I have long been interested – no fascinated – by currencies. When I was young, I would wonder what decides the price of a loaf of bread in France and Britain? Or cake, come to that. Who sets the exchange rate between currencies? And how do we compare the economies of different countries? If I took £10 overseas (note the island mentality is still strong here), change it to Francs then back again, why wouldn’t I get my £10 back?
Well today it is Euros rather than Francs and now it would be £1000 but these were the sort of ponderings I had as a teenager. So when I consider how much money floats round the world now, most of it speculative, I began to have a sneaking regard for the Tobin Tax as originally conceived back in 1972. Why should people just gamble money, probably on a hunch but maybe based on some confidential information, that a currency was about to tank or soar? It is not as if these transactions are without consequence, unlike betting on the 1.40 at Newmarket.
One of the famous episodes was when George Soros bet that sterling would have to exit the Exchange Rate Mechanism in 1992. The pound plummeted. The government raised interest rates to record levels and desperately bought pounds to avoid the currency losing value. This had the consequence of negative property equity and a massive slump. Sterling did exit the ERM anyway and the government was left with a lot of egg on its face. Soros reputedly made £1 billion in this and it cost the UK £3.3 billion to defend the indefensible.
Nowadays, there is a much more dynamic market in forex currency trading. Some people indulge in high frequency trading (HFT), where many trades are done by the same person even on the same day, jumping in and out of the same currency, can make a lot of money. Thanks to computing technology, this could not be done on anything like that scale 21 years ago so Tobin, or a Financial Transaction Tax, has reared its head again in the EU.
At first I thought an FTT was a good idea, particularly extended to almost all financial products albeit at a rather lower level than originally suggested – 0.01% on derivative agreements and 0.1% on non-derivative transactions. This should, according to the Commission, raise a considerable amount of money – some €57billion it is claimed. To prevent tax avoidance an FTT would be applied where one of the parties is resident in the EU – it is doubled if both are in the EU. It is claimed it will strengthen the single market, prevent unilateral action distortions and risky activities, complement regulatory measures and generate revenue.
I doubt it – only the last point is true and even then, over-estimated. In fact, some argue that it will raise net zero and it would a have a negative impact on everything from GDP to pensions. Most of the objections stem from the assumption by the Commission of a ‘closed economy model’ – as if the rest of the world did not exist. Strange – but true. Perhaps the rest of the world is trying to keep its giggling quiet because of the potential damage to European competitors.
Here’s why. An FTT would:
- apply to all transactions in a chain, which means that the eventual tax charged on what is viewed as a single transaction could be many times higher. This will lead to pressure to reduce the chain length but the cost of so doing is to reduce flexibility;
- drive at least a number of these transactions to be completely outside the EU, away from EU view and regulation completely;
- not deal with risk in the financial industry where some banks are seen as ‘too big to fail’ – see for example the real estate industry where bubbles and crashes are frequent despite high transaction charges;
- adversely affect liquidity and force banks to hold more cash and fewer government securities;
- not address the problems of high frequency trading;
- lower trading volumes – Stockholm lost over 50% of its trade when Sweden imposed an FTT; in the mid ‘80s. This was never recovered when the tax was abolished and this sort of volume is likely to move completely out of the EU;
- reduce the sensitivity of the market to rapid external changes;
- massively increase the spread between buy and sell of any financial product;
- be unlikely to raise anything like the estimated amounts;
- adversely affect the GDP by between 5 and 20 times the amount raised according to some estimates;
- adversely affect charities such as the Welcome Trust, which estimates it would cost its £14bn fund approximately £32m a year;
- disadvantage European firms in a world market as the tax would apply if only one of the parties is in the EU;
- lead companies to divert funds away from the EU;
- be likely to aggravate tax avoidance rather than reduce it;
- adversely affect pension and other funds which are frequently rebalanced to optimise returns. This is not small – one estimate was that for European funds the returns could be reduced by as much as 50%. This of course affects everyone, not just the wealthy;
- increase borrowing and suppress saving interest rates as financial organisations will find hedging against changes more expensive.
One aspect not discussed goes back to my original question – just how do you calculate the value of one currency in terms of another. And here is, to me, the point finale.
Speculative currency trading is an essential part of that process. Love it or hate it, that’s the way it is. Unlike horse racing or general gambling, the market has the effect of establishing instantly the value of one currency vis-à-vis another. This process goes on 24/7 so you don’t have to wait or make a particular request. It responds to issues and while sometimes it over-responds as lemmings follow each other, sooner rather than later, this is corrected. Much is done now by high frequency trading so imposing a tax would decimate this market, leading to less accuracy and even larger spreads between buy and sell.
I suspect that the FTT is just a way of slamming the gate after the financial horse has bolted, ignoring the fact that neither trading nor investment banking were the cause of the financial crash – it was rubbish mortgages and insurance scams. Proponents of the FTT seem not to realise this and possibly don’t understand the way the markets work at all. Worrying.
There are better ways of raising revenue from the (as was) highly profitable financial sector but before we do, we have to see what is the effect of new regulation. We have already seen one response from the Co-Op which has pulled out of the proposed purchase of some of Lloyd’s branches. We have to be very careful here, particularly in the UK which has a large financial sector, in not throwing out the baby with the bathwater.