While the smoke clears from the worst of the financial crisis and regulators investigate new regulation to prevent another financial meltdown, it isn't surprising that talks of enacting a Tobin Tax are resurfacing. The Tobin Tax was proposed back in 1971 when the United States first went fully off the gold standard, and has since been frequently discussed, but never enacted.
During November's meeting of G20 finance ministers, Gordon Brown, the British prime minister, presented the idea once again of a Tobin Tax on financial transactions. A Tobin Tax would place a small tax, between 0.1 percent and 0.25 percent, on all currency transactions. Considering the currency markets have an average daily volume of $2-$3 trillion, we are talking about netting $2-$3 billion per day - a pretty hefty sum.
The idea behind the Tobin Tax is simple. It would discourage short-term speculation in the currency markets in favor of more long-term, stable transactions. Regulators believe that by placing a small tax on each transaction, it will discourage speculators in the market, and therefore lead to a more stable financial system.
Proponents of the Tobin Tax see it as a way to create a buffer and prevent a future financial crisis. Over time, a reserve can be created that, in the event of a future crisis, can be used to bailout corporations and governments, and stem the spread of a crisis. It would essentially act as an insurance policy to prevent a future financial crisis.
Some proponents see a Tobin Tax as a way to redistribute wealth. Tax revenue generated by a Tobin Tax could be used towards humanitarian efforts, saving the environment, and in aiding developing nations. Other proponents have a simpler agenda. They see a Tobin Tax as a way to make the large corporations that caused the financial crisis, who are now paying record bonuses, pay for their excess and greed. There are many motives out there to enact a Tobin Tax, but what does it mean for the individual Forex trader?
Impact on the "Small Guy" Forex Trader
If a Tobin Tax were to be implemented, barring they don't exclude individual retail traders, it would dramatically impact the retail trader and possibly even wipe-out the entire industry. Forex traders already have to fight for every pip and surmount broker fees. If you tack on an additional 0.1 percent tax to each transaction, it would make it nearly impossible for the "small guy" to compete.
The good news is that it isn't likely that a Tobin Tax will be implemented. First, the Tobin Tax is an all-or-none deal. To be successfully implemented, it would require all governments to be onboard; otherwise funds would funnel through countries that don't have the tax. Second, the U.S. is against a Tobin Tax. U.S. Treasury Secretary Timothy Geithner has expressed his disapproval of the tax. Finally, it doesn’t really make sense to tax retail traders out of the market. Retail Forex traders were not the cause of the financial crisis, but rather serve an important role of providing liquidity to the markets. Liquidity does not come from a high turnover ratio, but rather from a large diversity of traders with different views. By looking at the social indicators and reading the discussions on Currensee, it is pretty clear we have a large diversity of traders with different views.
If you would like to read more about the Tobin tax, the Financial Times has a couple good articles titled EU Leaders Urge IMF to Consider Tobin Tax and Tobin or Not Tobin. Dani Rodrik also wrote an interesting piece on the Tobin Tax on the Project Syndicate website.
How do you feel about the Tobin Tax? What do you think the chances are that something like this would be passed?
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.