The War vs. Hot Money

The Asian financial crisis of the late 1990s showed the serious side effects of hot money, or speculative short-term funds that disrupt the international financial market. Hot money was pulled out en masse in 1997 from the securities and foreign exchange markets of Korea, Thailand, Indonesia and Malaysia, driving the region into an economic meltdown. Then Malaysian Prime Minister Mahathir bin Mohammed condemned “playing with hot money” by international foreign exchange speculators but critics said he had no idea what he was talking about. Mahathir’s criticism, has earned considerable backing over time, however.

Japan`s monetary authority Tuesday lowered its key interest rate from an annual 0.1 percent last week to zero to 0.1 percent in a return to the era of a zero interest rate. Tokyo also announced a policy of “quantitative easing” designed to pump in more liquidity into the financial market. The U.S. will also likely conduct additional quantitative easing in its monetary sector early next month. As advanced economies race to lower interest rates and inject money to recover from the economic slump, excess liquidity is flowing into emerging economies in Asia and South America, which have sustained high growth and interest rates, appreciating the currencies values of these economies. Naturally, countries under attack by hot money seek to defend themselves.

In an unusual criticism of Japan’s neighbors, Japanese Prime Minister Naoto Kan and Finance Minister Yoshihiko Noda said Wednesday that Korea and China are intervening in their foreign exchange markets. They apparently expressed discontent over the surging yen even after Japanese authorities intervened in the FX market and cut the main interest rate. Tokyo`s criticism of Seoul is ill advised, however. Last month, the Korean stock market saw net capital inflow of 3.7 billion dollars and the bond market saw 2.7 billion dollars. The Korean won also surged to 1,120 to the dollar Wednesday, fueling fears over the fast appreciation of the Korean currency.

In the past, many experts criticized the regulation of hot money as an anti-market policy. After the global economic crisis erupted in 2008, however, such claims have lost legitimacy and ground. A U.S. financial reform act that took effect in July this year also included restriction of banks’ investment in hedge funds, as well as toughening of requirements for hedge fund registration and information provision. Korea also needs to significantly reinforce oversight and regulation of short-term funds. If considering domestic factors only, Korea might need to raise its benchmark rate from 2.25 percent but doing so could significantly risk sparking a further inflow of hot money.

Editorial Writer Kwon Sun-hwal (shkwon@donga.com)