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Comment on the “OPINION OF THE EUROPEAN ” on the Belgian law for a transaction , Dated from 4th of November 2004 (CON/2004/34)

Prepared by Peter Wahl World Economy, Ecology and Development – WEED, Berlin for the Hearing of the Special Commission on Globalisation of the Belgian Chamber of Representatives Brussels July 13 2005

Introduction This paper deals only with the economic assessment of the CTT by the (ECB). This part is developed in point 6 to 11 of the Bank’s statement. This paper will first go through the economic arguments of the Bank one by one and finally make a general assessment.

1. Perception of the pro CTT position According to the ECB, the main arguments „generally linked“ to the pro tax position are that the CTT:

• allows more autonomy in monetary policy,

• prevents speculative attacks,

• has a great potential to raise revenues. (i) This perception is correct. However, it is incomplete. In particular it does not take into consideration the first and central interest in the CTT: the reduction of specula- tion in the daily and ordinary functioning of the financial markets and not only in pre- venting speculative attacks. Already Tobin himself was putting this in the forefront, when he developed his proposal. Tobin foresaw in the beginning of the 1970s that the end of the fixed system of Bretton Woods would result in dramatic increase in speculative transactions. Deterring is the regulatory inten- tion behind the CTT, which can be found as Leitmotiv in the subsequent discussion since the UNDP-proposal from the nineties, when the proposal re-entered the agenda until today (Haq et al 1996).

1 have to be deterred, because they: a. create instability, b. absorb resources that could be used in the real economy to create employ- ment, c. reinforce income inequality. Among the plurality of different camps in economic theory only the neo-classic one is of the opinion that speculation is not negative but positive. Even if one would accept this position, it could be expected that the European Central Bank takes up the cen- tral argument of the proponents of the CTT and attempts to refute it instead of simply ignoring it.

(ii) The issue of speculative attacks is dealt with in this paper under point 8.

(iii) It is worthwhile to note that the third point, the question of raising revenues, is not mentioned any more in the Bank’s statement after it’s introduction in point 6. of its statement. It becomes not clear, whether this means, that the Bank accepts the valid- ity of the argument – in that case it would have been a matter of correctness to be explicit on it – or whether the authors have simply forgotten to deal with it. As it is a basic feature of to have the double potential of regulating economic or social issues a n d to raise money, the latter should not be ignored, in particular: a. in the light of the intense discussion on the Millennium Development Goals and the prominent proposals to finance them through innovative instruments like the CTT, b. the imminent UN-summit in September where these issues are on the agenda, c. the increasing support for the CTT by political forces and leaders. Even if the criticism of the ECB against the regulatory dimension of the CTT was valid - they are not, as we shall see below - the question remains, whether the posi- tive effects of the revenue would not outweigh the “regulatory inefficiency”. In a com- plex world almost all decisions have to deal with ambiguity and decision making nor- mally is not simply a choice between “good” and “evil”.

2. Does the CTT not reduce volatility? According to the first basic argument against the CTT, there would be no reduction of volatility, but at the contrary, the tax might even provoke an increase. The question cannot be answered empirically, because the CTT is not implemented, and therefore it is impossible to have practical prove neither for one nor for the other side. Therefore, the bank’s argument that “empirical evidence indicate(s)” that the CTT does not reduce volatility, is not valid. On the level of analytical evidence, the Bank’s position is based on the neo-classical assumption that more liquidity on the markets leads to more stability. As the CTT re- duces the number of transactions it would reduce “depth and liquidity” of the markets.

2 However, the number of transactions is one variable for the degree of liquidity but not the only one. If the number of transactions decreases, it is very probable that a sec- ond variable might compensate the decrease in numbers by increasing the amount of each single transaction. The decisive question is: what are the reasons for vola- tility? Before presenting an answer, it is necessary to make a methodological clarification: there is a difference between term (intra-day) volatility and medium-term volatil- ity (quarterly changes). Whereas the intra-day volatility is less relevant, the medium term volatility is important. The ECB remains vague on to which kind of volatility it is referring. In this paper, volatility always means the medium-term volatility. Of course, there can be several reasons for volatility. First and foremost changes in the “fundamentals”. This type of reason for volatility is not controversial. However, the dominant driving force for volatility is the pro-cyclical behaviour (“herd- ing behaviour” or momentum ) of the market forces, with their – often irrational - profit expectations. As we can see from the Euro/US-Dollar exchange rate, it would be absurd to interpret the range from 0.90 US-Dollar to 1.30 US-Dollar for one Euro as a change in the “fundamentals”. Once there is disequilibrium or the expectation of it, it is the run for profits that makes the investors behave in the same direction. As a result, equilibrium is reached after some time and the price is “right”. Capital then immediately seeks a new disequilibrium and the game starts from beginning. The ECB is right to say, that the CTT reduces the number of transactions by making them unprofitable. As the incentives for pro-cyclical behaviour are reduced, the reduction of volatility is a logical consequence.

3. The CTT is reducing liquidity Liquidity on exchange markets is not a purpose in itself, but an instrument to reach other goals, in particular providing finance for international trade and investment. From there, unlimited liquidity as such is not positive per se. Over-liquidity is, like overproduction on other markets, a distortion between supply and demand. Tobin and others argue that the CTT reduces over-liquidity (“sand in the wheels”) but does not liquidate liquidity as such, because this would mean “stopping the wheels”. There is in fact, what could be called a “technical minimum of liquidity” (Jetin 2005). To put into a metaphor: it is necessary for ships on a river, to have enough water/liquidity under the keel, but it is bad if the banks of the river are flooded, both for the ships and the banks.

4. Is the CTT hampering hedging? The ECB correctly states that “a large part of the daily turnover in short-term transac- tions is related to hedging and distribution of risks among market participants.” The implementation of a CTT, they argue, could hamper this sector. On this issue at first glance the ECB has a point. The distribution of risks in the so called “hot potato trade” has in fact reached a degree, where the risk of a single risk taker has reached almost zero. If these transactions are taxed, it might be possible that the costs of each single hedging transaction would increase. However, on second glance the argument does not really speak against the CTT. Because, if the tax reduces volatility, the costs for insurance against exchange rate

3 volatility in general would go down. This would compensate the increase of the single hedging transaction. Furthermore, if “efficiency” is not reduced to the lowest cost possible but includes, for instance, more stability or the purpose of raising money for development, the inter- nalization of these goals would have to be reflected in the price. This is a frequent experience we make in the day to day life. There is no reason, why financial markets should be exempted from this.

5. The impact of volatility on trade, investment and growth It is very audacious of the central bank of the Euro to argue that trade would not be hampered by exchange rate volatility. After all, the abolishment of the exchange rate risk in order to improve the efficiency of trade and foreign investment was one of the main reasons for the introduction of the Euro as common currency. The establish- ment of the Euro was the ideal and definitive solution to the exchange rate problem. A common currency has been, since the medieval times, a factor for the emergence and integration of a single market. This process came often, as in the case of Ger- many in 1848, even before the establishment of the national state. Pointing on hedging as mentioned above, the ECB itself delivers the argument that volatility involves costs. In so far, the text of the Bank is contradictory in itself. Also in Point 8 of its paper the ECB admits that “excessive volatility may adversely affect economic transactions, allocation of investment and, hence, growth …” thus making twice inconsistent its position on the relations between trade and volatility. Furthermore, there is enormous empirical and analytical material in the literature, where exchange rate volatility and proposals to overcome it, are discussed. They all have as starting point that volatility is a problem. Among those from recent discussions, one can find Mundell’s (Nobel Price Laureate and adversary of a CTT) proposal to create a monetary union among the G3. Or take Bofinger’s concept of managed floating, which is successfully implemented in the Slovenian exchange rate policy towards the Euro. Bofinger is not a nobody, but one of the five official economic advisors of the German government. Pugh and al. (1999) analyse 16 OECD countries from 1980 until 1992 and find that exchange rate volatil- ity leads to a decrease in the level of trade by about 8%. Dell Ariccia (1998) also finds a significant and substantially negative effect of exchange rate volatility be- tween the EU (of 15) and Switzerland. For developing countries, evidence is even stronger. The Financial Stability Forum (FSF), established after the Asian crisis, considers in its first report short term flows and the volatility risks linked to them as one of the three major problems of the inter- national financial system. Several studies of the IMF consider volatility to be a problem for developing countries (Zee 2000). A report of the UN Secretary General considers “a stable exchange rate” (UN 2004) to be beneficial for the developing countries. A study of UNCTAD comes to the explicit conclusion that the volatility not only of their own currency but between the G3 (NB) is detrimental to trade, debt service and FDI. The ECB might disagree with all these positions, but it should not ignore them.

4 6. Circumventing the CTT The ECB believes, that “ participants are likely to find ways to cir- cumvent the tax.” It is true that there are enormous efforts and sometimes even criminal energy in the finance community to avoid taxes. However, this issue has been extensively dealt with by the proponents of the tax. It has been pointed out, that the international settlement systems, such as TARGET and the CLS Bank offer an appropriate institutional framework for the CTT. Therefore it is surprising, that the Bank does not present a single argument to support its opinion or discuss the pro- posals brought forward. First of all, the argument of circumvention is not a specific argument against the CTT. Every tax can be circumvented and is, as a matter of fact, circumvented. This is no reason to give up taxation. Even more, it is more difficult to circumvent the CTT than many other taxes. Beside the fact that foreign exchange transactions have to be disclosed to the respective central banks there is a deep rooted material reason to comply with the tax: trade takes place 24 hour a day subsequently in three time zones, one after the other. If the tax is levied in the European time zone, the business has to go through the Euro Zone, London and Zürich. This would function like a filter, which every transaction has to pass. The option, not to trade during 8 hours is completely unfeasible, because it would mean losing a huge amount of business opportunities, compared to which the tax is an absolute quantité négligeable. Dislocation, too, for instance to another place in Southern Europe, Western Asia or Africa or Off-Shore (point 11) involves incompara- ble higher costs. As there is a high and ongoing process of concentration in the business, where most of the trade is effectuated by approx. 20 big actors, as well as the already mentioned international settlement system, make a control by supervisory bodies or central banks very easy. Furthermore, recent trends in electronics would permit, to add electronically to each transaction a kind of electronic identity card, carrying all relevant data. This works al- ready in the retail trade of major supermarkets where every item has its electronic identity card, as well as in some countries in services such as the health sector, where every patient has his/her case history on an electronic chip. This procedure could easily be applied to every financial transaction. Circumvention through derivatives (point 11), too, is rather improbable. The Belgian law was so wise to include derivatives, without restrict itself on a special type. This covers also future developments. And, even more important, the use of derivatives invokes costs. Given the low of the CTT, there would be no instruments that are cheaper than the tax.

7. Unilateral implementation The nature of financial markets to operate in the logic of time zones tackles also the argument of the Bank, that there would be a need for “universal implementation of the tax” (point 11). The CTT could be implemented unilaterally in the European time zone. Of course, the revenue would be less than with the inclusion of the other time

5 zones, but this is not a principal argument against the CTT. Spahn calculated for that case a revenue of 17-20 billion EURO with a tax rate of one basis point.

8. CTT and speculative attacks In point 8 of its paper the ECB notes “that the tax might not help prevent speculative attacks.” This is true for the “classical” proposal of Tobin. But none of the proponents of the tax has ever pretended that it could do so. They always said that speculative attacks must be fought back either by instruments such as the capital controls or the with its two-tier system. With regard to the Spahn variant (point 9), they do not maintain the argument but be- lieve having discovered another disadvantage: price uncertainty. However, every- body who has read and understood Spahn’s proposal should have learnt that there is even an absolute price certainty. Transactions passing the limit of the corridor will be punished by a deterring tax absorbing the share beyond the limit. This is why the second tier fulfils the role of a selective circuit breaker, while trade inside the band may continue. Moreover, the two-tiered tax would attract foreign investment by giving additional safety and offering the prospect of stable prices.

9. Monetary and exchange rate autonomy The ECB gives no arguments to its declaration, that monetary and exchange-rate autonomy would not benefit from a CTT (point 10). However, the capacity to deter speculative attacks provides, of course, political space, in particular to developing countries and smaller currencies of industrialized countries, whereas the major cur- rencies are hardly exposed to that threat. In case of a crisis, they could at least gain time before taking action. Finally, the Banks assessment that there would be sufficient exchange-rate auton- omy in the world sounds rather ideological. In a globalising world no country with a freely convertible currency disposes of exchange rate autonomy today - with the ex- ception of the US. Nevertheless, it would be desirable that such a monetary auton- omy exists. The present economic situation in the EU in general, and the interest-rate policy of the ECB in particular are the best prove for that. Despite the advise even of the IMF and the OECD to lower interest rates in order to promote a devaluation of the Euro vis à vis the US-Dollar – and creating at the same time an incentive for real in- vestment and employment - the ECB is following the one-sided monetarist approach, which exclusively cares for . There are several crucial problems in the Euro- Zone today. Inflation is not among them.

10. General conclusions The document of the ECB bears the following general characteristics:

• It does not meet the requirements of a serious and thorough discussion of controversial issues in an open end democratic society;

• It is not made transparent, whether the ECB has sufficiently taken note of the positions of the proponents of the CTT. There is no bibliography or any other hint on what their assessment is based. Looking at the arguments, the im-

6 pression emerges that they either have not taken notice of or understood ba- sic pro CTT arguments;

• The foundations of their own positions are not presented in a precise manner. Several assessments remain very vague. What means for instance “exces- sively” and who defines it?

• The text contains logic contradictions, giving the impression that it has not been worked out thoroughly;

• There is a trend towards ex cathedra declarations and hermetic arguing;

• All in all the text seems to be inspired by a lack of respect towards other actors and the public. The ECB should be asked to respond more detailed and thoroughly to the questions raised here.

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