Mismatched Socks

Khan Academy » Finance » Macroeconomics » How and why Greece would leave the Euro (part 3)

So that whole “inflate your way out of debt” thing I was talking about earlier? That would only work if Greece had its own currency — which it does not. In order to do that it would have to declare a “banking holiday,” which is far less relaxing than it sounds. A banking holiday would be a temporary shutdown of all of Greece’s banks to facilitate the transition from Euros to their new currency, probably a new form of the Drachma. They’d declare a conversion rate, convert all deposits into the new currency, and then reopen the banks and introduce the new currency into foreign exchange markets, where the value of the new currency would be dictated by the free market.

If you’ve got money in Greek banks, this could be terrifying for you. The conversion rate they set may be far higher than the actual value of the new currency, and as soon as the new currency hits the free market your savings could drop in value significantly. 

But it’ll probably happen. Austerity isn’t working, nobody likes it, and the rest of the Eurozone really doesn’t wanna be associated with Greece anymore. So they’ll probably move back to their own currency and inflate their way out of debt (along with a few cutbacks, but nothing quite as severe as what’s been done already). 

Good luck Europe.

Khan Academy » Finance » Macroeconomics » Greek Financial Crisis (part 2)

Something I wanna touch on that I think I forgot in the last post: Greece’s spending has been higher than it’s tax revenue for some years at this point. This means that their debt has been steadily (or not-so-steadily) increasing over this time period, and this was in part due to some shady accounting. What this does is lower investor’s trust in the country, and so they start demanding higher interest rates, thus increasing spending further (spending on interest payments) without actually increasing public services or anything meaningful.

Now we’ve gone over why austerity seems like such a bad idea (slows down the economy, reduces tax revenue, and it’s politically unpopular (to put it lightly)). So what do you do then? 

Well, one idea is to inflate your way out of debt. Print more cash, put it into circulation, nominal GDP increases proportionally to inflation, but debt and entitlement obligations stay constant — they do not increase with inflation! So you can literally inflate your way out of debt. Sure you’re still cutting people’s pensions in half in terms of buying power, but it’s much more politically stable to inflate away people’s buying power than to literally cut their pensions. 

That’s the logic anyway. I kinda think it’s bullshit because you’re doing the same exact thing, but there’s truth to it. People aren’t rational. And the economy is largely a function of the masses’ confidence. So you have to play the game according to those rules. 

We’ll see how it goes.

Khan Academy » Finance » Macroeconomics » Greek Debt Recession and Austerity (part 1)

So I’m a little late watching these videos, but they’re at the end of the Macroeconomics playlist; what was I supposed to do?

Anyways, Greece is majorly fucked. Their debt-to-GDP ratio is horrendous, with debt overshadowing GDP by 165%. Their GDP has been shrinking the last several years. Things are looking pretty bad.

So what’s the solution? Austerity! Austerity, derived from austere (just meaning minimalist, cut back to the bones; almost spartan), in economic terms is essentially just cutting spending. Cut education, cut garbage collection, cut water and gas and public services!

Okay, so if you haven’t figured it out by now, austerity is not actually effective at helping Greece climb out of this crisis. The thing about austerity is that when you cut spending like that, you can actually slow the growth of the economy — fewer services are provided for people to take advantage of, money circulates more slowly (as in any recession), but most importantly people are less wealthy and thus tax revenue decreases also.

So now you’re spending less, sure, but at the expense of critical public services (there are literally bags of trash on the streets of Greece right now) AND you’re making less revenue from taxes because unemployment is skyrocketing and people have no money.

So the cycle continues.

Khan Academy » Finance » Macroeconomics » Math Mechanics of Thai Banking Crisis

So in 1996 the Thai baht (Thailand’s currency) was pegged to the USD by Thailand’s central bank at an exchange rate of 1 baht <=> $25. It had been like that for many years, and in 1996 interest rates in the United States were about 8% and interest rates in Thailand were about 12%. 

Thai financial institutions couldn’t help but notice the opportunity for profit.

1. Buy $1 million for 25 million baht at 8% interest (let’s imagine a 2-year loan, so you pay interest for 2 years and then pay back the principle).
2. Lend out 25 million baht at 12% interest.  That’ll earn you 3 million baht per year in interest payments, which you can convert into $120K. A $1 million loan at 8% interest has you making interest payments of $80K per year, leaving you with $40K per year profit.
3. Repeat.

Seems like free money for very little risk — but it all rests on the assumption that the exchange rate between the baht and the dollar remains pegged at 25 baht per dollar.

Then 1997 happens, and for whatever reason the baht depreciates in value. Now $1 is worth 45 baht. So you still get your 3 million baht in interest payments, but now they’re only worth $67K; and since you have to pay $80K in interest on your original $1 million loan, you’ve just lost $13K. But it gets really bad next year — in 1998 you have to pay back the principle. So even if you made some great loans and everyone paid them back, you get 25 million baht and can only convert it into $556K — and you owe $1 million!

Of course, this was a contrived example to illustrate the Thai banking crisis. In reality, financial institutions had taken out not millions, but billions in loans (so just go through the example again and add a few orders of magnitude :D).