Financial transaction tax proposal - a tried and flawed concept

The concept of a tax on financial transactions has always been a favourite of beleaguered politicians. In previous incarnations it has been known as the ‘Tobin Tax’, after Nobel Laureate James Tobin who first proposed the idea in 1972, shortly after the collapse of the Bretton Woods system of global foreign exchange controls.

The idea tends to get wheeled out repeatedly in such times of stress, and was therefore also aired during the 1992 European Monetary System crisis and during the 1997/8 Asian Crisis. No surprise that this latest crisis has once again stirred the slumbering corpse of this horribly flawed concept.

There’s an age-old tradition among politicians to blame big, bad speculators; from Harold Wilson’s ‘Gnomes of Zurich’, (apparently responsible for the 1964 Sterling Crisis), to then-Malaysian Prime Minister Mahatir’s 1997 attack on George Soros in particular, and hedge funds in general. 

So much easier to blame such scapegoats than to admit to the fundamental economic flaws which are actually driving a currency down or a government bond yield through the roof.

But why not bash the banks? Always a popular target and still viewed suspiciously after their admittedly central role in creating the mortgage backed securities lie that almost sank the global financial system. Surely this would be pretty painless, in fact gloriously satisfying, for everyone, except for Petrus-guzzling bankers?

The answer is ‘no’, it wouldn’t be painless at all. Firstly, if such a tax were levied on financial markets, (which markets anyway? FX? Equities? Bonds? CDS?), then the law of unintended consequences would apply and liquidity in these markets would be severely diminished, as the number of market counterparties would surely be reduced, as would their enthusiasm to enter into large transactions. This would mean, for example in FX, that the prices ‘real’ hedgers - corporate treasurers, say - would have to pay would be that much worse, directly impacting the profitability of industry and doing nothing to help the fledgling economic recoveries of the West. In some currencies it might even become impossible to find any FX  hedging prices at economically viable prices.

Add to that the inevitable impact on banking profits with its knock-on effect upon banks’ willingness and ability to lend to industry.

Actually, nobody need worry as, in reality, how on earth might such a tax ever be politically acceptable, as it would severely damage Europe’s financial industry and just drive business to New York, Singapore, Hong Kong, etc, etc? If it were purely a Eurozone measure, or even an EU-wide measure, (but there’s no chance of the U.K. ever signing up to this), then give it a few months only before the markets have deserted Europe in favour of these other obvious and attractive destinations, with disastrous consequences for Europe’s financial centres.

Now, were it only to be implemented in Eurozone countries, or on Eurozone banks, then of course, London would also become one of those undoubted massive beneficiary cities to which I alluded above.