I have generally been on the side of the Free Market Barons against the Robin Hood tax in the blogosphere discussions so far. This does not mean I think it is simple. The problem for me is that the argument is largely misspecified. As James Macintosh demonstrates, many of the charities that are behind the tax don’t seem to understand what they are on about.
Start with the advert. It seems to imply: “this is infinitessimally small, this tax. 0.05%! Compare that to 17.5% on VAT!. So surely uncomfortable looking banker Bill Nighy, you could not complain about this itsy bitsy thing?” But it is not itsybitsy – it is huge. To understand why, look at this graph plucked from random about the £-$ rate last Friday:
For a typical retail punter, in this glorious age, you can deal on this price as a speculator with a spread of 5 pips. (for an example, see the prices moving here: disclosure, I worked there for a long time). Although for a bank the spread might be tighter, this may depend on the size – shifting $100m and the spread might be 5 pips again.
Most speculators open or close their positions well within the time period shown on this graph. And observe: the price moves from 15600 to 15640. If you paid a 0.05% charge round-turn, or 8 points in this case, then you are wiping away most of the profit opportunities. You would have to be fairly convinced that you have a 10 point advantage over the market in order to win. As it turns out, 10 points is Don Bradman territory – in current markets . To consistently out-guess markets to that degree would normally involve an edge that bordered on criminal.
So the point about the 0.05% is not to divide through by the entire value of the currency but by the reasonable range of its variation. In this case, more like 1% (In fact, most speculators would enter a trade with a stop-loss much closer than this.). So, for most short term speculators, it is the equivalent of taking a project of some kind or other, and charging 5% of the revenues just to start up.
To conclude this first part: this is not a tax on something that is in any way comparable to, say, a shopkeeper taking a product, marking it up and selling it. It is a tax on speculation, but at these levels, it is something even more: it is a virtual outright ban on any speculation that is not looking for very large average profits. Consider: a typical trade for a retail punter might be to buy £500,000 £/$. 0.05% of this is about £250. The typical brokerage fee for a futures trade might be $6. If that £500k is 10 contracts, the itsybitsy tax is in fact about 6 times a broker’s charge. No industry survives that – imagine, say, that there was a £50 tax on cinema tickets.
So what? Why are we sitting around discussing how to make life easier for people betting on a number? How on earth can the ease with which one irrelevant reptile beats another irrelevant reptile, at their irrelevant-but-possibly-dangerous game of poker, matter in any way whatsoever? Several answers here:
- Even if it did not matter, if the tax were fully enforced as imagined, the people proposing it can clearly have no idea what it would do to volumes – and therefore revenues. To say “cratering” is an understatement; for FX alone you are clearly trying to remove a high multiple of the profits already available**. It is like trying to guess what the yield from a £1-per-email tax would be.* So: no revenues anywhere near those proposed
- What would remain? Well, FX (I’m sticking with FX for simplicity) would remain in some form. The vast majority of punters interested in sub 50pip movements would be gone. But there would still be profits to make. In fact, there would be VAST profits to make – because the market would suddenly be really inefficient. Because no-one would be trying to pick off small anomalies, small under-reactions to news, the market would be illiquid, jumpy, unreliable, gappy. (A bit like the CDO market, in August 2007). Instead of it being a market with very high volumes and low per-trade profits, there would be terribly low volumes and large per-trade profits.
- In many ways, this is far more fun for finance. You can justify all sorts of other charges, when the perils of dealing in the market are so high. Of course, you have a price to pay the government, but you have a large gappy market within which all sorts of other practises can take place.
- But the market would still be illiquid. And this is where the real cost lies. Currently, there are hordes of small speculative positions, and then giant ‘end users’ of finance, who need to convert risks from one form to another. It is those end users that would really take a hit. Instead of facing a 0.2% spread for doing a gigantic FX transaction, the absence of millions of small other-speculators on the other side might blow this out – to 0.5%, to 0.9%, more. Who knows? But this translates into a giant cost of capital charge on everyone else.
The real point I wanted to make from this rant is: don’t try to address the potential costs of doing this by using the wrong model. The ‘wrong model’ pictures banks doing something – a metaphorical equivalent of digging gold out of the ground – and currently passing it on to a customer. This proposal, under the wrong model, imagines an itsy bitsy extra charge of 0.05% on this. How could that hurt? The ‘wrong model’ also goes onto to imagine that the banks take all this charge, meekly cutting their profits. Hence ensues a largely irrelevant argument on LibCon between Sunny and otheres about whether they would or not. This is missing the point.
Instead, what this proposes is to raise a much smaller amount than suggested, in return for which an entire field of speculative activity would be laid waste. Masses of markets reliant on the underlying spot market would be wiped out – options need a liquid spot market, for example. As a result, the real firms and businesses, from insurance to industry to government finance, would face a massively higher cost. Their costs would rise, in all sorts of difficult to understand ways. They would hold back from some opportunities that they would have otherwise exploited more fully. They would raise some prices higher than they might have. Some new entrants will be put off, so industries would be less competitive.
The consequences would be very hard to predict, against an equally-hard to predict benefit. I don’t know where the trade-off lies. Like James again, I think finance needs controlling, but in other ways; this is the equivalent of asking it to work with inferior technology, or lobotomised staff. It is, in short, a deliberately induced supply shock on the whole economy, like a sudden loss of technology. Not a decision to take lightly, or with the wrong mental model of what you’re doing …..
I’ve broken my word limit. NO time to make it shorter. But there are good come-backs like – spreads were far larger in the 1980s and we still grew then – so what is the problem?
*If some bright spark thinks “a lot”, then ask yourself why you still don’t think it is a good idea
**My best guess is that if banks make $20bn annually from FX, then that is about 0.005%, or a tenth of the proposed charge.