> 00:07:35.049
because the more people that jump

00:07:35.049 --> 00:07:37.440
on the band wagon and do
this exact same strategy,

00:07:37.440 --> 00:07:39.496
the faster the central bank's reserves

00:07:39.496 --> 00:07:40.417
are going to deplete,

00:07:40.417 --> 00:07:46.116
and the more likely that this situation

00:07:46.116 --> 00:07:48.555
right over here plays out.


Using reserves to stabilize currency

WEBVTT
Kind: captions
Language: en

00:00:00.205 --> 00:00:01.948
Narrator: In the last video we saw how

00:00:01.948 --> 00:00:04.400
everyone in country A got
excited about investing

00:00:04.400 --> 00:00:06.775
in country B and so they
wanted to convert their

00:00:06.775 --> 00:00:09.937
currency into country B's currency.

00:00:09.937 --> 00:00:13.187
Left to its own devices
with this new demand

00:00:13.187 --> 00:00:16.273
for currency B, it would
have made currency B

00:00:16.273 --> 00:00:19.127
more expensive, but
instead of allowing that

00:00:19.127 --> 00:00:22.272
to happen the central bank of country B

00:00:22.272 --> 00:00:23.979
said no, no, no, no,
no, I want to keep the

00:00:23.979 --> 00:00:25.947
exchange rates relatively stable,

00:00:25.947 --> 00:00:29.284
so I'm going to print
B's and use those to buy

00:00:29.284 --> 00:00:30.618
up A's.

00:00:30.618 --> 00:00:32.729
So at the end of that
video the central bank of

00:00:32.729 --> 00:00:36.818
country B ended up with
foreign currency reserves.

00:00:36.818 --> 00:00:40.051
It ended up with some of A's currency

00:00:40.051 --> 00:00:41.929
on its balance sheet.

00:00:41.929 --> 00:00:43.466
What I want to do in
this video is think about

00:00:43.466 --> 00:00:46.064
what if demand goes the other way

00:00:46.064 --> 00:00:48.865
and how could the central
bank use its foreign

00:00:48.865 --> 00:00:51.335
currency reserves to prevent its currency

00:00:51.335 --> 00:00:52.932
from devaluing.

00:00:52.932 --> 00:00:56.192
Let's go to the next stage in our little

00:00:56.192 --> 00:00:58.265
hypothetical story here.

00:00:58.265 --> 00:01:00.659
Let's say people in A,
all of this investment

00:01:00.659 --> 00:01:03.329
happened in country B,
everyone was all excited.

00:01:03.329 --> 00:01:07.114
Probably a bubble was forming of some kind

00:01:07.114 --> 00:01:09.003
and then all of the sudden the investors

00:01:09.003 --> 00:01:10.741
in country A start to
get a little bit scared.

00:01:10.741 --> 00:01:13.002
They start to hear reports
of the bubble forming,

00:01:13.002 --> 00:01:15.904
they start to realize that
conditions in country B

00:01:15.904 --> 00:01:17.817
weren't as good as they thought it might

00:01:17.817 --> 00:01:20.935
have been initially,
so they start to panic.

00:01:20.935 --> 00:01:24.678
They start wanting to
unwind their investments.

00:01:24.678 --> 00:01:27.159
Whatever they had in country
B they want to sell it,

00:01:27.159 --> 00:01:29.745
they get B's currency
for it and they want to

00:01:29.745 --> 00:01:32.237
convert that to their home currency.

00:01:32.237 --> 00:01:34.075
Now you have the reverse situation

00:01:34.075 --> 00:01:36.074
of what we saw in the last video.

00:01:36.074 --> 00:01:39.491
Everyone wants to sell their B's,

00:01:39.491 --> 00:01:41.873
so they had invested in country B

00:01:41.873 --> 00:01:43.334
maybe they had bought
some real estate there,

00:01:43.334 --> 00:01:44.286
they're going to sell their real estate,

00:01:44.286 --> 00:01:45.490
they're going to get B's for it

00:01:45.490 --> 00:01:47.012
and then they're going to get out of that

00:01:47.012 --> 00:01:47.923
countries currency.

00:01:47.923 --> 00:01:49.405
They're going to want
to convert that money

00:01:49.405 --> 00:01:52.586
back in to A's, but this
is the opposite situation.

00:01:52.586 --> 00:01:54.318
Now everyone wants to run out of country B

00:01:54.318 --> 00:01:59.980
and there isn't a lot of
supply of A's in return.

00:01:59.980 --> 00:02:02.325
No one's really looking
to trade A's for B's now.

00:02:02.325 --> 00:02:04.780
Everyone is irked, the
market is going completely

00:02:04.780 --> 00:02:07.319
in the opposite direction.

00:02:07.319 --> 00:02:10.318
If, once again, foreign exchange markets

00:02:10.318 --> 00:02:13.455
were allowed to float
freely what would happen?

00:02:13.455 --> 00:02:16.819
In this situation all
the demand is for the A's

00:02:16.819 --> 00:02:19.316
and all the supply is on the B's

00:02:19.316 --> 00:02:23.384
so you would have either more ...

00:02:23.384 --> 00:02:25.387
Let me write it this
way, you would have fewer

00:02:25.387 --> 00:02:27.050
A's per B.

00:02:27.050 --> 00:02:30.654
(writing) Fewer A's per B

00:02:30.654 --> 00:02:34.156
... or you could have more B's per A.

00:02:34.156 --> 00:02:35.993
These are the same statement.

00:02:35.993 --> 00:02:39.255
(writing) More B's per A.

00:02:39.255 --> 00:02:42.185
In general, A has now
become more expensive

00:02:42.185 --> 00:02:49.188
in terms of B or B has
become cheaper in terms of A.

00:02:49.188 --> 00:02:50.587
Let's say you're the central bank

00:02:50.587 --> 00:02:52.074
and you say well I don't like this either.

00:02:52.074 --> 00:02:54.991
Now all of a sudden,
usually this unwinding,

00:02:54.991 --> 00:02:56.904
this panic happens much faster

00:02:56.904 --> 00:02:59.587
and in more dramatic
fashion than the initial

00:02:59.587 --> 00:03:00.918
phase over here.

00:03:00.918 --> 00:03:02.584
You say, oh my God people in our country

00:03:02.584 --> 00:03:04.072
they might not be able to ...

00:03:04.072 --> 00:03:07.452
If this were to happen
foreign imports would become

00:03:07.452 --> 00:03:09.255
so expensive people
might not be able to even

00:03:09.255 --> 00:03:11.989
afford food that we have to import from

00:03:11.989 --> 00:03:13.716
other countries or essential supplies

00:03:13.716 --> 00:03:15.319
from other countries.

00:03:15.319 --> 00:03:17.073
So they say, no, we're going to intervene.

00:03:17.073 --> 00:03:18.586
We were able to accumulate some of these

00:03:18.586 --> 00:03:21.073
foreign currency reserves
so we can use those

00:03:21.073 --> 00:03:23.712
now to try to stabilize our currency.

00:03:23.712 --> 00:03:26.521
In this situation what
the central bank would do

00:03:26.521 --> 00:03:28.382
is say okay I've got some reserves of A

00:03:28.382 --> 00:03:30.585
what I'm going to do is I'm going to go

00:03:30.585 --> 00:03:31.921
into the open market.

00:03:31.921 --> 00:03:33.916
I'm going to go into the open market

00:03:33.916 --> 00:03:36.320
and also sell my reserves ...

00:03:36.320 --> 00:03:41.654
and sell my reserves of
A and try to equalize

00:03:41.654 --> 00:03:44.251
the supply and the demand.

00:03:44.251 --> 00:03:46.238
So, once again, if
they're able to sell these

00:03:46.238 --> 00:03:48.484
reserves, now all of the
sudden their currency

00:03:48.484 --> 00:03:51.988
will not devalue or maybe
not devalue as much.

00:03:51.988 --> 00:03:54.995
The one kink in the system
here is that they only

00:03:54.995 --> 00:03:58.587
have a finite of reserves.

00:03:58.587 --> 00:04:02.154
This right over here is finite.

00:04:02.154 --> 00:04:04.585
In the previous video
when we saw that they were

00:04:04.585 --> 00:04:07.325
printing their own
currency to build reserves,

00:04:07.325 --> 00:04:08.856
they could do this all day, all night

00:04:08.856 --> 00:04:10.784
because they have the
right to print as much

00:04:10.784 --> 00:04:12.454
of their own currency as they want.

00:04:12.454 --> 00:04:14.914
But now they are using
reserves of someone elses

00:04:14.914 --> 00:04:17.183
currency to keep their own currency from

00:04:17.183 --> 00:04:19.657
being devalued, but
they can't print someone

00:04:19.657 --> 00:04:20.853
else's currency.

00:04:20.853 --> 00:04:24.446
They're hoping that what they have on hand

00:04:24.446 --> 00:04:27.316
is enough to fight this
... what they're probably

00:04:27.316 --> 00:04:29.311
perceiving is a short term imbalance,

00:04:29.311 --> 00:04:30.663
but it could be scary.

00:04:30.663 --> 00:04:33.189
What happens if all of
this currency runs out?

00:04:33.189 --> 00:04:35.117
Then they blow all of
their currency reserves

00:04:35.117 --> 00:04:37.913
and if this kind of panic keeps occurring

00:04:37.913 --> 00:04:40.160
then you're going to go
back to the free market

00:04:40.160 --> 00:04:43.452
forces and their currency
will have to devalue.

00:04:43.452 --> 00:04:49.585
That's how central banks attempt to keep

00:04:49.585 --> 00:04:51.512
their currencies relatively stable.

00:04:51.512 --> 00:04:54.772
In future videos we'll go through real

00:04:54.772 --> 00:04:56.316
cases of when this happened

00:04:56.316 --> 00:04:58.514
and what exactly happened when the foreign

00:04:58.514 --> 00:05:01.552
currency reserves ran
out and how speculators

00:05:01.552 --> 00:05:04.778
could use that knowledge
to essentially make

00:05:04.778 --> 00:05:08.027
an easy speculative buck.


Accumulating foreign currency reserves

WEBVTT
Kind: captions
Language: en

00:00:00.535 --> 00:00:05.286
Let's say we've got two countries: country A and country B

00:00:05.286 --> 00:00:08.202
And at the start of our little hypothetical thought experiment

00:00:08.202 --> 00:00:11.119
they have a very stable exchange rate, maybe it's one for one.

00:00:11.119 --> 00:00:16.970
Every A, if you were to go into a foreing currency markets, you could get a B for it.

00:00:16.970 --> 00:00:23.368
So there's this kind of this stable supplying demand between this two currencies.

00:00:23.368 --> 00:00:30.370
Now let's say for whatever reason folks in A start to believe that country B is the hot place to invest.

00:00:30.370 --> 00:00:35.118
They want to buy country B's real state, they want to invest in country B's stock market.

00:00:35.118 --> 00:00:44.537
and so if they wanna buy stuff in B they essentially have to hold more B's currency and so more and more people in A

00:00:44.537 --> 00:00:51.702
want to exchange their "A's" for country B's currency. So you have this huge supply of A comming out to the foreign exchange markets

00:00:51.702 --> 00:00:57.701
but you still have the same amount of B that wanna go the other way, maybe, you know,

00:00:57.701 --> 00:01:02.503
these are maybe there to either invest in country A or maybe buy some of country's A exports,

00:01:02.503 --> 00:01:03.969
or whatever it might be.

00:01:03.969 --> 00:01:09.287
But if we just let this happen on it's own when all of a sudden there's a much larger demand for converting

00:01:09.287 --> 00:01:16.568
A into B than converting B into A, you'll have a situation where the B will just get more expensive.

00:01:16.568 --> 00:01:19.170
There's more demand for B than there are for A.

00:01:19.170 --> 00:01:21.904
It'll get more expensive in terms of A.

00:01:21.904 --> 00:01:28.500
So if you look at it from country A's point of view, you're now having to pay more A per B

00:01:28.500 --> 00:01:32.081
At a completely equivalent statement from country B's perspective

00:01:32.081 --> 00:01:39.638
you now have to pay fewer B's per A.

00:01:39.638 --> 00:01:48.170
Now, let's say for whatever reason you are the central bank (right over here) of country B

00:01:48.170 --> 00:01:51.414
and you don't like your currency becoming stronger,

00:01:51.414 --> 00:01:54.035
maybe you just don't like the volatility in the exchange market,

00:01:54.035 --> 00:01:58.332
you don't like the idea that the exchange rates go up and down so dramatically,

00:01:58.332 --> 00:02:02.169
maybe you just don't want your exports to get expensive or that imports

00:02:02.169 --> 00:02:03.748
from another country to get cheap.

00:02:03.748 --> 00:02:07.037
For whatever reason you do not like this movement happening

00:02:07.037 --> 00:02:11.638
and so what you're going to do is, because you have the right to do it,

00:02:11.638 --> 00:02:13.770
because you are the central bank of your country,

00:02:13.770 --> 00:02:19.332
you can print more of your currency (right here the currency pies)

00:02:19.332 --> 00:02:24.902
so you're gonna print more of these, you could print more of them

00:02:24.902 --> 00:02:26.102
just like that

00:02:26.102 --> 00:02:29.637
and then you could use that extra bit that you've just printed to buy more A's

00:02:29.637 --> 00:02:36.505
and so now you've kind of renormalized the supply and the demand for B.

00:02:36.505 --> 00:02:38.170
But what's going to be the end product of that?

00:02:38.170 --> 00:02:42.915
Well, you did succesfully keep your currency from appreciating relative to the A's

00:02:42.915 --> 00:02:45.969
which, based on how this was all set up, that was your goal,

00:02:45.969 --> 00:02:50.502
but the other thing that you ended up with is such a printed B's that you're able to buy A

00:02:50.502 --> 00:02:58.170
at the open market, you now, on your balance sheet, you have a bunch of A.

00:02:58.170 --> 00:03:02.302
And so when people talk about foreign currency reserves

00:03:02.302 --> 00:03:10.104
and pretty much every bank, every central bank has

00:03:10.104 --> 00:03:11.838
foreign currency reserves,

00:03:11.838 --> 00:03:13.569
this is what they're talking about.

00:03:13.569 --> 00:03:18.462
That central bank printed their own currency and went out to currency for and exchange markets

00:03:18.462 --> 00:03:21.236
and bought other countries' currencies.

00:03:21.236 --> 00:03:23.378
And there's multiple reasons for them doing it.

00:03:23.378 --> 00:03:26.837
This might be one of them, or it might be to protect them in the case that

00:03:26.837 --> 00:03:29.546
this whole dinamic reverses in the other direction,

00:03:29.546 --> 00:03:33.546
specially if it reverses in a very dramatic way.


Why Current and Capital Accounts Net Out

WEBVTT
Kind: captions
Language: en

00:00:00.134 --> 00:00:01.780
- [Tutor] Let's see if we can

00:00:01.780 --> 00:00:04.640
give ourselves an intuitive understanding

00:00:04.640 --> 00:00:07.340
of why the current account balance

00:00:07.340 --> 00:00:10.320
and the capital account balance nets out

00:00:10.320 --> 00:00:12.220
and over here I have simplified versions

00:00:12.220 --> 00:00:14.050
of the current account
and the capital account

00:00:14.050 --> 00:00:16.882
for the US in 2007.

00:00:16.882 --> 00:00:18.060
We'll just go line by line

00:00:18.060 --> 00:00:19.610
and think about what this is saying

00:00:19.610 --> 00:00:21.330
and also think about the big picture

00:00:21.330 --> 00:00:25.670
in terms of the actual
transfer of US dollars.

00:00:25.670 --> 00:00:27.690
So first right over here
on the current account,

00:00:27.690 --> 00:00:29.271
we see that we have a balnce of trade

00:00:29.271 --> 00:00:31.730
or we have a trade
deficit right over here,

00:00:31.730 --> 00:00:35.540
the US is importing much
more than it is exporting

00:00:35.540 --> 00:00:37.857
and so for net basis, you're
importing a bunch of stuff,

00:00:37.857 --> 00:00:41.170
you have to pay the foreigners
for the stuff you imported

00:00:41.170 --> 00:00:43.680
and so you have an outflow of funds

00:00:43.680 --> 00:00:45.630
and this dominates the
current account right here,

00:00:45.630 --> 00:00:48.931
it's the great majority of
the current account balance.

00:00:48.931 --> 00:00:52.240
This right over here, this 95.7 billion,

00:00:52.240 --> 00:00:55.650
this tells us that in that year, in 2007,

00:00:55.650 --> 00:01:00.290
Americans got 95.7 billion more in income

00:01:00.290 --> 00:01:02.540
from assets that they owned abroad

00:01:02.540 --> 00:01:07.300
than foreigners got in income
that they had from US assets,

00:01:07.300 --> 00:01:09.370
so this was an inflow of funds,

00:01:09.370 --> 00:01:12.640
a net inflow from that income,
but then the US gave away

00:01:12.640 --> 00:01:14.437
more than that to the rest of the world,

00:01:14.437 --> 00:01:17.380
now this could be foreign
aid from the US government

00:01:17.380 --> 00:01:20.060
or it could just be American citizens

00:01:20.060 --> 00:01:21.900
sending payments to their family members

00:01:21.900 --> 00:01:22.970
in other parts of the country

00:01:22.970 --> 00:01:25.610
or also doing some type of a donation

00:01:25.610 --> 00:01:27.860
for some type of aid
program or whatever else,

00:01:27.860 --> 00:01:29.680
but we see that the balance of trade

00:01:29.680 --> 00:01:31.350
is really what's dominating.

00:01:31.350 --> 00:01:33.120
So if you really were to look

00:01:33.120 --> 00:01:34.773
at the current account
in very rough terms,

00:01:34.773 --> 00:01:37.960
especially if you were to
focus on the balance of trade,

00:01:37.960 --> 00:01:40.890
we see what's happening
is, what's coming to the US

00:01:40.890 --> 00:01:43.821
and so let me write over
here, this is the US

00:01:43.821 --> 00:01:46.953
and right over here let
me write, rest of world.

00:01:49.471 --> 00:01:51.270
So the US for the most part,

00:01:51.270 --> 00:01:52.720
the story that this is telling us

00:01:52.720 --> 00:01:57.720
is that the US is getting a bunch of stuff

00:01:57.980 --> 00:02:00.241
and then it's paying for that stuff

00:02:00.241 --> 00:02:03.250
and then also giving away
a little bit more than that

00:02:03.250 --> 00:02:06.830
and so what the rest of
the world is getting,

00:02:06.830 --> 00:02:08.430
the rest of the world is getting

00:02:09.806 --> 00:02:13.510
is net 710.8 billion in US currency,

00:02:13.510 --> 00:02:17.520
so 710.8 billion

00:02:17.520 --> 00:02:21.564
times so in US currency.

00:02:21.564 --> 00:02:24.540
But we know that that's
not the entire picture,

00:02:24.540 --> 00:02:27.339
we also have the change
in ownership of assets

00:02:27.339 --> 00:02:28.510
and so what I'm gonna do

00:02:28.510 --> 00:02:32.150
is I'm just gonna focus
on the top two lines

00:02:32.150 --> 00:02:33.830
of the capital account right over here,

00:02:33.830 --> 00:02:37.630
which focuses on change,
foreign purchases of US assets

00:02:37.630 --> 00:02:39.880
and US purchases of foreign assets

00:02:39.880 --> 00:02:41.712
and oftentimes when people
talk about the capital account,

00:02:41.712 --> 00:02:43.970
they're really just talking
about these two lines,

00:02:43.970 --> 00:02:45.820
although technically the capital account

00:02:45.820 --> 00:02:47.160
is all three of these lines

00:02:47.160 --> 00:02:48.484
and the way some people differentiate it,

00:02:48.484 --> 00:02:51.059
this is kind of the narrow
definition of the capital account

00:02:51.059 --> 00:02:54.000
and then the broader definition
of the capital account

00:02:54.000 --> 00:02:55.554
would be all three of these lines.

00:02:55.554 --> 00:02:58.210
But let's just focus on these
two lines right over here,

00:02:58.210 --> 00:03:00.100
the foreign purchases of US assets

00:03:00.100 --> 00:03:02.170
and the US purchases of foreign assets.

00:03:02.170 --> 00:03:05.281
So we see that foreigners are
buying many more US assets,

00:03:05.281 --> 00:03:06.922
than Americans are buying abroad,

00:03:06.922 --> 00:03:08.460
but we could actually net it out

00:03:08.460 --> 00:03:10.410
and let's get our calculator to do it.

00:03:10.410 --> 00:03:13.680
So if we net it out, so
foreigners are buying

00:03:13.680 --> 00:03:16.978
two trillion worth of US
assets, so that's an inflow,

00:03:16.978 --> 00:03:20.620
they have to pay us dollars
to buy our real estate

00:03:20.620 --> 00:03:22.360
and our stocks and whatever else,

00:03:22.360 --> 00:03:24.127
but then Americans are going out there

00:03:24.127 --> 00:03:25.700
and they're using those dollars

00:03:25.700 --> 00:03:26.738
and they're converting
it to foreign currency

00:03:26.738 --> 00:03:29.060
and they're buying other
foreigners' assets as well

00:03:29.060 --> 00:03:31.498
to the tune of about 1.3 trillion,

00:03:31.498 --> 00:03:34.357
so that's an outflow, so
let's subtract that out,

00:03:34.357 --> 00:03:37.600
1289.5,

00:03:37.600 --> 00:03:41.680
so if we just net out
these first two lines,

00:03:41.680 --> 00:03:45.279
we have 768.2 billion, so
one way you could view this,

00:03:45.279 --> 00:03:48.480
if you were to net this
out, on a net basis

00:03:48.480 --> 00:03:53.209
foreigners are buying
768.2 billion of US assets,

00:03:53.209 --> 00:03:54.923
so let me write it this way.

00:03:57.490 --> 00:04:00.930
So foreigners are getting US assets,

00:04:00.930 --> 00:04:02.940
US assets,

00:04:02.940 --> 00:04:06.427
and in exchange Americans,
Americans are getting,

00:04:06.427 --> 00:04:11.427
what was that, 768.2 billion of currency,

00:04:12.546 --> 00:04:14.970
now this is an interesting thing,

00:04:14.970 --> 00:04:17.420
Americans are shipping
this currency abroad

00:04:17.420 --> 00:04:20.860
to buy mainly stuff, some
of it's a kind of giveaway,

00:04:20.860 --> 00:04:24.870
but mainly to buy stuff, 710.8 billion,

00:04:24.870 --> 00:04:26.980
but more than that is coming back

00:04:26.980 --> 00:04:29.481
for foreigners buying US assets

00:04:29.481 --> 00:04:31.770
and so it leads to an
interesting question,

00:04:31.770 --> 00:04:33.360
how is this possible?

00:04:33.360 --> 00:04:35.650
How is more coming in than going out?

00:04:35.650 --> 00:04:37.098
And the only way that this is possible,

00:04:37.098 --> 00:04:39.770
that foreigners are able
to ship more dollars to us,

00:04:39.770 --> 00:04:42.160
than we're shipping to
the rest of the world

00:04:42.160 --> 00:04:46.720
is if the foreigners had a
pile of currency to begin with.

00:04:46.720 --> 00:04:49.640
So if they had a pile of
currency to begin with,

00:04:49.640 --> 00:04:52.162
so let's say that they had
this in their central bank,

00:04:52.162 --> 00:04:55.970
so they have a pile of US dollar reserves,

00:04:55.970 --> 00:04:57.680
well, maybe we'll have time
to go into the details,

00:04:57.680 --> 00:04:59.600
but you can imagine there's a pile

00:05:00.544 --> 00:05:03.520
of dollar currency in
the rest of the world

00:05:03.520 --> 00:05:04.950
and the only way that
they're going to be able

00:05:04.950 --> 00:05:07.920
to ship us some more dollars
than we've shipped to them

00:05:07.920 --> 00:05:12.633
is if they dig into their
reserves of US currency

00:05:12.633 --> 00:05:13.621
and how much are they going

00:05:13.621 --> 00:05:14.989
to have to dig into the reserves?

00:05:14.989 --> 00:05:16.070
Well, it's just going to be

00:05:16.070 --> 00:05:17.340
the difference between these two,

00:05:17.340 --> 00:05:19.250
let's see how much they
have to dig into it.

00:05:19.250 --> 00:05:24.250
So we are sending, this is how
much they're shipping to us,

00:05:24.630 --> 00:05:26.320
we're shipping back to them

00:05:26.320 --> 00:05:27.870
mainly because of the balance of trade,

00:05:27.870 --> 00:05:30.534
but in general because of
the current account deficit,

00:05:30.534 --> 00:05:35.340
710.8 billion

00:05:35.340 --> 00:05:38.430
and so that leaves, there's 57.4 billion

00:05:38.430 --> 00:05:41.470
that's not accounted for by
what we're shipping to them,

00:05:41.470 --> 00:05:42.450
so essentially they're going

00:05:42.450 --> 00:05:44.330
to have to dig into their reserves

00:05:44.330 --> 00:05:47.807
by 57.4 billion to make up the difference

00:05:47.807 --> 00:05:50.190
and that's what we have right over here,

00:05:50.190 --> 00:05:52.800
the foreigner's reserves
are going to have to go down

00:05:52.800 --> 00:05:56.649
by 57.4 billion, so let me
write this, this is net,

00:05:56.649 --> 00:06:00.450
let me make it clear, we could
do this as our net change,

00:06:00.450 --> 00:06:02.920
net change in official,
and I'll write it here,

00:06:02.920 --> 00:06:04.540
foreign,

00:06:04.540 --> 00:06:07.750
foreign, foreign reserves

00:06:07.750 --> 00:06:09.130
and in general we view this

00:06:09.130 --> 00:06:11.170
as the central banks of other governments,

00:06:11.170 --> 00:06:14.085
they had some piles of dollars around

00:06:14.085 --> 00:06:16.390
and for whatever reason,
they decided to use

00:06:16.390 --> 00:06:19.100
some of those dollars in
foreign exchange markets

00:06:19.100 --> 00:06:21.930
mainly probably so their
own people could go out

00:06:21.930 --> 00:06:25.000
and buy US assets or to buy US things

00:06:25.000 --> 00:06:27.290
or transfer money in some way to the US

00:06:27.290 --> 00:06:29.000
and also we'll go into more detail,

00:06:29.000 --> 00:06:32.280
so it doesn't affect the
exchange rates too much.

00:06:32.280 --> 00:06:35.245
But this is essentially why
these two things add up,

00:06:35.245 --> 00:06:37.820
any amount that these
two things don't add up,

00:06:37.820 --> 00:06:40.200
any amount by which the
current account balance

00:06:40.200 --> 00:06:41.760
and the narrow definition

00:06:41.760 --> 00:06:44.415
of the capital account
balance do not add up,

00:06:44.415 --> 00:06:47.182
then that's going to have
to be a change in reserves,

00:06:47.182 --> 00:06:50.060
there's going to have to
be in this case more net,

00:06:50.060 --> 00:06:53.600
more money US dollars
are being sent to the US,

00:06:53.600 --> 00:06:55.349
so someone's pile of US dollars

00:06:55.349 --> 00:06:57.160
some place in the rest of the world

00:06:57.160 --> 00:07:02.160
had to be depleted to the
effect of $57.4 billion.

00:07:02.980 --> 00:07:04.630
In future videos we'll talk a lot more

00:07:04.630 --> 00:07:07.173
about central banks' reserves of dollars

00:07:07.173 --> 00:07:09.191
and even interesting things
about how George Soros

00:07:09.191 --> 00:07:12.683
made a lot of money by kind of
gaming that and all the rest.