Monday, February 25, 2013

Attacks on Financial Transactions

The European Union has proposed a tax on financial transactions for eleven members that use the euro, including Germany, France, Italy, and Spain. The EU would impose a tax of one-tenth percent on the trading of shares of stock, bonds, and other financial assets, both on the buyer and on the seller. There would also be a tax of one-hundredth of one percent on the trades of derivatives such as options.

The proposed tax would raise about 50 billion euros per year to reduce the European government deficits, and it is claimed that the tax would reduce “irresponsible” financial speculation. On January 23, 2013, the EU’s finance ministers endorsed the financial transaction tax (FTT).

While superficially it may seem that the mere trading of stocks and bonds would not be productive, in fact there is an economic benefit to financial transactions, as they move funds to those areas that the market actors believe are most productive. The financial movement of funds then impacts the real economy, which needs the financial sector for investment. Any economist will tell you that it is best to minimize transactions costs.

Indeed the European Commission has estimated that the FTT would reduce the GDP of the eleven economies by .28 percent. But one also has to consider how the revenues are spent. If the funds are invested in these economies, such as for education or infrastructure, the combined GDPs would increase by .2 percent, for a net loss of only .08 percent. But then the tax revenue would not reduce the countries’ deficits.

A tax on transactions shifts them to less-taxed places. Even though the tax rate seems small, some financial actors make many trades, seeking small discrepancies in prices. They would move their business away. But the proposed tax would cast a wide net, fishing for taxpayers outside the territory of the taxing countries. The proposal uses the “issuance principle,” in which a trade of an asset originating in the home territory can be taxed even if the parties are outside the territory. For example, if an American buys a stock in a French company, and the seller is in Japan, the transaction would be taxed, on top of taxes imposed by the traders’ countries.

Some European countries already tax financial transactions. France taxes the purchase of shares in large companies at a rate of .2 percent. After the implementation of the tax in August 2012, trading in these shares were reduced relative to non-taxed shares.

Another effect of taxing transactions is avoidance. Financial guys are clever, and they will find ways to circumvent a tax by creating new types of securities and derivatives.

High-frequency trading did not cause the Crash of 2008. An error in the software could cause a temporary fluctuation in pricing, but the normal operation of computerized trading is to thicken the market, to add many more transactions that add liquidity, making it possible for financial actors to quickly buy and sell at the current market prices. Frequent trading involves arbitrage, equalizing the prices of assets in various locations, and that is beneficial. Of course the financial markets can be manipulated, facilitated by high-speed trading, but a tax on transactions will not stop speculation, manipulation, and the fabrication and multiplication of derivatives.

As to government revenue, the root reason for the chronic deficits is that the current tax systems punish production and consumption. Europe has a value-added tax (VAT), a tax on the value added by each stage of production. Is it good or bad to add value? Of course it is good, which is why any produced value should not be taxed. The VAT destroys the essence of the economy, value added. Taxes on income and goods are also destructive.

While Europe punishes production and consumption, it subsidizes its landed aristocracy. Today’s European aristocracy may not have fancy titles and serfs tied to the land, but the economic impact is the same as in the old days of royalty. Today’s landed aristocracy consists of persons having title to land, who do not pay back to the state the rent and land value created by the state’s public goods and welfare spending. People don’t see this implicit reality, because they no longer see the appearance of the old titles of Baron, Lord, Earl, Duke, Prince, and Grand Poobah.

The subsidy of the land barons implies that public revenues have to come from productive activities, including financial transactions. But high taxes on production have the effect of depressing the economy, and meets political resistance, so governments borrow to finance the welfare state. Government welfare ends up pushing up land rent, and so tenants get taxed by paying more for real estate, for which they superficially blame landlords and the market.

The concept of taxing financial trading is old. A tax on currency conversions was popularized by the economist James Tobin, and is sometimes called the Tobin Tax. The term was then applied to taxing financial transactions in general.

London is a major global location for finance, and the economy of the U.K. depends on the finance industry. The FTT would damage the economy of the UK. The tax would impose costs on brokerage firms and banks outside the taxing countries. Its implementation would be costly and add one more bureaucracy to a European Union already suffering from euro-sclerosis.

Europe is slowly committing economic and cultural suicide on many fronts: economic, demographic, and environmental. We may still be able to visit its interesting ruins, but economic dynamics are shifting to Asia. Financial activity will keep shifting to Hong Kong and Shanghai as Europe and also America keep tax-punishing production and transactions.

Friday, February 15, 2013

US Bans Americans from Predictions Market

On November 2012, the predictions market Intrade announced that U.S. persons would no longer be able to hold accounts and engage in its predictions trades. The U.S. federal government has jurisdiction over financial markets within its territory, but Intrade is located in Ireland. However, the U.S. government also has jurisdiction over U.S. persons world-wide.

Intrade provides betting contracts for future events such as elections, the weather, the Academy Awards, and financial market averages. For example, there was a predictions contract for the U.S. presidential election of 2012. One could, for example, on the Intrade web site, buy a contract for Obama to win. If the current price was $60, one would pay $60 for the contract, and then if Obama won, one would get back $100, for a gain of $40. If Obama lost, the contract holder would lose the $60.

The price of the contract was based on the bids and offers of the participants. If more speculators believed that Obama would win, they would bid to buy the win contracts, which would push the price up. If more later believed that Obama would lose, they would sell the contracts, since they would collect $60 if they were right, and push the price down.

Economists who have studied such predictions market have concluded that these markets make more accurate predictions than do polls. That is because the speculators have seen the polls, and they go beyond the polls to analyze the campaigns or financial markets to estimate the future outcomes. The bettors are placing their own money, so they have a keen interest in getting the bet right. In fact, the Intrade market for the U.S. presidential election of 2012 correctly predicted the win by Obama, whereas the polls were evenly split.

In 2012 Intrade yielded to pressure from the U.S. government, and told its American customers that their accounts would be closed in December. The Commodities Futures Trading Commission charged Intrade with violating its ban on off-exchange commodity options trading. The CFTC’s complaint also accuses Intrade of making false statements about their options trading website. Americans are allowed to trade only on CFTC-registered exchanges. The CFTC considers it a commodity option market if the traders can bet on whether, for example, the price of gold will be $2000 per ounce or greater, on December 31, 2013.

The CFTC claims that its “requirement for on-exchange trading is important for a number of reasons, including that it enables the CFTC to police market activity and protect market integrity.” But to my knowledge, none of the participants of Intrade were victims of fraud. There was no evident lack of market integrity.

In a completely free society, with a pure free market and true free trade, there is no restriction or tax on peaceful and honest human action. Nobody is harmed when a person voluntarily buys a contract on whether some future event will occur. Government agencies such as the CFTC, which are supposed to protect market participants, instead end up preventing them from engaging in what to them seems the most profitable and interesting opportunities, which also provide social benefits. Predictions markets benefit society by reducing the uncertainty of the future. These markets provide a measurement of the expectations of people who are betting their own money. Predictions markets facilitate better forecasts by rewarding those whose insight is right and penalizing those whose analysis was faulty.

The U.S. government also restricts gambling on the Internet, even when the web sites are in foreign countries. U.S. government officials criticize foreign countries for restricting the freedom of expression and reading, but it too imposes restrictions and prohibitions.

Intrade will continue to have contracts held by non-Americans, and there are other predictions markets besides Intrade. But every year brings ever more restrictions, mandates, and taxes on peaceful and honest human action. Each additional intervention reduces the equity and efficiency of the economy. Each extra imposition is like another rock on a ship, so we should not be surprised at the current slow progress of the economic ship, the continuing high unemployment and sluggish growth. Keep adding more rocks, and eventually the ship will sink.

One of my favorite quotes is from the German philosopher Hegel: “What experience and history teach is this - that nations and governments have never learned anything from history, nor acted upon any lessons they might have drawn from it." We seem to have learned nothing from the decline of civilizations such as that of the ancient Mayans, Egyptians, and the Roman Empire.