Stealth attack of the Tobin tax

Sarkozy lines up somemiddle-rank supporters for a financial transactions tax; and how an FTT can improve financial markets.

The idea for a generalized Tobin tax (financial transactions tax – FTT) on financial transactions continues, slowly but steadily, to gather supporters.

For a long time it was mainly backed by starry-eyed development NGOs who wanted to tax currency speculators (as in Tobin’s original proposal), but to fund a UN war on poverty. Tobin dissociated himself from this linkage. Either way, Tobin tax v.1 didn’t get anywhere.

It took the current financial crisis to revive it in the generalised v.2 form. Nicolas Sarkozy was SFIK the first political heavyweight to back an FTT. Gordon Brown supported him in 2009. The European Commission has tabled a proposal for an EU FTT tax. The IMF is sitting on the fence. Now Sarkozy has been pushing the idea at the G-20, though there’s no mention in the Cannes communique.

The latest converts, according to press reports from the G-20 conclave at Cannes, are Argentina, Brazil, Spain and South Africa. It’s unclear to me why any of them were against it in the first place, given the ideologies of their governments, no friends of Wall Street. Perhaps successful lobbying by local bankers on an issue their governments didn’t take seriously before, and now do.

What are Sarkozy’s chances of pulling this off? Not great, but not zero. The USA are opposed but not fighting it for others – it’ll just attract business to Wall Street. The UK, whose economic policy is now mainly run by Tory politicians whose non-political work experience has been as PR flacks to the City, is vehemently against, unless the tax is introduced worldwide, i.e. never. Japan, Canada, Australia, and China make up the club of noes.

Sarkozy’s best bet seems then to introduce it as a eurozone tax, marketed as a way of paying for the bailouts. It would need London’s cooperation on cross-border transactions. British opposition is so obviously a defence of the City’s interests rather than the country’s that it may be vulnerable to a shift in public opinion – in turn empowering Lib Dem coalition ministers like Vince Cable – and to street anti-banker protests.

Punishing bankers is such good fun and a necessary catharsis that it’s easy to forget that you need to be clear about the objectives. Tobin’s original idea, following Keynes, was a tax on foreign currency operations only, intended to reduce the volatility of exchange rates and the risk of speculative runs like Soros’ billion-dollar bet against sterling in 1992. With most exchange rates freely floating, and the disappearance of most European currencies into the euro, this specific problem has faded. Speculators like Soros are free to try their luck against the Bank of China’s administered exchange rate, backed by $3.2 trn in foreign exchange reserves; an opportunity which curiously appears unattractive.

The new FTT is mainly marketed today as a way of making the finance industry pay for the crisis it unleashed on us in 2008 and to insure against future ones. It’s not clear that a transaction tax is better here than a levy on assets or profits, which are much easier to collect. (To be fair to Cameron’s government, it has introduced a bank levy in the UK).

Joseph Stiglitz has endorsed a global FTT in statements to the press . I can’t find a formal paper or speech by him giving his reasoning – bleg anybody?

So here goes: bloggers rush where angels &c. The argument has to be that wholesale financial markets are too liquid for their own good. In pursuit of tiny arbitrage profits per dollar, financial firms generate colossal volumes of trades and pile up huge balance sheets of claims against each other. British banks, according to the Vickers report, have £6 trn in assets, of which only a third represents lending to British households and non-financial businesses. The rest is mostly lending in a circle to other banks and financial companies.

What for? This lending greatly exceeds the minimum liquidity required by say insurance companies. A lot, as we Main Streeters painfully discovered in 2008, goes to leverage both sides of huge zero-sum bets on derivatives within the finance club. At best that increases volatility, at worst increases counterparty risk when a player cannot meet a losing bet, and in any case reduces transparency, at some of these bets are incomprehensible even to those who make them.

The counterparty risks of this merry-go-round are not properly priced, and conceivably can’t be; they are assumed to be low until a chaotic change in sentiment makes for a sudden spike, and markets in particular securities cease to exist. Shifting risk into specialised CDSs and the like merely moves the counterparty problem, it doesn’t solve it.

In all these ways a hypertrophied financial sector doesn’t – as we’ve seen – reallocate risk efficiently as it claims, it manufactures risk and volatility. To contain systemic risk, regulators now insist on greater capital reserves – this is real capital which is sucked out of more genuinely productive sectors of the economy, and in the aftermath of crises, often comes directly from taxpayers.

If this deeply sceptical view of the current activities of financial corporations is correct, then raising their transactions costs would be a Pareto improvement. Compare the dermal denticles of sharks, the dimples on golf balls, and the fine grooves on fighter fuselages, which counter-intuitively improve their hydrodynamics. A little roughness often makes things go smoother. An FTT also represents a market alternative to heavy-handed regulation, always at risk of being captured or outmanoeuvred by financiers whose intelligence is as great as their scruples are low.

Since the plausible rate (a fraction of one percent) would be irrelevant to a transaction with a non-financial entity like you and me and Apple Corp., the tax would shift the incentives of financiers back to providing services to customers and away from incestuous deal-making. With luck it would make the industry less obscenely profitable, more boring, and less attractive to the best young minds coming out of our universities.

So for now I hope Sarkozy succeeds.

PS: another idea for banker-bashing, served half-baked for commenters to cook or bin. The enforcement of private contracts by the courts is seen as an unconditional right. Should it be? Why should secret contracts for large sums, often the mechanisms for Adam Smith’s conspiracies against the public, enjoy the privilege of enforcement by the state?

An efficient market requires transparency: participants need to know what deals others are making, so as to adjust their own behaviour rapidly. Well-regulated securities and commodities markets already approach this ideal: think of an open outcry trading pit. So my impeccably neoclassical free-market idea is to make any contract for over say $1 million only legally enforceable if it (or perhaps an accurate précis) is published. Anybody would still be free to make secret deals relying on non-binding private arbitration: we’d quickly find out how popular that would be. Vampire squid won’t like the idea; they rely on clouds of ink.

Author: James Wimberley

James Wimberley (b. 1946, an Englishman raised in the Channel Islands. three adult children) is a former career international bureaucrat with the Council of Europe in Strasbourg. His main achievements there were the Lisbon Convention on recognition of qualifications and the Kosovo law on school education. He retired in 2006 to a little white house in Andalucia, His first wife Patricia Morris died in 2009 after a long illness. He remarried in 2011. to the former Brazilian TV actress Lu Mendonça. The cat overlords are now three. I suppose I've been invited to join real scholars on the list because my skills, acquired in a decade of technical assistance work in eastern Europe, include being able to ask faux-naïf questions like the exotic Persians and Chinese of eighteenth-century philosophical fiction. So I'm quite comfortable in the role of country-cousin blogger with a European perspective. The other specialised skill I learnt was making toasts with a moral in the course of drunken Caucasian banquets. I'm open to expenses-paid offers to retell Noah the great Armenian and Columbus, the orange, and university reform in Georgia. James Wimberley's occasional publications on the web

8 thoughts on “Stealth attack of the Tobin tax”

  1. I like the Tobin tax, pretty much for Wimberley’s reasoning. But I don’t like his publication idea at all.

    First, it doesn’t make any sense as stated. If Virtuous Corp took out a $10 million loan from the Vampire Squid, the competitors of Virtuous would love to look at the covenants–they might give a good idea of Virtuous’ business plan to cure cancer within three years.

    Second, it is easy to game. Since Vampire Squid has good lawyers, it would arrange an 11-member syndication to get every lender’s exposure under a million.

    Third, it is already in large part the status quo for purely financial contracts, like derivatives. A good chunk of these contracts is published today–everybody uses ISDA documentation.

    1. Not sure I have much of an opinion on the publication/disclosure idea, but I don’t think you present a great counter-example – the financial terms would be disclosed, but not every detail of the company. It’s common for agreements to have benchmarks, but these don’t have the level of detail you seem to suppose. Also, the tack a company is taking in its research often isn’t particularly secret, and the whole system of IP protection in this country relies on disclosing the nature of your invention in order to protect it.

      1. It’s not a great counter-example, admittedly (although trade secrets are a perfectly legitimate form of IP protection and indeed the norm in many industries.) It’s just the first thing that popped into my head. But I still think it is remarkably easy to game, and hard to properly specify.

  2. In short, a FTT would ecourage banksters to become useful members of society.
    Very good piece. Thank you.

  3. The enforcement of private contracts by the courts is seen as an unconditional right. Should it be? Why should secret contracts for large sums, often the mechanisms for Adam Smith’s conspiracies against the public, enjoy the privilege of enforcement by the state?

    I myself have been thinking that this technique would be one way to get control of things in the financial sector: go ahead and cook up what you want, but we’re not going to enforce those contracts.

  4. Adam Smith went beyond not requiring government to enforce dangerous contracts, all they way to suggesting government outlaw certain banking agreements with large potential negative externalities:

    “To restrain private people, it may be said, from receiving in payment the promissory notes of a banker for any sum, whether great or small, when they themselves are willing to receive them ; or, to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty, which it is the proper business of law not to infringe, but to support.

    Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.”

    — Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, Book 2, Chapter 2

    1. Quite so. Adam Smith was not talking about systemic risk, however.

      In this context, he was worried about consumer protection. Large banknotes (greater than about 5 pounds or so) would only circulate among merchants and gentry, who could be presumed to know the quality of the issuer. Small bank notes would circulate among a much wider group, many of whom (Smith thought) would accept notes from poor issuers at face value. Such notes often traded at a discount among the cognoscenti.

      American employers, in the early 19th century, were known to buy low-grade bank notes at the market discount, and pay them to their employees, at face value. The local merchants were in on the scam, and pretended to take the notes at face value, but marked up their wares accordingly.

      This is the kind of freedom Ron Paul wants to restore to us.

  5. There’s another reason an FTT could be useful: by making high-frequency trading less favored, it would reallocate some of the profits from volatility away from the financial firms (who by virtue of millisecond connections within the exchanges can get ahead of any significant market move) toward investors who at least have a colorable claim to be acting on information that might involve a firm’s real-world prospects.

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