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How interest rates affect interest rates, financial flows, and exchange rates - YouTube
Channel: Khan Academy
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what we're going to do in this video is
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try to think of the chain of events that
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would happen if the supply of loanable
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funds were to increase in the united
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states and the way that that could
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happen is let's say the federal reserve
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were to so to speak print money and then
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use that money to buy
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treasuries in the u.s so it's inserting
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those federal reserve notes into the
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quantity of loanable funds
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well what would happen is that the
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supply of loanable funds would shift to
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the right so
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our new supply would look like this
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would look like this i'll call that s
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prime and then we'd have a new
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equilibrium price of those funds which
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we would call our real interest rate
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so then we get to r
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prime
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so our real interest rates have gone
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down and we have a higher quantity of
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money that is being loaned q prime
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but what would be the effect of that
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what would be the effect of that
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relative to other countries and i'm just
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picking japan here as another country
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but this could be the case with many
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other countries where they have
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relatively free flows of of goods and
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financial capital and to help us think
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through that i drew the balance of
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payments for each country and the
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balance of payments is made up of the
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current account which is talking about
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the flows of goods and services and then
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you have what's sometimes called the
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capital account sometimes the capital
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and financial account which is talking
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about the flow of uh oftentimes you
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could think of it as financial
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investment or investments of some kind
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or the flow of funds so pause this video
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and think about what would happen
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well if the real interest rates go down
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in the united states and we're assuming
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that all else equal in every other
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country well then you have a situation
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where in japan the relative real
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interest rates are now higher so
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relative
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relative
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real
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interest rates
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interest
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rates
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are
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higher
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now in general people might want to say
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hey if i can get a higher or higher than
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before relative real interest rate it
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might not be absolutely higher but it's
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higher than it was before relative to
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the united states well that might
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increase the financial flows from the
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united states to japan
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and so you might have some more people
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not everyone but some more people than
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before who want to take their dollars
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convert it into
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yen
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and buy
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buy financial assets in in japan where
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they can get that relatively now higher
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real interest rate
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well if these folks are converting from
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dollars to yen what's the immediate
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effect of that
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well it will increase demand for the yen
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and so the price of the n in dollar
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terms will go up or another way to think
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about it is this is going to cause the
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dollar
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to depreciate
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depreciate
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relative
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relative
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to the yen so we're just going to put
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that aside right over here because this
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is going to have other implications but
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that dollar it use it's used to buy yen
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and then those investors will will maybe
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buy japanese bonds
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and so what's happening well we're
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talking about the transfer financial
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assets and so in the united states the
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capital and financial account that will
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go down
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this will go down you could think of it
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it is being
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debited
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and in japan they are getting they are
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getting an increase in financial assets
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people are investing more in japanese
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bonds however you want to think about it
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and so that increase in funds that goes
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up and so this is getting
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credited
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now in other videos we've talked about
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how over time the balance of payments
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tend to balance out if one side is
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getting debited the other side is
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getting credited or vice versa so how is
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that going to work out in this situation
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well that all goes back to the fact that
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the dollar has depreciated relative to
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the yen if the dollar depreciates
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relative to the n what is that going to
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do
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well now
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american goods
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american
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goods
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are
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relatively cheaper
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relatively cheaper or cheaper than they
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were before
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cheaper
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in japan
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and that's hard to read and japanese
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goods
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more expensive
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more expensive
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in
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the u.s
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and so what is going to happen
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well in that situation that means that
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the u.s is going to export more to japan
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their goods are now
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are now cheaper in japan japanese goods
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are now more expensive in the u.s so
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they're going to buy
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fewer
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japanese
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japanese
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goods
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and sell and export
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export
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more
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american goods american
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goods
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and so what's going to happen on our
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current account well if you're exporting
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more that means your current account
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goes up it is going to be credited
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it is going to be credited
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and then the opposite's going to happen
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to japan relative to the u.s it's going
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to export less and import more so its
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current account is going to be
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is going to be
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debited
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now
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economies are complex things and what
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i've just done is a little bit of a
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simplification but these are the general
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trends that you would expect other
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things that you might expect is well if
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you have this flow of of financial
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capital into japan
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well that might increase their loanable
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funds and so their real interest rate
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might eventually go down and all of
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these cycles would keep going and
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reverberating back and forth over time
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but this is the general chain of events
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that you might expect that the re the
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interest rates in japan will become
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relatively higher and so you have the
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flow of financial funds going from the
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u.s to japan in the process when they
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convert from dollar to yen the dollar is
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going to get cheaper the yen's going to
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get more expensive
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the american capital and financial
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account goes down because you have this
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net outflow of financial funds but
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because of the depreciation of the
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dollar the u.s is now importing less and
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exporting more
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now a question is is is this good or bad
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for either country well it depends what
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the country's goals are this might be
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good for the u.s if their goal was to
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export more american goods or it might
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be bad for the u.s if they said hey now
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japanese goods are more expensive and
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maybe they're dependent on some type of
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japanese goods
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in some way shape or form that might not
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be the case with the u.s but in another
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country let's say they're dependent on
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oil from other countries or they're
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dependent on military hardware from
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other countries and if those things
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become more expensive that might or food
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that might make it a lot harder for
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their citizens so it's an interesting
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thing to think about uh whether this is
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good or bad and how all of these things
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fit together
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