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Current time:0:00Total duration:5:09

Video transcript

in the last video we saw how everyone in country a got excited about investing in country B and so they wanted to convert their currency into country B's currency and left to its own devices with this new demand for currency B it would have made currency be more expensive but instead of allowing that to happen the central bank of country B said no no no I want to keep the FLE exchange rates relatively stable so I'm going to print B's and use those to buy up a's and so at the end of that video the central bank of country B ended up with foreign currency reserves it ended up with it ended up with some of s currency on its balance sheet what I want to do in this video is think about what happens if if kind of demand goes the other way and how could the central bank use its foreign currency reserves to prevent its currency from devaluing so let's go to a net the next stage in this our little hypothetical story here let's say people and a so all this investment happened in country B everyone was all excited probably a bubble was forming of some kind and then all of a sudden people the investors in country a start to get a little bit scared they start to hear reports of the bubble forming they start to realize that conditions in country B weren't as good as they thought it might have been initially so they start to panic and they start wanting to unwind their investments so whatever they had in country B they want to sell it they get B's currency for it and they want to convert that to their home currency so now you have the reverse situation of what we saw in the last video everyone wants to sell their B's so they invested in country B maybe they bought some real estate there they're going to sell their real estate they're going to get B's for it and then they're going to get out of that country's currency they want again they're going to want to convert that money back into a's but this is the opposite situation now everyone wants to run out of country B and there isn't there isn't a lot of supply of a's in return no one's really looking to trade a's for B's now everyone is earthed the market is going completely in the opposite direction now if once again foreign exchange markets were allowed to float freely what would happen and well in this situation all the demand is at for the A's and all of the supplies on the B's so you would have you would have either more let me write it this way you would have fewer A's per be fewer A's per B or you could have more B's per a more these are the same statement more B's per a in general a has now become more expensive in terms of B or B has become more has become cheaper in terms of a but let's say you're the central banking like I don't like this either now all of a sudden especially and usually this unwinding this panic happens is much faster and in more dramatic fashion than the initial phase over here you say oh my god people in our country they might not be able to if if this were to happen foreign imports would become so expensive people might not be able to even afford food that we have to import from other countries or essential supplies from other countries so they say no we're going to intervene we were able to accumulate some of these foreign currency reserves and so we can use those now to try to stabilize our currency so in this situation what the central bank would do is it okay I've got some reserves of a what I'm going to do is I'm going to go into the open market I'm going to go into the open market and also sell my reserves and sell my reserves of a and try to equalize the supply and the demand and so once again if they're able to sell these reserves now all of a sudden their currency will not devalue or maybe not devalue as much now the one kink in the system here is that they only have a finite they only have a finite amount of reserves this right over here is finite in the previous video when we saw that they were printing their own currency to buy to build reserves they could do this all day all night because they have the right to print as much of their own currency as they want but now they're using reserves of someone else's currency to keep their own currency from being devalued but they don't they can't print someone else's currency so they're they're hoping that they what they have on hand is enough to to fight this what they're probably perceiving is a short-term imbalance but it could be scary what happens if all of this currency runs out then they blow all their currency reserves and if this kind of panic keeps occurring then you're going to go back to the free market forces and their currency will have to devalue so that's kind of a currency well that that's how central bank's fight attempt to keep their currencies relatively stable in future videos we'll go through real cases of when this happened and what exactly happened when the foreign currency reserves ran out and how speculators could use that knowledge to essentially make an easy speculative buck