The most contemporary Closing Conference to Save the Euro finished in disarray when the UK refused to sign up to a proposed set of EU treaty changes. The UK’s veto was due to the inclusion of an EU-wide Tobin Tax on security transactions in the set of proposals. The justification for an international Tobin Tax is quite strong. Hypercompetitive securities markets with excessively-large trading volumes and hyper-quick price changes are a serious danger to global financial stability. A Tobin Tax would eliminate these perilous trading extremes without impinging much on underlying market efficiency. On other hand, the UK government’s refusal to sign up to an EU-only Tobin Tax, imposed on the City of London while the US and Asian global financial centres remain outside the tax net, was an obvious and sensible policy choice for the UK.
After the proposed EU treaty changes were restricted to a coalition of the willing, the Irish government fretted that a Tobin Tax might particularly disadvantage the Irish financial services industry, given that the UK will be outside the tax net.
What should be Ireland’s policy stance toward an international Tobin Tax? Should Ireland do the right thing as a global citizen by supporting such a tax within the Eurozone, or should it protect its international financial services industry from UK (and non-EU) predation and consequently veto any such tax proposal? It would be much better for all concerned if the Tobin Tax may possibly be imposed at a global rather than EU level.
Sometime in the future, May 6th 2010 might rank with August 9th 2007 as a “notification date” for a subsequent financial market disaster. Recall that starting on August 9th 2007, quant-trading hedge funds experienced an extremely turbulent, credit-market-related meltdown. Although the quant-trading markets pleased down after about two weeks, many analysts now admit this as an early notification signal of the subsequent global credit crisis. In an fascinating parallel, on May 6th 2010, high-frequency trading systems generated a “flash crash” of US equity markets, causing a 9% fall and 9% rise of the US stock market within a 20 minute period. Some individual stock prices went bananas; completed trades at crazy prices during this small “flash crash” period were annulled that evening by the NYSE enter. Since the markets righted themselves within a day or two, many analysts have forgotten about this thing. But may possibly this “flash crash” be an early notification sign of a subsequent “permo-crash”? High frequency trading (HFT), by entirely computerized systems to trade at hyper-second frequency, now constitutes 70% of US equity and equity-related (equity baskets, futures, options) trading volume, and 30% in the UK. If HFT generates a flash-crash at the end of the trading day, rather than mid-day as on May 6th, and something else goes incorrect at the same time, it may possibly lead to an enormous disaster.
Tobin originally proposed his tax for the unknown exchange market, which was the first financial market to have hyper-competitive trading costs. He saw that most of the trading volume in forex markets provided very small economic value. A small tax would have a huge influence on trading volume, rendering purely speculative and potentially destabilizing trading strategies losing, while having small or no impact on the real economic value of these markets. Tobin called it “throwing sand in the gears” of securities market trading. Nowadays, Tobin’s “sand in the gears” metaphor is widely misunderstood. Tobin was a World War Two naval officer and throwing sand in the gears was an accepted way to improve machine performance in his day. For mid-twentieth century machinery a small sand in the gears would slow down the mechanism (reflect of something like a navy ship’s water pumps) and make for more reliable performance with less opportunity of overheating. With modern precision engineering the notion of “sand in the gears” as a renovate method seems ridiculous, so commentators assume Tobin is advocating sabotage of securities markets. That was not what he meant – “sand in the gears” is an ancient-fashioned procedure to slow down machinery so that performance improves, not a means of sabotage. Oddly, the tax is designed to generate minimum revenue – it relies on the elasticity of trading volume to net costs, and tries to drive out destabilizing small-term trading strategies while collecting minimal tax revenue.
Now, after decades of hard-fought liberalization, US and UK equity markets have the same hyper-competitive trading costs as forex markets. HFT has hijacked this and feeds off this market cost improvement (and by earning net profits from “habitual” market traders) with trading systems that add small real efficiency improvement for markets. Eliminating their net profits with a small tax would do small harm, and make markets safer. The very bright notebook scientists who run these HFT firms may possibly go back to socially useful activities like designing better software.
There is another fascinating parallel to the global credit crisis. US housing regulators worked for thirty years to increase access to owner-full housing for lower and middle income households and this was a huge success. Then, they took that policy too far, and the policy was hijacked by self-interested actors in the US property lending and securities trading sectors. There was too much of a excellent thing in stipulations of the too-low-credit-quality US residential property lending market. The same applies now with securities market trading costs and trading access. Regulators have succeeded in driving out terrible securities trading practices and greatly lowering trading costs, but this process has gone too far. It has been hijacked by HFT. I call this the Too Much of a Excellent Thing (TMGT) scheme of regulatory capture.
During the credit bubble, Ireland enthusiastically joined the dumb-down contest to impose the minimal possible regulation on the financial services sector. Perhaps now Irish policy leaders may possibly make amends by joining the push for a Tobin Tax.
How would a Tobin tax impact the competitive draw of Dublin for its brand of “off shore” financial services? Perhaps it would be the death knell for the Irish stock exchange since all trading volume might migrate to London. Ireland policymakers should encourage a global solution, bringing the US and UK in particular into the plot. Asian markets (which are not yet competitive for HFT) might be willing to cooperate as well, since there is no fantastic cost for them.