ShmoopTube

00:00

Principles of finance ah la shmoop ah Brief history of

00:04

foreign exchange So bretton woods you have a meeting thing

00:09

No relation to tiger here bretton woods fixed exchange rates

00:13

for strategic reasons And yeah we're not talking about some

00:16

country club kid named bretton Well the bretton woods agreement

00:21

was established in nineteen Forty for naomi and world war

00:23

two between the us and a few other countries who

00:26

all agreed that it might be in everyone's Best interest

00:28

tio you no get along and not just in terms

00:31

of blowing off enemies but also in terms of trade

00:35

So these countries all got together and they decided how

00:38

much each country's currency was worth relative toe every other

00:42

country's currency and decided to set those currencies at a

00:46

fixed rate and or range thereby allowing for future international

00:50

trade Right and trade is good It give people something

00:54

to lose when they go to war against each other

00:56

So that was fixed They fix their rates within a

00:59

pretty tight range However floating is vastly the more common

01:03

form in which currencies around the world trade today the

01:06

floating thing and basically just means that there are no

01:09

rules for how one currency is valued relative to another

01:13

the way there were in the bretton woods era for

01:15

a few years after world war two If suddenly putin

01:17

decides to print boatloads a rubles destroying the relative value

01:22

of their currency and more or less against all other

01:25

currencies in the world by creating so much supply and

01:28

basically flat demand then the ruble two dollar exchange rate

01:31

might suddenly gap down teo no a dollar buying one

01:34

hundred rubles instead of fifty or sixty it was buying

01:38

last month Well the same khun work in the other

01:40

direction as well If the russian fed or central bank

01:43

decides to raise rates dramatically wanting to protect the value

01:47

of its currency globally making its currency mohr scarce like

01:50

less supply and or more precious well the same exchange

01:54

rate might suddenly float the other way Like all of

01:56

a sudden a dollar on levi's twenty rubles and maybe

01:59

less or the reverse could be true that you might

02:02

go back to a world where a dollar but you're

02:03

twenty rubles toe one ruble buying twenty dollars like the

02:07

whole thing could flip in the world values rushing currency

02:10

More than americans but we give fog at this notion

02:12

because we're americans right Well if the russians end up

02:15

defending their currency the way they've defended their best election

02:18

hackers you never know right Well You can imagine how

02:20

a country could go bankrupt trying to defend its currency

02:24

An easy path there in this path almost bankrupted europe

02:27

when the euro came out was to set a price

02:30

ceiling That is you set a maximum exchange rate so

02:33

that your currency is never valued less than some ratio

02:37

to ah hard currency like the u s dollars Well

02:39

at that time commodity traders took big advantage of the

02:42

european central banks narrow mindedness and well they made a

02:45

killing essentially shorting the euro just before it started to

02:48

float Now move this thinking to moscow like let's say

02:51

that russia demanded that buyers never be able to buy

02:54

one hundred rubles for less than a dollar if the

02:57

ruble declined in relative value so that the floating exchange

03:01

rate got to the point where a dollar was buying

03:03

one hundred one rubles while then russia would essentially have

03:06

to be buying back its own rubles like using quote

03:09

Hard currencies unquote that it had accumulated from trading with

03:13

other countries to do so like using dollars in chinese

03:16

yuan in japanese yen and so on to them by

03:19

well russia would be hoping to constrain world supply keeping

03:23

its ruble prized at one hundred to one at least

03:26

against the dollar And why would this matter if russia

03:29

had to buy product using rubles from the u s

03:32

which only took us dollars and it couldn't pay for

03:35

those products in barter Aii things that owns tons of

03:38

like natural gas and lumber and russians the more prize

03:42

the ruble relative to the dollar the cheaper those u

03:45

s products would be to the russian buyer who's buying

03:48

in rubles Think about a chevy bolt It would go

03:51

from costing thirty thousand dollars and three hundred thousand rubles

03:55

to still costing thirty thousand dollars But on ly requiring

03:58

a hundred thousand rubles were missed sir putin Teo add

04:01

this awesome car to his collection But it's a one

04:04

hundred to one there Okay so how does all this

04:05

work Its scale like it's More than just being about

04:08

some weird american with a fetish for zombies and nuclear

04:11

Waste wanting to do one transaction in the balmy green

04:14

suburbs of chernobyl why do we need to worry so

04:17

much about foreign currency relative valuations anyway Well because business

04:21

does you like to eat right eat as in wine

04:25

french cheeses vodka from russia thank very much Caviar glows

04:29

in the dark that swedish herring thing that makes people

04:31

dry heave when they smell it well it's likely you'll

04:34

get a job in the business than that Business will

04:36

be highly affected by the prices at which it exports

04:39

its product and the prices of the commodities that imports

04:43

often from overseas vendors Teo build its product brian i

04:46

think of us We both come from importing wood and

04:49

guidance systems and eat well This currency exchange process is

04:52

a huge part of the global economy Consider that while

04:59

you're in american underwear seller column barbara's boxers doing business

05:03

selling underwear the latin american drug lords in the nineties

05:06

when the colombian peso was inflating it about one percent

05:10

a day Yes that's right per day Like for hundred

05:13

percent plus annualized Well you'd sell what was at the

05:17

time ten thousand u s dollars worth of your no

05:20

go commando line of underwear to the drug lords But

05:23

then if you were paid thirty days later well the

05:26

bill was to be paid as million pesos and yes

05:29

we're rounding exchange rates here a lot just to make

05:31

the math easy So a month passes and you actually

05:34

get paid a million colombian pesos and yes you're thankful

05:38

to have been paid You really didn't want to have

05:40

tio send the guys with the baseball bats after the

05:43

drug lord Those bats always seemed to disappear when the

05:46

guys were sent home but you were paid a million

05:48

colombian pesos thirty days later That's the good news the

05:51

bad news talents that the value of those million pesos

05:55

declined by ah lot the new value of those million

05:59

pesos under one per present today inflation well it was

06:02

million divided by one point zero one do the thirtieth

06:06

power there ah million over about one point three five

06:09

college or rather that million dollars buying power thirty days

06:13

later was only seven hundred forty two thousand pesos worth

06:16

give or take the ten thousand u s dollars worth

06:19

the revenues you originally got from the sale ended up

06:22

being more like well seven thousand four hundred twenty ation

06:25

change and that's a huge problem in the underwear industry

06:27

which is inherently low margin low profit margin to begin

06:31

with and drops in purchasing power or rather than negative

06:34

effects of hyperinflation take a company doing business profitably to

06:38

one not doing business profitably So this transaction was a

06:41

deal consummated with currency rates fully floating likely with both

06:45

the seller and the buyer knowing that there was massive

06:47

inflation coming the values of exchange were initially calculated on

06:51

the spot that moment and that flavor of transaction is

06:54

called yes a spot rate It's the simplest kind of

06:57

transaction and unfortunately with no protection ends up with your

07:01

company calling bust or losing big money on the sale

07:04

Yet the kissing cousin to a spot rate is a

07:06

forward rate or forward transaction In this structure a deal

07:10

is cut such that in end days as some number

07:13

of days or weeks or months or whatever one party

07:16

delivers that given value in a set currency like you

07:20

could have said in thirty days you will pay me

07:22

ten thousand dollars for this load of underwear that is

07:26

the drug lords would have been liable for the forward

07:28

pricing of that product And instead of the million colombian

07:32

pesos buying on ly a seventy four hundred bucks in

07:34

change they would've had to have come up with something

07:37

like one point three million pesos to then by ten

07:41

thousand u s dollars worth of the underwear And yeah

07:44

pay their bill that way In this example the buyer

07:47

bears the risk of the currency not the seller The

07:50

basic idea is that since bretton woods ended foreign exchanges

07:54

only and always will be a moving target and in

07:58

order to not be destroyed by transactions is where the

08:01

currency ratios go against you You have to aim your

08:04

arrows well in front of the direction The key currencies

08:07

you care about are moving especially when you you know 00:08:11.04 --> [endTime] really care

Full Transcript