Tax on currency speculation won’t affect strong shekel

There is no reason to think that tax proposed by Steinitz will have any impact on the long-term rate of the shekel versus foreign currencies.

By ASHER MEIR
January 27, 2011 22:33
3 minute read.
New Israeli Shekels

Money Shekels bills 521. (photo credit: Courtesy)

Once upon a time, through a good part of the 20th century, most exchange rates were fixed by central banks. Speculating on exchange-rate movement generally meant digging in to a huge and very risky position that a sudden devaluation would take place over weeks or days.

Nowadays, most exchange rates are determined by supply and demand, and speculation may mean trying to guess movements anticipated in the coming minutes or seconds. It is estimated that the overwhelming majority of currency trades are not made by businesses that need to buy goods or pay workers in foreign currency or even by speculators taking long-term positions (like George Soros’s famous 1992 charge on the British pound), but rather by currency speculators taking short-term positions that are closed out in a matter of days.

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British economist John Maynard Keynes noticed a similar phenomenon in the stock market in the 1920s. In his magnum opus, The General Theory of Employment, Interest and Money, he proposed a win-win solution: a tax on all financial transactions.

“The introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States,” he wrote.

A very small tax (perhaps a few tenths of a percent) would have almost no deterrent effect on an investor who favors a stock, because of his assessment of its long-term value, but it would be deadly for a speculator who is buying and selling many times a day. (It would also have the salutary side effect of raising money.) Keynes’s idea was resurrected by Nobel laureate James Tobin after the very strict fixed exchangerate regime fell apart in the 1970s, specifically in the context of foreign currency. The idea is that exchange rates would be allowed to adjust to their natural levels, but the changes would be damped somewhat to give central banks a little more room to maneuver and stabilize markets.

Since then the idea has come to be known (somewhat unfairly) as a “Tobin tax.”

Recently this obscure idea, previously familiar mainly to economics professors, became familiar to shekel investors worldwide.

Last week, Bank of Israel Governor Stanley Fischer, convinced that short-term speculation was keeping the shekel at an artificially high level, imposed a somewhat unorthodox “reserve requirement” on short-term currency speculation.

This week, Finance Minister Yuval Steinitz announced that the Treasury would impose a tax on profits from these short-term transactions, “in the wake of the increase in foreign currency entering Israel due to the interest-rate spread.”

Despite the superficial likeness between these steps, and the identical policy objectives, there is actually a big difference between the two. Fischer made a short-term fix to combat a short-term phenomenon (that short-term speculation was making the shekel artificially high), and he made a temporary decree to quiet things down.

But in the long term, speculation doesn’t alter the levels of currencies; all it does is affect their volatility. (Some kinds of speculation reduce volatility, others augment it.) So there is no reason to think that the kind of tax proposed by Steinitz will have any impact on the long-term rate of the shekel versus foreign currencies.

Short-term fluctuations may possibly be “ironed out” and the Treasury may make some money (not a bad thing), but there is no effect on the fair-market value of the shekel and no effect on the shekel’s ability to reach that level.

For the same reason, the effusive praise heaped on Steinitz by exporters is misplaced. Given the state of the market this week, Steinitz’s announcement was followed by, and perhaps even responsible for, a fall in the value of the shekel. But there is no particular reason to think it will encourage devaluation in the longer term.

I think the transaction tax is an idea worth trying.

Besides Tobin, other contemporary supporters of the idea include economists Joseph Stiglitz, Paul Krugman, Jeffrey Sachs and Jeffrey Frankel.

But it is not useful as a tool of exchange-rate manipulation. Steinitz might be doing the right thing, but he is giving the wrong reason.

ethics-at-work@besr.org

Asher Meir is research director at the Business Ethics Center of Jerusalem, an independent institute in the Jerusalem College of Technology (Machon Lev).


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