Hot money

In economics, hot money is the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. These speculative capital flows are called "hot money" because they can move very quickly in and out of markets, potentially leading to market instability. Illustration of hot money flows The following simple example illustrates the phenomenon of hot money: In the beginning of 2011, the national average rate of one year certificate of deposit in the United States is 0.95%. In contrast, China's benchmark one year deposit rate is 3%. The Chinese currency (renminbi) is seriously undervalued against the world's major trading currencies and therefore is likely to appreciate against the US dollar in the coming years. Given this situation, if an investor in the US deposits his or her money in a Chinese bank, the investor would get a higher return than if he or she deposits money in a US bank. This makes China a prime target for hot money inflows. This is just an example for illustration. In reality, hot money takes many different forms of investment. The following description may help further illustrate this phenomenon: "One country or sector in the world economy experiences a financial crisis; capital flows out in a panic; investors seek a more attractive destination for their money. In the next destination, capital inflows create a boom that is accompanied by rising indebtedness, rising asset prices and booming consumption - for a time. But all too often, these capital inflows are followed by another crisis. Some commentators describe these patterns of capital flow as 'hot money' that flows from one sector or country to the next and leaves behind a trail of destruction." Types of hot money As mentioned above, capital in the following form could be considered hot money: Short-term foreign portfolio investments, including investments in equities, bonds and financial derivatives Short-term foreign bank loans Foreign bank loans with short-term investment horizon The types of capital in the above categories share common characteristics: the investment horizon is short, and they can come in quickly and leave quickly. Estimates of total value There is no well-defined method for estimating the amount of hot money flowing into a country during a period of time, because hot money flows quickly and is poorly monitored.