Hot Money Flows, Commodity Price Cycles and Financial Repression in the USA and China: The Consequences of Near‐zero US Interest Rates

• Published date: 01 July 2013
• Author: Ronald McKinnon
• DOI: http://doi.org/10.1111/j.1749-124X.2013.12025.x
• Date: 01 July 2013

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China & World Economy / 1–13, Vol. 21, No. 4, 2013

©2013 The Author

China & World Economy ©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Hot Money Flows, Commodity Price Cycles and

Financial Repression in the USA and China: The

Consequences of Near-zero US Interest Rates

Ronald McKinnon*

Abstract

Under near-zero US interest rates, the international dollar standard malfunctions. Emerging

markets with naturally higher interest rates are swamped with hot money inflows. Emerging

market central banks intervene to prevent their currencies from rising precipitately. They

lose monetary control and domestic prices begin inflating. Primary commodity prices rise

worldwide unless interrupted by an international banking crisis. This cyclical inflation on

the dollar’s periphery only registers in the US core consumer price index with a long lag.

The zero interest rate policy also fails to stimulate the US economy as domestic financial

intermediation by banks and money market mutual funds is repressed. Because China is

forced to keep its interest rates below market-clearing levels, it also suffers from financial

repression, although in a form differing from that in the USA.

Key words: commodity price, financial repression, hot money flows, zero interest rate

JEL codes: F31, F32

I. Hot money Flows and Inflation in Emerging Markets

The international dollar standard is malfunctioning. The Federal Reserve ’s reduction of the

interest rate on federal funds to virtually zero in December 2008 (a move that was followed

by other industrial countries) exacerbated the wide interest rate differentials with emerging

markets and provoked world monetary instability by inducing massive hot money outflows

by carry traders into Asia and Latin America (McKinnon, 2013). A “carry trader” is one who

exploits interest rate differentials across countries by borrowing in low interest rate

currencies to invest in currency domains with higher interest rates (Menkhoff et al., 2012).

*Ronald McKinnon, Professor, Department of Economics, Stanford University, Stanford, CA, USA.

Email: mckinnon@stanford.edu.