Eco Currency

Back in 1978, James Tobin proposed a small tax (the Tobin Tax) – these days the suggestion is 1/10 percent – on all foreign exchange (forex) dealings, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion as of April 2007. After that many discussions about tobin tax arose, but up until now nothing like it has been introduced anywhere.

Originally the tobin tax was designed to reduce disruptive speculation in de forex market by raising the cost of such speculations. This idea, of raising taxis over speculation builds on an even earlier proposals dating back to 1936 when Kaynes in his book ‘The General Theory of Employment, Interest and Money’ proposed the imposition of a small transaction tax on all stock exchange dealings to diminish instability in domestic stock markets. This proposal was a reaction on the stock market crash of 1929, combined with the observation that speculation tended to be more prevalent on Wall Street than on Throgmorton Street (home of the London stock exchange) in part due to the absence of a tax in de New York market. Quoting Keynes:

It is usually agreed that casinos should, in the public interest be inaccessible and expensive. And perhaps the same is true for stock exchanges.

Apart from this effect, it originally was designed for, tobin tax would raise a lot of money which then could be used to fund a system like eco currency.

In the conference proceedings published by New Rules for Global Finance Coalition, 2003 on a conference about the tobin tax, both those in favor and those against a transaction tax present their papers expressing various difficulties and opportunities. In this post, a short summary of pro’s and con’s of the tobin tax is presented and the consequences using tobin tax to fund eco currency would have.

In ‘The Economic Case for the Tobin Tax’ Thomas I. Palley (Open Society Institute) is positive about the Tobin Tax. Main arguments why this should be introduced are that the tobin tax will reduce currency volatility and damaging speculation, it can enhance the power of domestic monetary policy, it will raise a lot of tax, it will reduce the dominance of financial interests over economic policy. In this article, Palley makes an analogy with casinos. Gambling costs resources which are justified because casinos are a form of entertainment. Much activity in forex markets are a from of noise trader gambling which have no entertainment value but do cost real resources.

Apart from these arguments why the Tobin Tax in essence is a good thing to introduce, Palley discusses the feasibility of the Tobin Tax. First he opposes to the argument of ‘jurisdiction shopping’ in which opponents of the Tobin Tax state that it will only work if introduced globally which is hardly feasible. Palley gives a number of arguments why this wouldn’t necessary happen. He states that if the tobin tax would be introduced in e.g. the G-7, the ‘Bank of International Settlement’s’ example shows that introducing guidelines which would make banking more expensive does not mean that banks would shift to jurisdictions where these rules do not apply. Instead, applying to the ‘Bank of International Settlement’s’ standards has become the equivalent of a seal of good housekeeping. Focussing on the top 9 markets (UK, US, Japan, Singapore, Hong Kong, Switzerland, Germany, France and Australia) would already cover 84% of the forex dealings (Felix, 1996). Polley states that arguments and evidence suggest that introducing a tobin tax is feasible and that ‘political will’ is the ultimate constraint. Bottom line; the amount of revenue that the tax raises and the behaviors it discourages outweigh the possible difficulties it will bring along.

In ‘Lessons for Tobin Tax advocates: the politics of policy and the economics of market micro-structure’ Randall Dodd (New Rules for Global Finance, Financial Policy Forum) states quite the opposite. Dodd gives a few examples (security transaction tax in Sweden (1993) where 60% of trading volume moved, exchange-traded derivatives market which moved from London to Germany when tax implications changed (late 1990’s)) which show that change of legislation does bring forth jurisdictional shopping. As another reason why the tobin tax is bad policy Dodd argues that it will be a extraordinarily costly to implement. Forex transactions occur in the largely (if not entirely) unregulated over-the-counter market where surveillance and enforcement is most difficult. Another interesting argument against the hight of the revenues tobin tax would create is that the tobin tax is designed to reduce the very market it is getting its revenues from.

In this publications, many more arguments before an against are discussed. In these papers, Jo Marie Griesgraber, detects two types of language, the activists’ and campaigners’ which is quite different from the technical language of the economists. Both sides though agree on the need to expand regulation of over the counter derivatives markets and financial markets in general. Also it is clear that many policy makers do not understand the language used to identify problems associated with the financial consequences.