Although the concept of hot money being stolen is one use for the term, in the finance world it means something completely different. Hot money refers to the movement of capital from one country to another. This movement is designed to earn profit over the short haul based upon differences in interest rates or exchange rates. Because this kind of speculation is often very quick and intense, the funds are termed “hot money” and have the potential of creating market instability.
Money being invested in China is often considered hot money at this point. Because the Chinese currency is undervalued, a result of deliberate government policies, investors from the United States often place their funds in a Chinese bank, earning about 3 times as much as they would at home. This is good for China, probably good for investors, but not particularly good for the United States. However, hot money can take many other forms as well.
The term “hot money” can also be used to describe the movement of money from one economic sector or country to another as a result of panic when investors search for better investments during times of economic hardship. The inflow of funds may cause a temporary boom which is likely to be followed by yet another crisis; and the cycle continues.
Critics of this type of asset management point out that many times bank-based market manipulations are behind the ebb and flow while they themselves stay insulated from the trends but continue to make money. Such banks actively pursue “hot money” by offering short term CDs with above-average interest rates.