Europe likely to send hot money to China

Photo taken on March 16, 2014, shows yuan (central) and other currencies in the picture. [Photo/IC]

Dramatic monetary policies in Europe have lots of potential to create a new surge of hot money inflow into China, says Simon Derrick, chief currency strategist at the Bank of New York Mellon.

Hot money is speculative money that flows quickly between markets as investors cast about for high interest rates and returns. It can create distortions in sufficient quantity.

This impact is similar to that caused by quantitative easing by the US Federal Reserve on China in 2009, when excess money created was looking for a home in a high growth economy, Derrick says.

Simon Derrick, the chief currency strategist at the Bank of New York Mellon, says China has made strides to liberalize its currency to allow freer trade and investment flows in and out of the country.

As China experiences this inflow of hot money, it is tempting to introduce exchange rate controls similar to a repeg of the renminbi to the US dollar, he says, but such measures are not advantageous for the longer term.

"The temptation is to step in and intervene, but the problem is that you'd simply end up with the same old reserve policies and reserve problem that characterized the currency war for the last 25 years," says Derrick.

Instead, the brave thing for China is to decide that it has committed to liberalizing the currency, so it should use monetary policy to control inflationary pressures, he says.

"I hope that will happen, as it shows that the People's Bank of China, and more generally the Chinese government, have had faith in what they were doing. I really do believe what's happened over the last 18 months is an important step and I'd like to see it continue to happen," says Derrick.

The two events in Europe that Derrick made reference to are the European Central Bank's intention to execute quantitative easing in March and the introduction of a negative interest rate by the Swiss National Bank.

According to European Central Bank announcements in January, at least 1.1 trillion euros will be injected into the ailing eurozone economy.