To move us in this direction, Mr. Fullerton supports a financial transaction tax (FTT) applied across all financial instruments, not just derivatives, for reasons outlined in his April Press briefing in Washington. In short, he believes that an FTT would (a) enhance financial system resiliency, (b) shift capital allocation (at the margin) toward longer term investment and away from short term speculation, and, (c) raise much needed revenues to recover the uncosted externalities of financial system destabilization; and his press briefing explains why he believes the concerns some have over an FTT's effect on liquidity are unfounded. These beliefs seem to be supported by theoretical thinking and empirical research by many scholars going back to the Great Depression. The latest paper on the subject is one presented on November 2nd, 2010, to an IMF audience by Professor Stephan Schulmeister, a scientist who has been researching and publishing papers in this area for over 30 years at Austria's prestigious Institute of Economic Research. That paper, entitled "entitled “Short-term Asset Trading, long-term Price Swings, and the Stabilizing Potential of a Transactions Tax” can be downloaded from this link. It concludes as follows: The empirical evidence presented in this paper does not “prove” the efficacy of introducing a FTT. However, it does show the following: • Long swings in asset prices in either direction result from the accumulation of persistent upward (downward) “mini” runs lasting longer than counter-movements over an extended period of time. • The most popular trading practice, e. g., technical analysis, focuses on the exploitation of such price trends. • The widespread use of technical trading systems reinforces the boom-and-bust pattern of asset price dynamics as a sequence of persistent price movements interrupted by “whipsaws.” • Technical models, including “automated trading systems”, are used at ever increasing data frequencies. This development has strongly contributed to the tremendous rise in transaction volumes in asset markets, particularly in derivatives markets. fundamental speculation contributes strongly to the overshooting of asset prices. A small FTT would then dampen the volatility of asset prices over the short run as well as the magnitude of the swings over the longer run. be much more difficult because the idea of taxing transactions in the “freest” markets calls implicitly into question that “Weltanschauung” which has become mainstream in economics and politics over the past decades. (A presupposition that clearly now needs a nuance to respond to recent evidence of market disequilibria -- author's note). Evidently the concern Mr. Fullerton and I share about the financial sector's loss of clarity in distinguishing between real investment and speculation is becoming increasingly recognized in both expert and decision-making financial circles. Mr. Fullerton has written a chilling elaboration of the consequences of our failing to draw a distinction between speculation and investment in his blog post "The End of Investment". The Abacus mortgage testimony to the US Congress of Goldman Sachs' CEO Blankfein also demonstrates this point, irrespective of what one thinks about the Goldman defence. The importance of allocating capital to truly productive investment is more important than ever as we contemplate the multi-trillion dollar shift to a sustainable economic system, one that respects ecological limits while addressing gross social injustice. In this new economic world, speculative excess is destabilizing and wasteful and has profound consequences. Doesn't Capital have a much higher calling?, asks Mr. Fullerton. Questions such as this one are not easy to address, but if we set them aside for the sake of simplicity we now know it will be at civilization's peril. So the question for such globally responsible bodies as the G20, the International Financial Stability Board, and the IMF, as well as for national regulatory and supervisory bodies, is now: How do we get there from here? That's a question being addressed, with the help of an international network contributing generously afforded insight, in another paper on this website accessible via this link. An FTT won't do all that we need done to focus capital on meeting truly pressing needs, but some form of a smart FTT looks increasingly likely to many to help what else is being done in this critical direction. .. |
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| Financial Derivative Contracts (FDCs), which in this paper includes all financial assets that do not document current title to a real economy good/service, were either invented to facilitate capital being matched to talent, labour, and leadership in order to meet real human needs or only to make money. Money, of course, is a potential good; but as we have seen a lot of recently, its spending can also (inadvertently?) result in a lot of harm. Which is it what, and when? FDCs form the legal links in a series of variously timed, overlapping cycles mediated by derivative market makers. Up to a little before the time of the bailout of AIG and failure of Lehman the global total of outstanding FDCs was growing much faster than World GDP. Evaluation of the risk posed by FDCs being an increasing proportion of bank assets was by then beginning to get the attention of regulators, but it was probably the consequence of an economic principle articulated perhaps most succinctly by former Federal Reserve Chairman Alan Greenspan to the US Senate Banking Committee in 2003, that permitted such a trend to reach the point where FDCs amounted, at the Lehman collapse, to about 11 times World GDP: “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so." That belief evidently sounded a reliable one to the US senate of seven years ago. But what we now can be clear happened in the next five years leading up to the debacle of 2007-8 was that risk was being transferred by increasingly complex derivatives to people who, if they thought (contemplating their prospective bonuses?) they had the capability to take it on, in actuality – when the moment of truth arrived – didn't. In the Lehman case its leaders had not matched the maturities of their real estate assets to their sources of funding and were, in a word, over-leveraged. For others it was somewhat different stories, but all were over-leveraged. Worst of all, no one at the top of the central banking, commercial banking, investment banking, trading, or financial insurance communities was either recognizing or acknowledging that was happening, and the risk raters seemed to be either reluctant or too befogged to warn their clients of impending catastophe until it was too late. On the contrary, the chief high priest of finance of that period, the Fed Chairman, was devoted (aided and abetted by millions of people who were adoring worshippers of such alluring simplicities as "the invisible hand always does best") to free markets. A (lucky?) exception, however, was Canada. What some understood in those heady days is that a necessary concomitant of free markets is diligent application of either the intelligent human principle of fully costing and charging for externalities (such as is neatly described in "The Undercover Economist") or effective action and means to forbid behaviour creating such externalities. Unfortunately, their honest and courageous attempts to get the externalities identified and costed attracted disgraceful "psychodiagnostic jeers" (such as "Commie!" or "Socialist!") from the "dyed-in-the-wool hard right". At the time of the Lehman failure outstanding FDCs were estimated to have amounted to approximately $US 650 trillion. That figure, according to most, declined somewhat in the next 18 months or so. But indications in some parts of the financial industry, especially those employing high- frequency trading exploitation of trends, suggest it is again growing rapidly as “the players” strive to return to their all too human ideations of "normal”. Set against that prospect are the pages of legislation that, after two long years of political wrangling, are only now beginning to point us back to the modest controls on unfettered market freedom that were enacted in the Great Depression. Can we expect regulators now armed with thousands of pages of legislation on both sides of the Atlantic to bring about changes of behaviour from those which resulted in, for example, the SocGen Kerviel catastrophe or the Goldman Sachs Abacus mortgage deceit? Can laws bring about a change in values in which the idea of making money for money's sake gives way to the principle of making a truly valuable contribution to society? Even if we were to fund regulators and supervisors enormously much more than we are now, there's little prospect of the world's financial sector correcting herd gambling quickly at the sole behest or demand of regulators or supervisors: the financial sectors of many countries have already demonstrated the will/desperation to spend money on lawyers to the point where many say there's now no difference between avoiding taxes and evading them. So let's face it: regulation/supervison in many respects can often amount to not much more than expensive pie in the sky for society at large and a sky-high boondoggle for lawyers -- again with the notable partial exception, and this time a deliberate one, of Canada. So what else can effectively meet the necessity to curb virtually world-wide abuse of the financial derivative concept? What is clear about FDCs is that, although some of the activity supporting their growth continues to be driven by real needs in the economy, a large portion is driven more by the habituated (and primitive?) beliefs of “players” whose motivation appears to be to use money for the sake of making money rather than for hearing, feeling, and helping to identify and meet the true needs of the growing numbers of people who are sinking, all around the world, not just in "third world" countries, into desperate, and therefore potentially violent, straits. To get a handle on this issue, John Fullerton, Founder and President of the Capital Institute, estimates the segment shares of the major functional segments in the need/capital cycle facilitated by all forms of FDCs as:
Everyone agrees that purely speculative capital flows (casino gambling) can be highly disruptive to the best and most nobly practical plans. This is not to say that some disruptions brought about by carefully planned derivative strategies are not necessary, but it is to emphasize that by the time of the Lehman failure the overall role of speculative flows was very much more disruptive than virtually everyone in retrospect would agree was optimal. It therefore seems rational to envision, and try to bring about, a future in which figures for the mix of the three major functional segments described by Mr. Fullerton follow a path illustrated by the following exhibit: .. |
| Financial Derivatives and Need/Capital Cycles |
| (c) 2010, all rights reserved by Angus Cunningham Principal, Authentix Coaches (specializing in executive leadership psycholinguistics) angusc@authentixcoaches.com |
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| * Chart intended only to indicate a desirable trend in relative shares |