The Hot Money Trap

SHANGHAI – The recent financial crisis has seen Asia emerge as an economic powerhouse – indeed, as a key driver of global growth. Within five years or so, Asia’s total economy could be as large as that of the United States and the European Union combined.

Indeed, while Asia is rising, the rich industrial countries of the old G-7 have been drifting into a liquidity trap. As the ongoing recession exhausts the traditional instruments of monetary policy, central banks are opting for new rounds of quantitative easing (QE). And, with investors seeking higher returns, more QE – especially by the US – will drive “hot money” (short-term portfolio flows) into high-yield emerging-market economies, which could inflate dangerous asset bubbles in Asia, Latin America, and elsewhere.

The US Federal Reserve and the Obama administration remain rhetorically wedded to maintaining a “strong dollar.” But it is the dollar’s weakness that has boosted US corporate earnings since the crisis erupted, propelling the Dow Jones Industrial Average above 11,000 for the first time since May. Since early 2002, the dollar has fallen by one-third against major currencies, and recently this decline has intensified.