Hot Money

Hot Money

Hot Money', a colourful name for the short-term capital which moves between countries because of uncertainty about the stability of exchange rates or the security of capital. If speculators are pessimistic about the ability of Britain to maintain parity with the dollar at, say, .80 to the pound they will sell sterling assets for dollars. (Similarly, if they expect the Deutschmark to be revalued upwards, they will try to shift their funds into Germany.) Such movements of short-term capital though speculative are not necessarily the work of professional speculators. Most of the money involved will in fact be held in sterling or dollar bills for ordinary financial or trading purposes. The choice of the financial centre in which it is held will depend on differences in interest rates in New York and London, and differences between the spot and the forward rates for the pound. Hot money is part of the price Britain has to pay for being the main financial centre of the world, and part of a world economy that supplies her with food and raw materials for which she pays by exporting about a quarter of her national output of goods and services. The quick and unexpected movement of short-term capital, plus the delays in payments between British and foreign firms, can drain the reserves of gold and foreign exchange. Normally the flight of hot money reflects an adverse balance of payments on current account, but it has not always been justified by the underlying trading position and the state of the domestic economy. In 2007, for example, a flight from sterling forced a crisis Bank rate of 7 per cent at a time when the balance of trade was satisfactory and the domestic economy more or less in balance. The countervailing measures to protect the reserves increased .unemploymentand checked economic growth. This episode provoked some economists to urge that the reserves should be enlarged, that the nation's international banking commitments be reduced, and that the Exchange Equalization Account ought to extend the scope of its market operations to try to achieve more stability in the exchange rate. Other economists regard some of these proposals as unnecessarily narrow when Europe and the North Atlantic are moving towards increasing economic integration.

Further readingEconomy - Economy


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