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Thursday, 27 August 2009

BUBBLE & TAX (squeak!)

One of my Summer breakfast specials is bubble & squeak. Adair Turner (head of FSA) threw into the political frying pan (of our credit crunch dog’s breakfast) the idea of Tobin Tax, a sizzler conceived in 1972 by Prof. Jimmy Tobin at Princeton to reduce exchange rate volatility. 1972 was 17 years before the first BIS survey data of world FX markets collected triennially over 2-3 weeks that remains today only way we know roughly how much FX trading there is). In case you don’t know, there is roughly $3.5tn in daily FX transactions, $1tn a day in money markets, $0.5tn per day in bonds, and $0.25tn per day equities trading world-wide (total turnover divided by 2+ to get a single-counted value of transactions). These are my figures only, for the egregious fact is no-one knows exactly as none of the major wholesale markets are entirely “on exchange”; FX & MM not at all, bonds only slightly, equities mostly, but not entirely. They do not have to report. BIS surveys FX periodically (in Springtime every 3 years) but not MM or Bonds?
For a tax on wholesale financial market transactions to work at all, requires all the taxable transactions to be undertaken within regulated exchanges. Free market liberalism has resisted this for over a century and continues to do so. Now, in policy debates dragged up from muddy ocean depths by the Credit Crunch, it has been stated by many decision-takers that credit markets should be brought “on exchange”, but progress is stymied and slow. What underpins this is the question of quality of price discovery, quality of markets, long ago kicked into the long grass when stock exchanges became private corporations able to denationalize by merging across borders and pursue global relevance, and when any number of competitor systems were allowed, and when cost of transactions became more the competitive focus than quality. In arguable fact, ever since Tobin Tax, the world’s wholesale markets pursued a directly opposite goal of cheaper easier trading.
Therefore Tobin’s idea was only ever a theory proposition – it never had a snowball’s chance. His idea was also structural; to tax financial exuberance of the first world to fund a transfer of money to the third world. Well, the one benefit of Credit Crunch and asset bubbles was surely to deliver unexpectedly prolonged high growth for third world exporting countries, for which they may be ever grateful.
Tobin Tax (TT), as an idea was raised many times in the ‘80s and ‘90s when folks could not understand how it is that financial markets can apparently trade the equivalent of world GDP every 6-8 weeks, and that’s before we consider the same again in nominal value of derivatives trading, which is at least mostly on-exchange? In theory, TT might discourage speculation by making currency trading more costly, but that would only ever have been a first-order effect, most likely dissipated as the tax is passed on. FT reporting on this posited the theory that the volume of destabilizing short-term capital flows would decrease, leading to greater exchange rate stabili. But, of course, there is as yet no global tax authority to impose global taxes on global financial transactions, no monitoring, no formal reporting, global or otherwise, and no academic or other theory to explain how must is genuine need to trade and how much is speculation; old data suggests roughly a 20%/80% split before we consider market-makers who merely churn the market. TT is a speculation tax, but FX is a zero-sum game. Therefore, the global tax has to be on turnover, not profit.
And anyway, which currency should all be measured in, and at what moments in time. When FX margin spreads go to the 4th to 6th decimal places, how many decimal places further on should the tax be exerted, and could trading systems accounting be trusted to measure that? Even if a tax on FX turnover was say 0.05% or 5bp at both ends of the deal the result is $one trillion or more than the total GDP of the African continent. To be complete about this TT should apply to all derivatives and to MM, Bonds and equities, in which case the tax would equate to the total GDP of China plus India. Sounds great, but a global tax on this scale would undoubtedly reduce the volume traded enormously - and derivative or other measn found to emulate or track without actual cash-market trading i.e. the tax would be avoided and evaded!
So why is the clever Adair Turner suggesting this as an alternative to “swollen” financial sector paying excessive salaries grown too big for society. He says debate on bankers’ bonuses is a “populist diversion” and more drastic measures are needed to cut the financial sector down to size.
He adds that FSA should “be very, very wary of seeing the competitiveness of London as a major aim”, claiming the city’s financial sector has become a destabilising factor in the British economy. Mayor Boris Johnson discounts this as an aberration view that Lord Turner should rethink since the Mayor wants London’s wonderful competitiveness to emerge even stronger from the crisis!
Turner’s question is actually sensible and legalistic. It is against EU law for the UK to support its financial sector for competitiveness gains. It is not really, as FT surmises, that “Britain is becoming increasingly sceptical about the perceived advantages of being a leading financial centre”. Lord Turner’s suggestion that a “Tobin tax” is a reproach to the debate over bankers’ bonuses (BB) is something of a blind. BB we can all do something about, however problematic. TT is another matter entirely! The question of BB is linked to London as a financial centre insofar as BB is defended as being competitively necessary on the grounds that there would be a business flight to centres where BB would not suffer any capping. This is baloney in my view, for reasons I shall not enumerate here, not this time, save to say that bonus earners are 1. not nearly so valuable as is pretended and 2) they don’t all want to go live in tax-havens, or they’d all have done so long ago.
Lord Turner is sensibly worried too about a return to “business as usual” (mentality and/or actuality) in the banking sector, suggesting that new taxes may be necessary to curb excessive profits and pay in the financial sector. Indeed, correct, but this has a complex aspect, which is that bankers do not know their value or their riskiness other than what they can get away with. They are as star-gazing as those who cannot explain how it is that the world’s income appears to be traded ever couple of months, who cannot understand where all this niagra of finance money flow comes grom and goes to and how it is they have a pool ticket to swim in such deep fast flowing waters.
None of the academic instituites, governments or central banks have macro-economic macro-financial models to answer this question either. Despite our computer-data rich world the truth is that for almost everyone, including bankers, today’s science on the matter remains somewhere in the medieval world of astrology; it is definitely not astro-physics. Most bonus-bankers are clear about one thing, they prefer it that way, to be priests of voodoo-finance, not economists!

1 comment:


from FT: “If you want to stop excessive pay in a swollen financial sector you have to reduce the size of that sector or apply special taxes to its pre-remuneration profit,” says Lord Turner. He proposes higher capital requirements will be the FSA’s main tool to eliminate excessive activity and profit, but that a tax on transactions on a global level may be an additional option. Aides to Alistair Darling, UK Chancellor of the Exchequer, said no such taxes were under consideration. Mr Darling insists that the banking industry in London should continue to play a leading role in global finance.
Angela Knight, chief executive of the British Bankers’ Association, also defended the financial industry’s role in the economy saying the sector was a main provider of jobs and tax revenues and could be undermined by the wrong kind of taxes or regulation. The FSA chairman also said that parts of the financial services sector had grown “beyond a socially reasonable size”, including derivatives and hedging and aspects of the asset management industry and equity trading.
This is opening up (again) a wide range of issues that have been suppressed for years. But, we do not yet have the modeling tools or the official data to know precisely what we are talking about. Arguably, the whole schmozzle will be another even more remote populist distraction from other already quite remote populist distractions?