The international financial markets are suffering another wobble. Ruth Kelly asks whether we should consider a "Tobin" tax on foreign currency speculation - or does George Soros have a better idea?by Ruth Kelly / March 20, 1998 / Leave a comment
The Tobin Tax: Coping with Financial Volatility Edited by Mahbub ul Haq, Inge Kaul and Isabelle Grunberg Oxford University Press 1996, £17.50
The faces of the world’s international financiers grow longer by the day. The rout on the exchanges in southeast Asia is thought to pose a serious risk to global economic growth in 1998. The speculators have claimed a succession of victims: the European exchange rate mechanism in 1992; the Mexican peso, which crashed by 70 per cent in the winter of 1994-95; now the once mighty Asian tigers. In the words of George Soros, “the international financial system is suffering a systemic breakdown.”
It is hardly surprising that economists have been searching for new systems of controls on international markets. The latest attempt takes up a proposal put forward 25 years ago by James Tobin, US Nobel laureate, for a levy on international currency transactions. This collection of essays is the first serious attempt to assess its feasibility.
Since 1973 the foreign exchange market has grown fourteenfold, thriving in a market free from capital controls. The $1.3 trillion daily foreign exchange trading registered in 1995 has grown by 50 per cent since 1992 alone. By comparison, the annual global turnover in equity markets in 1995 was $21 trillion-equivalent to just 17 days trading on the foreign exchange market.
The rapid growth of derivatives trading is more recent, but none the less remarkable. The Basle-based Bank for International Settlements (BIS) estimates that the notional principal outstanding in financial derivatives rose from just over $1 trillion in 1986 to about $56 trillion in 1995. Fewer than half of these were traded on regulated exchanges.
It is no accident that the growth of international capital flows followed the 1973 collapse of the Bretton Woods system of fixed exchange rates. Under that system, currencies tended to move in tight bands, offering few opportunities for traders to make profits from arbitrage. Banks did not find it worthwhile to invest in the large-scale currency dealing facilities with which we are now familiar. All that changed with the break-up of the system, leading to an explosion of short-term capital flows. What subsequently happened has been described by John Eatwell, president of Queens’ College, Cambridge, and former adviser to Neil Kinnock, as the “privatisation of foreign exchange risk.”
The privatisation of risk meant that millions could be made from correctly predicting events-or indeed, forcing them…