Forex Blog

Posted: 20 Feb 2011 07:21 AM PST

Only two years after the worst financial crisis in decades, the DJIA is now back above 12,000. Yield-hungry investors are pouring record amounts of cash into emerging markets. Commodities and food prices are rising into bubble territory. In fact, not a single meaningful reform has yet to be passed that would prevent such an event from erupting again. The EU, however, is trying to change that, with the proposed introduction of the first-ever Tobin tax on foreign exchange trades.

The campaign is being led by French President Nicolas Sarokozy, who happens to be the current Chairman of both the G8 and G20. Recently, he has used his podium for populist rants against the international financial system. To his credit, Sarkozy has done more than bluster. He is fighting to advance the idea for a minute tax on all financial transactions, with the aim of reducing volatility and raising money for cash-strapped governments.

The so-called Tobin tax was first proposed in 1971 by Nobel Laureate James Tobin. While it has always enjoyed support from a handful of leftist economists, it has never been seriously considered by any western country. In the wake of the financial crisis, however, anger towards speculation seems to be peaking, and some governments might finally have enough political capital to push forward the idea. In fact, France has already obtained the tepid support of other EU members, notably Austria. In addition, the Economic and Monetary Affairs Committee of the European Parliament has backed the idea. The EU is fighting to keep the Euro alive and its member states solvent, and it clearly resents the (perceived) role of speculators in betting on default and breakup.

Proponents of the Tobin tax generally cite the amount of revenue it could raise as its chief benefit. For example, it has been estimated that a .005% on forex transactions could raise $26 Billion worldwide, while a .05% tax on all financial transactions could generate as much as $700 Billion in revenue. Even though studies suggest that it wouldn’t do much to reduce volatility (and perhaps speculation), the fact that it shouldn’t destabilize markets is enough to satisfy some of its naysayers.

Not surprisingly, the US remains opposed to such a policy, on the grounds that it could “send misleading signals that could hamper investment to end extraction and cause production bottlenecks.” This kind of incantation rings hollow, however, and it’s clear that the biggest obstacle to its being implemented is almost certainly the bank lobby, which has insisted that a Tobin tax would “cause serious damage to this highly efficient [forex] market.”

Personally, I’m a cautious advocate of the Tobin tax. At .005%, it would levy $10 on every round-trip lot ($100,000) forex transaction. This would punish those that engage in leveraged account-churning and computerized, rapid-fire trading, without impacting those that take a longer-term approach to forex. In addition, it would impact institutional traders and investment banks (which currently monopolize all financial markets) much more than retail traders. Then again, they would probably just shift more of their trading into unregulated, private markets.

At this point, the Tobin tax is still probably a long-shot. The fact that it’s being seriously considered, however, is nothing short of remarkable.