The sad irony of government intervention to curb speculation

PUBLISHED : Saturday, 19 March, 2016, 11:16pm
UPDATED : Saturday, 19 March, 2016, 11:54pm

The [yuan] saw its largest single day fall in a month on Tuesday after reports that Beijing planned to introduce a “Tobin tax” to curb speculation.

SCMP March 18

Let’s get a reality check in here first. In the quote above, take out the word “curb” and substitute the word “encourage” as this is what such monkeying about in the foreign exchange market actually does.

The Tobin here refers to James Tobin, an American economics professor who lived in academia all his life and never held down a job in the real world.

Such people are uniquely susceptible to the notion that government holds all the answers and Tobin was an exemplar of the breed. Among his many government-ought-to exhortations was taxing foreign exchange dealing because the forex speculation is a bad thing. It undermines government policy. This insight made him famous, hence “Tobin tax”.

I do not doubt the truth of the insight. Forex speculation does indeed undermine government policy. Hurrah! People everywhere would be poorer if speculators did not regularly put an early stop to ill-conceived government ventures in financial markets.

The applicable principle here is that just as vultures do not feed on live meat, so speculators do not feed on live markets. There has to be a false element somewhere in the pricing of what is bought and sold on a market before it can draw any sizeable flock of vultures flapping in.

Now, to change the metaphor, I am not much of a clairvoyant where reading the tea leaves of Beijing economic policy decisions is concerned but others are expert in this form of fortune telling and they see the future clearly in official pronouncements where I only see blah-blah.

Perhaps I should have seen it, too, last year in the difference up to August between the yuan/US dollar exchange rate on the market and the base rate established by the State Administration of Foreign Exchange (see the chart) but I didn’t.

The vultures did see it, however, and they pounced with record volumes of speculative capital outflow before Beijing finally did what it had apparently already signalled to them that it would do and instituted a “surprise” devaluation of the yuan, surprise to all but the vultures.

A Tobin tax will not stop it from happening again. Some vultures may wait a little longer for a bigger feed if they must share it with the taxman but more likely this will just drive them offshore. You can make a bet on anything in financial markets with a New York investment bank. Their range is wider than a London bookmaker in the football trade.

The only certainty, however, is that a Tobin tax will make life more difficult for legitimate mainland exporters, importers and tourists. The great irony here is that government intervention to fight off speculators invariably only creates more opportunity for them and draws more of them in. If you really want to eliminate speculation from a market then impose no restrictions at all other than the ones required by law.

Magic will result. The vultures will not know which way the market is going. They will then take opposite positions from each other, creating great liquidity for real investors while moving the market very little. Soon they will give up and flap back into the sky to look for dead meat elsewhere.

Fortunately, the Tobin tax idea has faded into the background again. Another academic nitwit, Janet Yellen of the US Federal Reserve Board, has declared that she hasn’t a clue of what she is doing and the yuan has taken heart ... for the moment.