China’s problems with foreign capital entering the country

China has experienced a sharp rise in the inflow of so-called “hot ,” foreign capital entering the country supposedly seeking short-term profits, especially in 2008. Chinese estimates of the amount of “” in China vary from $500 billion to $1.75 trillion. The of “hot money” is contributing to China's already existing problems with inflation. Efforts to reduce the inflationary effects of “hot money” may accelerate the inflow, while actions to reduce the inflow of “hot money” may threaten China's economic growth, as well as have negative consequences for the U.S. and global economy. This report will be updated as circumstances warrant.

Economic conditions in China are of considerable concern to U.S. policymakers, given the potential impact of China's economy on the global and U.S. economy. The recent large inflow of financial capital into China, commonly referred to as “hot money,” has led some economists to warn that such flows may have a destabilizing effect on China's economy. In an op-ed column in the Financial Times, two China experts wrote of hot money's “ensuing money creation is fueling rising inflation, systemic overinvestment, and an overextended banking system.”1 There are also indications that “hot money” flows have played a role in the recent rise and fall of China's stock and real estate markets. Other economists have expressed concerns that efforts by the to control “hot money” inflows could have significant negative consequences for the U.S. and global economy in the form of slower growth, greater inflation, or both.

Defining “Hot Money”

There is no formal definition of “hot money,” but the term is most commonly used in financial markets to refer to 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 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. Many economists maintain that the rapid outflow of “hot money” first from Thailand and then from other Southeast Asian economies was a significant contributing factor to the onset and severity of the East Asian Financial Crisis of 1997.