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Thursday July 7, 2005 - 11:21:30 GMT
Black Swan Capital - www.blackswantrading.com

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Hot money is a double-edged sword

Quotable

“As US interest rates continue to rise and the dollar strengthens, the hot money that flowed into Asia on the back of Rmb revaluation may have started to leave. I estimate the total amount of hot money at around US$700 billion. Such a reversal could have a major impact on Asian asset prices.”

Andy Xie, Morgan Stanley

FX Trading

$700 billion in hot money sitting in Asia, according to estimates by Morgan’s Andy Xie—that’s a big chunk of change! Much of that money flow was due to the expectation of “pending” revaluation of the yuan. And why not snap up some hot real estate, while waiting for the “pending” revaluation of the yuan. So, it can be assumed that much of the Shanghai property boom is part and parcel to revaluation—at least we are making that assumption.

So, imagine what happens when said “hot money” has its expectations squashed should it perceive two potentialities: a) The yuan revaluation is NOT “pending”, and 2) China IS slowing.

Short answer: Much of the $700 billion flows back out of Asia.

If you remember, in Tuesday’s piece—we reviewed Soros’ reflexivity theory, and how it relates to currencies: “Speculative capital moves in search of the highest total return. Total return has three elements: the interest differential, the exchange rate differential, and the capital appreciation in local currency,” according to Soros. And in that arrangement, the expectation of a rising exchange rate manifests itself as the key driver of “hot money.”

As “hot money” leaves any region, it usually trickles out at first. Those who recognize early trends, get on the bus. They aren’t likely to share their views until safely out of danger. But sooner or later, this trickle morphs into a flood—taking on a self-feeding quality and a seemingly sharp swing in sentiment—it is the nature of the market—human nature. Fear is a bigger motivator than greed. We have seen this before.

Could it be déjà vu all over again? “The amount of hot money in Asia is about three times the liquidity that left the region in 1998. The potential for another Asian liquidity crisis clearly exists,” says Mr. Xie.

Jack Crooks
Black Swan Capital

 

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