Hot Money

The term “hot money” refers to flows of money circulating between different markets. Otherwise, they’re known as speculative money. The purpose of these speculations is investors’ attempt to gain profits through the difference of interest rates offered by various countries, markets, or banks.

The term also refers to:

• a currency that easily flows between different financial markets;
• a short-term investment strategy based on a constant flow of money;
• capitals invested into rival companies.

Basically, hot money can be described as a means of earning higher interest rates. However, due to their constant flow, hot money might negatively influence on the economy of a country and often lead to market instability.

Also, the term “hot money” means stolen money which can be traced by special marks on them. But in this article, we’ll focus on the first meanings of the term related to the economic sphere.

Types of Hot Money

Hot money might be presented in different forms, such as:

• short-term deposits or loans in foreign banks;
• short-term investments on foreign markets.

However, they all share common characteristics, like a short period of investing and quick and easy movement of money between markets.

Banks’ interest in Hot Money

Banks are highly interested in hot money because they bring investments. Therefore, banks try to make attractive conditions in order to lure the capital owners. If a bank has to lower interest rates due to some circumstances, or if another bank finds an opportunity to offer investors more, the first one will probably lose some of its clients, who are in search for more profitable options.

Banks offer certificates of deposit (CDs), which differ from usual deposits by the obligation of keeping money in the bank till the end of the specified term. If an investor breaks this obligation, the bank might require a certain fee as penalty for early withdrawal of money. However, it still may be more reasonable to pay the penalty and transfer money to another bank with higher interest rates than leaving them under unsatisfactory conditions.

Hot Money influence on the economy

On the one side, hot money bring capital to the economy. Usually, the capital flows from countries with lower interest rates to the countries with the higher rates. On the other side, hot money are “hot” for the reason, they don’t stay at one place for a long time. Significant outflows of money can cause severe damage to the economy of a country. For example, lead to the economic crisis and all the associated negative consequences.

Surprisingly, unexpected inflows of hot money can cause damage to the economy as well. The country might be unprepared for such a substantial amount of investments, thereby suffering from inflation or other adverse effects.

In order to take these quick and continuing inflows and outflows of money under control, countries establish specific measures to protect the economy. Generally, these measures are called capital controls.

Example of Hot Money

Let’s suppose that the US certificates of deposit offer investors 1%, while the Chinese banks – 4%. Obviously, some investors might be attracted by this opportunity and put their investments in the Chinese banks under 4%, thereby winning on the difference between interest rates. Also, investors might take advantage of the currency value change.

China isn’t chosen for the example by chance. Since the beginning of the 21st century, China has showed a significant growth of the economy, including its presence on the stock market. Therefore, it becomes one of the most popular hot money attractor. The Chinese economy has had to learn how to manage these money flows and use it in its advantage. Sometimes, this capital supports the country’s development, but it also causes severe damage to the country’s economy. For example, in 2014-2015 China lost about $300 billion of hot money. The country managed to control it, and by 2016 this flow decreased significantly. Nevertheless, China still is considered to be very attractive to the foreign investors, including the ones who are operating with hot money.