Monday, March 31, 2008

Where is the hot money heading towards?

China is building its reserves at a scorching pace. Latest estimates quote that the reserves touched $1.7 trillion last month, which really made the financial gurus mad. Pettis, Peking university finance professor was wondering wherefrom the $30 billion out of $57 billion increase came? It is not definitely hot money but the money flow is steadily accelerating. Interest rate cut resulting in more liquidity in US and this cash finds its flow towards China. Collapse of the Bear Stearns added to the woes in money rush towards a safe haven.

As US became a non viable option for the investment because of the continuous interest rate cut by the federal reserves, Asia seems a better option. Incidentally the inflation rate in china had zoomed to 8.7 per cent in February. This is attributed to the rapid money flow rather an increase in the commodity prices. Too much money supply than what is required will add to the inflation woes. Pettis seems to have worried about containing the inflation.

The race to accumulate reserves highlights an unsustainable global monetary system. It is claimed that growth of reserves in China and Saudi Arabia would equal the monthly current account deficit of US for the month of February. China and US are mutually beneficial in that in that China needs US demand for its goods to thrive and the US needs Chinese money to finance its demand.

Chinese premier Wen Jiabao has pledged to take forceful steps to control inflation which is at 11 year high. The higher interest rate prevailing in China would only invite a rush of hot money which in turn would kick the inflation up. Let us wait and watch how China reins the inflation.

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