Some old wisdom from Jim Tobin

... very much worth repeating here. From his famous "sand in the wheels" article:

I believe that the basic problem today is not the exchange rate regime, whether fixed or floating. Debate on the regime evades and obscures the essential problem. That is the excessive international-or better, inter-currency-mobility of private financial capital. ... National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation. Specifically, the mobility of financial capital limits viable differences among national interest rates and thus severely restricts the ability of central banks and governments to pursue monetary and fiscal policies appropriate to their internal economies. Likewise speculation on exchange rates, whether its consequences are vast shifts of official assets and debts or large movements of exchange rates themselves, have serious and frequently painful real internal economic consequences. Domestic policies are relatively powerless to escape them or offset them.

The basic problems are these. Goods and labor move, in response to international price signals, much more sluggishly than fluid funds. Prices in goods and labor markets move much more sluggishly, in response to excess supply or demand, than the prices of financial assets, including exchange rates. ...

There are two ways to go. One is toward a common currency, common monetary and fiscal policy, and economic integration. The other is toward greater financial segmentation between nations or currency areas, permitting their central banks and governments greater autonomy in policies tailored to their specific economic institutions and objectives. The first direction, however appealing, is clearly not a viable option in the foreseeable future, i.e., the twentieth century. I therefore regretfully recommend the second, and my proposal is to throw some sand in the wheels of our excessively efficient international money markets.

But first let us pay our respects to the "one world" ideal. Within the United States, of course, capital is extremely mobile between regions, and has been for a long time. Its mobility has served, continues to serve, important economic functions: mobilizing funds from high-saving areas to finance investments that develop areas with high marginal productivities of capital; financing trade deficits which arise from regional shifts in population and comparative advantage or from transient economic or natural shocks. With nationwide product and labor markets, goods and labor also flow readily to areas of high demand, and this mobility is the essential solution to the problems of regional depression and obsolescence that inevitably occur. There is neither need for, nor possibility of, regional macroeconomic policies. ...With a common currency, national financial and capital markets, and a single national monetary policy, movements of funds to exploit interest arbitrage or to speculate on exchange rate fluctuations cannot be sources of disturbances and painful interregional adjustments.

To recite this familiar account is to remind us how difficult it would be to replicate its prerequisites on a worldwide basis. ...

At present the world enjoys many benefits of the increased worldwide economic integration of the last thirty years. But the integration is partial and unbalanced; in particular private financial markets have become internationalized much more rapidly and completely than other economic and political institutions. That is why we are in trouble. So I turn to the second, and second best, way out, forcing some segmentation of inter-currency financial markets.

...

The proposal is an internationally uniform tax on all spot conversions of one currency into another, proportional to the size of the transaction. The tax would particularly deter short-term financial round-trip excursions into another currency. A 1% tax, for example, could be overcome only by an 8 point differential in the annual yields of Treasury bills or Eurocurrency deposits denominated in dollars and Deutschmarks. The corresponding differential for one-year maturities would be 2 points. A permanent investment in another country or currency area, with regular repatriation of yield when earned, would need a 2% advantage in marginal efficiency over domestic investment. The impact of the tax would be less for permanent currency shifts, or for longer maturities. Because of exchange risks, capital value risks, and market imperfections, interest arbitrage and exchange speculation are less troublesome in long maturities. Moreover, it is desirable to obstruct as little as possible international movements of capital responsive to long-run portfolio preferences and profit opportunities.

How about generalizing this idea to all securities transactions, domestic as well as international? If leverage--short-term debt--is a big part of the problem, isn't taxing it an important part of the solution?

Comments

[jc]

The size of the DWL that the other side will no doubt try to argue would be produced by such a small tax has got to be tiny compared to the costs of working our way out of the current financial mess.
Such a tax would certainly have helped eliminate part of the more speculative movements associated with the present situation (e.g. perhaps the number of short term speculative bets placed by hedge fund managers). But I don't think it would have prevented troubles in the housing market such as we have seen.

[russellpittman]

I don't pretend to understand all this, but I remain stunned that the credit ratings agencies gave high marks to these sliced and diced loan packages whose weaknesses were being pointed out by Ned Gramlich and others. Why would anyone ever believe the credit ratings agencies again?

[paine]

thanx for the jimbulee

tobin or not tobin
that is the question

[strong]

By putting a time limit on cap market products of 7 days you slow down the xfer of cap between countries. With the IT systems we have today it is no problem to re-close 52 times a year. With this shorter time frame the cap market is turned into a normal market with normal supply and demand forces. The unstable cap market becomes a thing of the past.

[Derrill]

Thank you.

[Bruce Wilder]

I'd recommend a trip to the neo-dust-bowl of the Ohio-Michigan, or maybe the Yazoo Delta, before I got too carried away with idealizing one currency one world, but Tobin's point is well-taken.

[Josh]

Very interesting and enlightening post.

[Sebastian]

oh wow, I didn't expect you to come out in favor of this - not sure if you're aware of this, but Europe's biggest "anti-globalization" (more apropriately globalization critical) NGO - attac - was actually founded as a one-issue organization for the establishment of a Tobin tax. attac stands for "association pour une taxation des transactions financières pour l'aide aux citoyens".
So Dani has finally arrived in the camp of the anti-globalizers ;-)

[dominic corva]

"alter" globalizers, please. ATTAC was a key player in starting the World Social Forum, as an alternative to the anti-democratic WEF (World Economic Forum).

anyone for a Tobin tax is clearly pro globalization - the globalization and democratization of economic governance.

And yes, it is interesting to see Dani coming around (even if he doesn't realize it) to these ideas, which were revived at the end of the 1990s.

[ab]

i guess this would work like England's stamp tax on stock transactions. Nobody pays it. Market makers are exempt because otherwise there would be no market. Retail players simply buy contracts for difference from market makers. Since these are not stocks, but derivatives whose return mimics stocks exactly, they aren't subject to the tax.

Sand in the wheels is an excellent analogy. Why people think they are smart enough (even Tobin) to muck with a societal structure that has evolved over thousands of years is beyond me. I guess we want to experimentally find out what happens if we don't have efficient capital markets. It's exactly equivalent to passing a law suspending gravity so we can save money on transportation costs. Ignorance abounds.

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Here is something i have about him.a, Tobin was widely known for his suggestion of a tax on foreign exchange transactions, now known as the "Tobin tax". This was designed to reduce speculation in the international currency markets, which he saw as dangerous and unproductive. He suggested that the proceeds of the tax could be used to fund projects for the benefit of Third World countries, or to support the United Nations.

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