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What I want to do in this video is show you
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that some of the things that we've
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been talking about in the last few videos actually do happen.
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In particular, talk about how one
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of these speculative attacks on a currency
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can turn into a banking crisis.
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So this right over here, this is a chart from Oxford Economics.
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And it's a chart of two things, of Thailand's exchange rate
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and short term interest rates from the early '90s
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until the present.
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And so there's a couple of interesting things
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that you might see over here.
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The first is the exchange rate.
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You see from the early '90s all the way
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to the late '90s the exchange rate was relatively fixed.
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And just so you understand what this chart
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is, this is the number of the Thai--
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I believe their currency is a Thai Baht-- relative to the US
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dollar.
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So it looks like it was right around 25 or 26
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of the Thai currency per US dollars.
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And it was pretty much pegged to it.
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And we talked about how a central bank can peg a currency
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by buying and selling reserves of US dollars.
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But then all of a sudden, you see right over here in 1997,
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there was a devaluation.
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All of a sudden you had many, many more Thai Bahts
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per US dollar.
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And then it started floating.
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It no longer had a direct peg.
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And that's because it experience some of the dynamics
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that we saw in the last few videos.
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Now what I want to think about in this video is,
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OK, you might say, OK, that's bad.
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A speculative attack on a currency,
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all of a sudden imports are going to be more expensive.
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It's going to raise the cost of living
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for people in that country.
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But why is it so, so bad?
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And in this video, I want to give you
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one example of why it can be so, so bad.
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And that a speculative-- that an attack on a currency,
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or a massive devaluation of a currency,
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can lead to an actual banking crisis.
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So let's go back to the early '90s.
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So let me write this down, early.
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1990s.
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And you see here that Thailand had a pretty high, short-term
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interest rate.
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That's this blue line right over here.
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Let me underline it so you see that over here.
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If we go to 1992, we have a short-term interest rate,
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it looks like it's in the low teens.
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It's about 11%, 12% right over there.
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And so you could imagine the currency
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had a nice peg versus the dollar.
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People recognize that Thailand seemed
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to have a pretty healthy economy.
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Investors said, wow, I could go to Thailand
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and get pretty high interest rates.
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And you could imagine a Thai bank saying,
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well, look all these people want to invest in Thailand.
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Instead of me trying to borrow money
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from maybe depositors in Thailand,
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why don't I borrowed it from abroad
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and invest it in Thailand?
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So let's just think about this.
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So let's just think-- let's think of it
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in terms of US investors.
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But it was investors from all over the world.
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So that's the US.
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And this is Thailand right over here.
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And I haven't looked up the exact interest rates in the US,
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but let's just say for the sake of argument
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it was somewhat lower in the early '90s.
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So I'll just pick a number.
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Let's just say it was 7%.
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And in Thailand, for the sake of argument, let's say it was 11%.
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So you could imagine, if you were an enterprising Thai bank,
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so you're an enterprising Thai bank--
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I'll draw the bank right over here-- you would say, well,
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why don't I go to the US, borrow dollars at 7%--
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so I'm going to borrow here at 7%--
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and then I can go and bring it Thailand,
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I'll convert it into the Thai Baht.
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I'll get 25 Thai Baht for every one of those dollars.
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And then I can lend it out of 11%, or something close to it.
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So I'm pretty much going to be getting this 4% spread.
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Let me write this down, 4% spread.
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And what are the risks here?
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What are the risks of borrowing in a foreign currency
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and then lending in your own?
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Well the real risk is if the foreign currency we're
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to appreciate dramatically relative to your own.
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But if you're a Thai bank in the early '90s, you're like,
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there's this huge demand of other people wanting
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to convert their currency into the Thai Baht.
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In fact, so much so that in order to maintain this peg,
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the Thai Central Bank is printing money and buying
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those dollars, is trying to soak it up.
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So the Thai Central Bank is building
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this huge reserve of dollars.
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So for whatever reason, if those investors were ever
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try to pull out, the Thai Central Bank
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could still attempt to keep the currency pegged.
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So you say, oh, this is a pretty stable thing.
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And I could just make this spread, this 4% spread,
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easy money.
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But as we know, it's not always that easy.
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And risks that you're not aware of could very easily crop up.
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And so when you go to 1997, that's exactly what happened.
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All of a sudden, people realize that there's this boom going on
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in Thailand, there's all this lending going on in Thailand.
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But maybe that lending wasn't going on
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in the best possible places.
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And in particular, it was going on in real estate
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in a very speculative way.
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And we all know now that real estate
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is a good source of speculative bubbles.
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And investors start to get scared.
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And they start wanting to pull out.
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And we saw in the last videos, they just
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might naturally get scared.
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Then you might have a speculative attack.
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You might have currency speculators say,
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I'm going to start borrowing in Thailand.
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And then I'm going to convert that to dollars.
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And then invest it in the US, hoping
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that this devaluation will occur,
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knowing that if enough people kind of jump on the bandwagon
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that the Thai Central Bank would literally run out of reserves.
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And the reason why this is risky is
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once they do run out of reserves, what's
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going to happen to this person who had borrowed in dollars
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and then lent in Thailand.
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Well over here, you see that there
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was a massive devaluation, that overnight the value of the Thai
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Baht relative to the dollar almost went in half.
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So all of a sudden you borrowed in this currency
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and that currency is becoming worth twice
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as much as you thought it was relative to your own currency,
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relative to this inbound payments
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that you're getting right over there.
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And so all of a sudden, if your debts are doubled
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because the currency you borrowed in
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doubled relative to your own currency,
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you now own twice as much.
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And given that banks like the leverage a good bit,
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you're probably going to go out of the business.
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And this was happening on a massive scale.
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This was happening throughout the Thai financial sector,
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the entire banking sector.
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And so wasn't just a matter of imports getting expensive.
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It was a matter of the entire financial system collapsing.