Speculators may do no harm as bubbles on a steady stream of enterprise. But the situation is serious when enterprise becomes the bubble on a whirlpool of speculation.
-- John Maynard Keynes, Speculator and Economist
You know you've hit a hot button when publicly traded stock exchanges, futures brokers, and a host of bank stocks get slammed with the simple mention of a financial transactions tax ("FTT"). The market's response is understandable -- even a small transactions tax would have a significant impact on the high frequency trading and other "quant" trading strategies that now comprise an astonishing 70 percent* of vastly bloated trading volume.
The truth is simple: A modest financial transactions tax of less than 1 percent would serve as a remarkably efficient tool to achieve needed reform.
And to give it real teeth, it should be a dynamic tool of our systemic risk regulators, with the taxation rate automatically increasing during periods of heightened market volatility.
When managed with a public purpose in mind, securities markets are tools that efficiently facilitate investment in the productive real economy. But, in a confusion of means and ends, much of the market has morphed into a frenzy of destabilizing, short-term speculation that at best pollutes the financial system with instability and lost confidence, and at worst creates episodes of outright theft.
In our technology driven, short-term, speculative financial system, the arguments in favor of a financial transactions tax are stronger than ever. Nobel Laureate economist James Tobin called for a transactions tax in 1971 (the "Tobin Tax") "to throw some sand in the gears of our excessively efficient money markets." Tobin must have understood what systems scientists know now: excessive efficiency comes at a cost of system resiliency. Similarly, the famous speculator (and economist) John Maynard Keynes suggested a tax on currency transactions to address excessive speculation. In Keynes' time, speculation was a small distraction in the financial system hampering productive investment. Today it is a sideshow that has stolen the stage and needs to be put back in its place.
To be fair, not all quant trading is destabilizing. But, the constructive, technology-enabled market-making functions would easily adjust to any uniform tax. The financial markets are responding to short-term speculative financial interests rather than the long-term fundamental interest of real economic investment essential for creating productive jobs in the real economy.
A financial transactions tax will make certain information asymmetry, proprietary trading strategies unprofitable since they rely on nearly non-existent transactions costs. The goal of fair markets is to level the playing field of information. That's why trading on "inside information" is illegal. Stock exchanges, which have lost sight of their public purpose in the well-intended pursuit of competitive advantage, will suffer for a while. Misguided principles have consequences.
Despite claims that trading will flee jurisdictions that impose a transactions tax, such taxes exist today in the U.K., China, Hong Kong, Singapore, Switzerland, and other countries. If the leading financial centers of New York, London, France, Germany, and Tokyo together implemented a more comprehensive transaction tax regime, other countries would see it in their interest to follow suit. Technical feasibility in the digital age with centralized trading and settlement is not a problem, as Nobel Laureate Joseph Stiglitz and numerous studies have noted.
Conflicted bankers and exchange operators say, through their economist friends, that a transactions tax will hurt economic growth, presumably due to the lost efficiency. This argument is fallacious. The value of any efficiency loss is smaller than the resiliency gain and is a necessary tradeoff. And the growth of revenues and bonuses of the quant traders and exchanges that will be affected will be more than offset by the redeployment of this talent and capital into more socially productive purposes. How about more "quant" geniuses working on carbon sequestration, cancer research, and global access to safe drinking water?
This is all to say nothing of the substantial, desperately needed revenues a financial transaction tax could generate, which of course is why Sarkozy and Merkel brought it up now. More money, improved market resiliency we desperately need, and a reallocation of capital to productive long-term investment that fuels sustainable growth, creates jobs, and in the process reduces government deficits makes a financial transactions tax a win-win-win. Academic studies have estimated the value of a financial transactions tax could exceed $100 billion per year in the U.S. alone just from the tax revenue -- the other two wins come as a bonus.
Now that's the kind of bonus we can all applaud.
*More analysis from TAAB here.