[MUSIC] Welcome back. Let's take, almost there. Now we'll discuss as we promise, how a country could experience a currency crisis, we're almost there. But just I want you to pay attention something, which is what we call the concept of real exchange rate. Again, what does it term for exchange rate? Remember, exchange rate is the price of a currency in other currency's terms. Exactly, so. So what could be real exchange rate? It is the nominal exchange rate, minus the inflation differential of both countries. Because eventually, it might be confused. Remember real interest rates? Real interest rates is normal interest rates minus inflation. What's exchange rate? Exchange rate is price of occurrence in terms of another currency, nominal exchange rate. What's real exchange rate? Real exchange rate is the nominal exchange rate minus inflation? No, minus the inflation differential of both countries. That's what really affect my exports and imports. It's kind of tricky. But let's suppose, for example, that my nominal exchange rate, again, we are talking about Brazil. We're talking about our currency, reals, that the nominal exchange rate spot move from one year to another to 1 real, to on 1 US dollar to 1.20. The nominal exchange rate depreciated by 20%, okay? And also, let's suppose the domestic inflation was 10% Brazil inflation was 10% and US inflation was 2%. Based on a concept of a real exchange rate, my exchange rate in equilibrium, equilibrium exchange rate. Based on real exchange rate should be exactly the inflation differential between Brazil and United States, 10% minus 2%, 8%. So my real exchange rate, it is, or it should be 1.08. But that's not the market, the market is working at 1.20, so what's going on here? The market is working at 1.20 and the real exchange rate should be 1.08. So how do you think that the market is working? Well, if the market should be at 1.08, but the market is working at 1.20, did you realize that the market is more depreciated than this equilibrium exchange rate? So the real exchange rate is depreciated. Let's think the other way around. Let's think that my currency nominal exchange rate move from 1 to 1.05, and the real exchange rate is the same, moved to 1.08. Well, if the market is work at 1.05, and the real exchange rate is 1.08, surely, my exchange rate, my real exchange rate, is appreciated. I'm losing competitiveness because my exchange rate of equilibrium should be 1.08, I'm more appreciated than 1.08. This is something that we should know. And then it comes to the question, how can I fix it? Fix it? Exchange rate regime control hyper inflation environment, inflation in a hyperinflation environment. Let's go step by step. Let's suppose you have a country with a hyperinflation. There's a kind of plan that we had in Brazil, we had in Argentina, we had in Israel, we have in many countries in order to tap this huge problem that was hyperinflation. But again, we have hyperinflation, and the government decides to establish what we call a pegged exchange rate regime or a fixed exchange rate regime. Central bank will intervene, no matter what, to keep an exchange rate fixed. But price, wages are not fixed. So you will still have what we call a residual inflation. Let's suppose, we have 1,000% inflation. So once I fix the exchange rate, the price will not converge. Prices will not converge overnight to US price. So I still have, let's say, some inflation. And that inflation, given the fact that my nominal exchange rate is fixed, remember, nominal exchange rate fixed, and we have inflation. So what experience a real exchange rate appreciation? Because my exchange rate should depreciate according to my residual inflation. Now am I? Exchange rate is fixed. So we have a real exchange rate appreciation. If exchange rate appreciates, what's going to happen with your exports? Well, your exports going down, and your imports is going high. Well, this is good or bad? If you have a higher imports, you're going to have a higher competition within your country, domestic versus international Good. If we, for example in our country, we decided to increase the price of goods, is going to be much cheaper to import. So our CEO of our company, eventually they will decide not to increase price, that's why we managed to restrain the inflation. Obviously, we might have some problems with our balance of payments. Because, as you can see, exports will go down and imports will go up, and this will affect my current account. And that will lead us to the next question. How can a fixed exchange rate regime adopted as an instrument to control hyperinflation could lead the country prone to a currency crisis event? The good part, you know already, hyperinflation, fixed exchange rate regime. Residual inflation will lead to a real exchange rate appreciation, trade deficit, exports go down, imports go up. That's the bad part, trade deficit. If you have a trade deficit, remember, trade balance is part of my current account, current account deficit. How can I finance this current account? I try to get loans from abroad, increase my external debt. Well, the higher your external debt, the higher will be your interest on external debt. But interest on external debt is part of my balance of service, which in turn makes part of my current account. So let's get back a little bit. My trade balance is getting worse, yes. The interest on external debt is get worse, yes. So my balance of services get worse, exactly. So my current account is going to get worse, yes. If your current account get worse, you end up with a visual cycle, asking money from abroad. Can I have more money? Yes, until your current account in a huge deficit and the external lenders will come to you, say, sorry, but no more money. And if you have a fixed exchange rate regime, remember, I am the central bank, how can I defend the currency? I start to lose international reserve, I start to bleed. If I lose my international reserve, remember, Mary, remember John, I'm here to protect Mary. But if I start to lose an international reserve, one day, I cannot protect Mary. So I will experience a currency crisis. My currency is no longer fixed at 1 to 1. But it's going to be 1 to 1.92, that's why many countries like Brazil, Argentina, Mexico experience what we call a currency crisis. Because will they use a fixed exchange rate regime to control inflation? Yes, they control inflation, we control inflation, but we end up with the current account deficit and currency crisis. That's it? No, it could get worse. The question is, the last one, promise. How a currency crisis could lead to a corporate crisis, a banking crisis, and eventually, an economy crisis? Let's suppose a company, assets and liabilities, you have a company A. Let's suppose the company, we have 100 reals, let's say, but denominated in US dollar. They're denominated in foreign currency, right? And 20 million or 20 reals, that's my net worth. And you have 120 assets, do you understand? Assets are denominated in domestic currency. My liability is denominated in foreign currency, so I have a currency mismatch. If I experienced what we call 50% currency depreciation, what's going to happen with the balance sheet of that company? Well, assets will remain the same, 120, but what's going to happen with my liability? We reach 150, and my net worth that was 20 is going to be negative, minus 30, that's what we call corporate crisis. Your company went bust, that's what we say, currency crisis. If you experience, many corporates or many companies of your country are exposed to foreign currency and unhedged without protection. And you experience an exchange rate depreciation and then you end up with a corporate crisis. And just a corporate crisis? Well, maybe yes, maybe not. But if I have a huge amount of companies that used to go bust, what could happen with the banking system, if the banking system land money to those corporate? Eventually, we could end up with a banking crisis. Well, so I have a currency crisis, corporate crisis, a banking crisis. Well, if you have a banking crisis, certainly, we'll have a spillover effect in the real economy. My GDP will go down, so I have economic crisis. That's exactly what happened in Asia. That's exactly what happened in Mexico. That's somehow what happened in Russia. That's somehow until currency crisis, what happened in Brazil. That's exactly what happened in Argentina. Czech, for example, all the countries, they are eventually on the verge to experience currency crisis. If corporate are exposed to foreign loans, banking are too exposed to those corporates that are exposed to foreign loans. Otherwise, eventually, we'll have a very good strategy, business plan. We're going to think they're going to sell a huge amount of stuff and product and service in that country. But you forgot to analyze whether or not that country is on the verge to experience a currency crisis, corporate crisis, banking crisis, and economic crisis. That's why we say macroeconomics is important because it's the ceiling of your business plan. Anyway, hopefully you have enjoy. This is something I had to say, but obviously, we have lots of reading quizzes and I hope you have enjoy. And now, I think most of you realize how macro economics or economics is important for our business plan. Thank you. [SOUND]
