Ump on a Blog

In a New York Times editorial, economist and Nobel Memorial Prize in Economics winner Professor Paul Krugman advocates something he refers to as a “financial transactions tax,” used as a means not only to raise revenue but discourage speculation in financial currency markets. Professor Krugman is on the right track, but in my opinion he’s advocating a level playing field when really a tilted one is needed.

Professor Krugman advocates a small tax on all transactions in the foreign currency markets — buying or selling of contracts for the delivery of a given nation’s currency at a future date. These transactions are made by the millions every day, and are actually the mainstay of many banks’ profits. It’s called — you’ve heard this term — the money market. It is, literally, the buying and selling of money.

Money is worth money, which sounds stupid, but it’s worth other country’s money, and that amount varies from minute to minute in very small amounts. Large banks try to take advantage of those half-penny or quarter-yen swings in value, in massive quantities, to bring in profits. For example, $100,000,000 of Hungarian Forints that swings a few Forints between 10am and 11am on the Stockholm exchange could net a bank a few thousand dollars with very little risk. Institutional banks like Citibank, Bank of Montreal, and the Royal Bank of Scotland have entire rooms full of traders with their noses glued to computer screens, waiting for the right moment to strike and net their company a relatively risk-free profit.

A small tax, perhaps one-tenth of one percent of the gross profit of the transaction, could net the U.S. government billions of dollars in new tax revenue every year. And if that were the exclusive goal, it would be a good way to isolate big investors as the sole targets of such a tax — transactions such as these are largely out of reach to the small investor. But it’s my assertion that, as I mentioned, Professor Krugman has it almost right.

A financial transactions tax would target speculative investors in the currency market, to be sure. But why stop there? It was found that during the recent run-up in world oil prices, one company controlled almost 80% of the outstanding contracts for a given oil future. The kicker was, it wasn’t even an oil company that held them, it was a financial firm that had neither the means nor the intention of taking delivery of the raw materials. Such speculation in commodities markets has the potential (in this instance) to be a threat to our national security. Other commodities may be less important to our everyday lives, but no less inflationary or volatile when speculators decide to put it in play.

And what about stocks and bonds, the two most common investments of the American financial system? The advent of the Small Order Execution System (SOES) and the immediate emergence of hyper-leveraged “SOES Bandits,” has multiplied speculation on a level not seen since before the Great Depression. Arbitrage traders monitoring small stocks for swings of a penny or more, trading with somebody else’s money, have inflated prices and increased volatility in the markets that are supposed to be the investment of the common man. In doing so, they have put equity investments out of reach to most Americans.

Additionally, Professor Krugman’s financial transactions tax would apply to everybody. This would, in fact, generate a substantial amount of revenue. However, if the goal is to decrease speculation and re-establish price stability, we need not extend the tax to all investors. Any transactions in currency, derivatives or commodities markets where the purchaser takes delivery of the underlying asset should be exempt; and any transactions that are held for more than 365 days should also be exempt — from both this tax, and the existing capital gains tax. Such a change would be a cause for celebration for the GOP (a happy side-effect), who have been attempting to eliminate the tax since it was instituted. But it would also be a tangible encouragement for long-term investment by everyone from big businesses to the $25-per-month mutual fund dollar-cost-averaging parent trying to save for their kids’ college education.

The only other modification I would make to Professor Krugman’s proposal is the tax rate. I view this possibility as a deterrent, not a tool for generating revenue. As a result, the rate should be punitive in nature, as opposed to merely inconvenient: 50%. Additionally, the tax should not be able to be offset by financial losses — if you make a profit on a given transaction, you pay the tax, end of discussion. Such parameters would shut down market players that were interested exclusively in exploiting a liquid market for profit, while passing the non-financial costs of price volatility and artificial inflation on to the market at large. It would essentially bounce pure speculators out of the market overnight.

Speculation was a significant part of the underlying problem behind the financial collapse this country underwent in the last couple of years. The addiction to easy money has Wall Street under its spell. The most effective way to stifle some of this roll-the-dice financial management is to wave the magic wand of taxation and make it not worth their while. This type of a tax would put Wall Street in a different frame of mind and revise long-term business plans in the blink of an eye.