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.