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  • What I want to do in this video is show you

  • that some of the things that we've

  • been talking about in the last few videos actually do happen.

  • In particular, talk about how one

  • of these speculative attacks on a currency

  • can turn into a banking crisis.

  • 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

  • and short term interest rates from the early '90s

  • until the present.

  • And so there's a couple of interesting things

  • that you might see over here.

  • The first is the exchange rate.

  • You see from the early '90s all the way

  • to the late '90s the exchange rate was relatively fixed.

  • 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

  • dollar.

  • So it looks like it was right around 25 or 26

  • of the Thai currency per US dollars.

  • And it was pretty much pegged to it.

  • And we talked about how a central bank can peg a currency

  • 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.

  • All of a sudden you had many, many more Thai Bahts

  • per US dollar.

  • And then it started floating.

  • It no longer had a direct peg.

  • And that's because it experience some of the dynamics

  • that we saw in the last few videos.

  • Now what I want to think about in this video is,

  • OK, you might say, OK, that's bad.

  • A speculative attack on a currency,

  • all of a sudden imports are going to be more expensive.

  • It's going to raise the cost of living

  • for people in that country.

  • But why is it so, so bad?

  • And in this video, I want to give you

  • one example of why it can be so, so bad.

  • And that a speculative-- that an attack on a currency,

  • or a massive devaluation of a currency,

  • can lead to an actual banking crisis.

  • So let's go back to the early '90s.

  • So let me write this down, early.

  • 1990s.

  • 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 it so you see that over here.

  • If we go to 1992, we have a short-term interest rate,

  • it looks like it's in the low teens.

  • It's about 11%, 12% right over there.

  • And so you could imagine the currency

  • had a nice peg versus the dollar.

  • People recognize that Thailand seemed

  • to have a pretty healthy economy.

  • Investors said, wow, I could go to Thailand

  • and get pretty high interest rates.

  • And you could imagine a Thai bank saying,

  • 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 borrowed it from abroad

  • and invest it in Thailand?

  • So let's just think about this.

  • So let's just think-- let's think of it

  • in terms of US investors.

  • But it was investors from all over the world.

  • So that's the US.

  • And this is Thailand right over here.

  • And I haven't looked up the exact interest rates in the US,

  • but let's just say for the sake of argument

  • it was somewhat lower in the early '90s.

  • So I'll just pick a number.

  • Let's just say it was 7%.

  • And in Thailand, for the sake of argument, let's say it was 11%.

  • So you could imagine, if you were an enterprising Thai bank,

  • so you're 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%--

  • so I'm going to borrow here at 7%--

  • and then I can go and bring it Thailand,

  • I'll convert it into the Thai Baht.

  • I'll get 25 Thai Baht for every one of those dollars.

  • And then I can lend it out of 11%, or something close to it.

  • So I'm pretty much going to be getting this 4% spread.

  • Let me write this down, 4% spread.

  • And what are the risks here?

  • What are the risks of borrowing in a foreign currency

  • and then lending in your own?

  • Well the real risk is if the foreign currency we're

  • to appreciate dramatically relative to your own.

  • But if you're a Thai bank in the early '90s, you're like,

  • there's this huge demand of other people wanting

  • to convert their currency into the Thai Baht.

  • In fact, so much so that in order to maintain this peg,

  • the Thai Central Bank is printing money and buying

  • those dollars, is trying to soak it up.

  • So the Thai Central Bank is building

  • this huge reserve of dollars.

  • So for whatever reason, if those investors were ever

  • try to pull out, the Thai Central Bank

  • could still attempt to keep the currency pegged.

  • So you say, oh, this is a pretty stable thing.

  • And I could just make this spread, this 4% spread,

  • easy money.

  • But as we know, it's not always that easy.

  • And risks that you're not aware of could very easily crop up.

  • And so when you go to 1997, that's exactly what happened.

  • All of a sudden, people realize that there's this boom going on

  • in Thailand, there's all this lending going on in Thailand.

  • But maybe that lending wasn't going on

  • in the best possible places.

  • And in particular, it was going on in real estate

  • in a very speculative way.

  • And we all know now that real estate

  • is a good source of speculative bubbles.

  • And investors start to get scared.

  • And they start wanting to pull out.

  • And we saw in the last videos, they just

  • might naturally get scared.

  • Then you might have a speculative attack.

  • You might have currency speculators say,

  • I'm going to start borrowing in Thailand.

  • And then I'm going to convert that to dollars.

  • And then invest it in the US, hoping

  • that this devaluation will occur,

  • knowing that if enough people kind of jump on the bandwagon

  • that the Thai Central Bank would literally run out of reserves.

  • And the reason why this is risky is

  • once they do run out of reserves, what's

  • going to happen to this person who had borrowed in dollars

  • and then lent in Thailand.

  • Well over here, you see that there

  • was a massive devaluation, that overnight the value of the Thai

  • Baht relative to the dollar almost went in half.

  • So all of a sudden you borrowed in this currency

  • and that currency is becoming worth twice

  • as much as you thought it was relative to your own currency,

  • relative to this inbound payments

  • that you're getting right over there.

  • And so all of a sudden, if your debts are doubled

  • because the currency you borrowed in

  • doubled relative to your own currency,

  • you now own twice as much.

  • And given that banks like the leverage a good bit,

  • you're probably going to go out of the business.

  • And this was happening on a massive scale.

  • This was happening throughout the Thai financial sector,

  • the entire banking sector.

  • And so wasn't just a matter of imports getting expensive.

  • It was a matter of the entire financial system collapsing.

What I want to do in this video is show you

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Financial Crisis in Thailand Caused by Speculative Attack

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    James posted on 2015/06/15
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