Is Hot Money A Recommended Means Of Banking?

The term "hot money" can mean several different things. It can refer to types of fraud where money is illegally moved into different funds, or where the currency is identified as stolen (e.g. the bills are marked or the serial numbers are in consecutive order). It can also refer to funds that are invested in whatever accounts are defined as a high interest savings account, and that move very quickly from account to account. More specifically, hot money is used to describe funds that are moved from country to country based on the interest rates and currency exchanges that are offered.

When hot money is moved from country to country it can cause big changes rapidly. When it moves in, the country receiving the funds experiences positive growth. Yet nothing lasts forever, so when another country ends up offering better interest rates or a high interest savings account that is too good to pass up, the money is pulled out and reinvested in the new country. This causes a quick reversal in the value of the country's stock and currency and a drop ensues. If the drop is sudden enough and large, then there can be a shortage of funds. This is obviously not top banking but it happens all the time.

This shortage as a result of this trend in banking has greatly affected several nations. In 1994, Mexico experienced an economic crisis as a result and the same thing occurred in East Asia. A shortage of funds is something no institution wants to experience, and for a country the effects are even more devastating and can cause problems to ordinary citizens. As a result of the negative aspects to this kind of investing, some countries have put in place certain restrictions to protect themselves. Generally, these restrictions are about time; forcing an investment to remain locked for a period of time so that a sudden exit does not occur.

No banking guide or person would ever recommend relying on hot money, but some nations have little choice if they are unable to secure long term investors that are loyal to the country. Huge sums of money are required in order to run a nation, and that money has to come from somewhere. If a nation is lucky, it will be able to use that money effectively before it disappears; if the nation is not lucky, then it can run into serious financial problems.