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B1 Intermediate US 741 Folder Collection
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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.
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B1 Intermediate US

Financial Crisis in Thailand Caused by Speculative Attack

741 Folder Collection
James published on June 15, 2015

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