A Tax on Forex Trading ? and forex trading futures

A Tax on Forex Trading ? and forex trading futures the Forex reported that Brazil is considering a forex tax on capital inflows as a way of discourage the inflow of speculative capital that is causing the Real to appreciate. It turns out that Brazil is not alone; England and France, among others, are also mulling taxes on forex transactions. Their goal is not necessarily to discourage capital inflows, but rather to raise money to fund projects that would otherwise not be viable under current budgetary conditions. The UK “levy would raise $30bn-$50bn a year - enough to double spending on health in low-income countries.” The French plan, meanwhile, would “involve taking 0.005% of the proceeds of currency transactions, perhaps on a voluntary basis, to benefit global aid projects.”

While Brazil and England/France appear to be pursuing different ends, together their plans capture the idea behind the “Tobin Tax.” Originally proposed by Nobel Laureate James Tobin after President Nixon declared the end of the gold standard, the tax would be levied on all forex transactions with the proceeds deposited in forex stability funds. One of the most popular versions would only impose the tax during periods of volatility (i.e. speculation) so as not to punish those exchanging currency for “mundane” reasons.

Tobin Tax on Forex Trading While still a fringe idea, the tax initially gained momentum following the 1997 Southeast Asian economic crisis, and has found new followers in the wake of the ongoing credit crisis. Consider the unprecedented volatility in currency markets of late, manifested in wild daily fluctuations.

2009 Forex Volatility Even the US Dollar, the world’s reserve currency, has been on a veritable roller coaster of late, rising and falling by 10% in a matter of months. Prior to the rise of forex speculation ( already a $1 Quadrillion/year market! ), it was rare for a currency to move that much in a year. Given that such speculation probably accounts for 90% of daily turnover, it seems obvious as to who is causing this volatility.

USDX Dollar IndexDon’t get me wrong; there’s a role for speculation in the forex markets , just like there’s a role for speculation in all securities markets. When markets function efficiently and players act rationally, currences should and will reflect economic fundamentals and act to minimize global imbalances. Due to the rise of the carry trade and the herd mentality, however, the oppose often obtains in practice. This can cause currency runs and or artificially inflated currencies that compel Central Banks to act counter to the way they otherwise would (i.e. by raising interest rates rapidly to deter capital flight, crimping economic growth.)

A Tobin tax would work both to minimize speculation in the short-term (by taxing trades) and promote stability in the long-term (by providing Central Banks with funds that they can use to fight speculative “attacks.” Besides, given that forex traders already enjoy favorable tax treatment - i.e. taxed below the short-term speculative rate - it wouldn’t be the end of forex trading as we know it.

Japanese Yen Sinks with US Dollar, but at Slower Pace

Japanese Yen Sinks with US Dollar, but at Slower Pace . Speaking of seven-month lows, did anyone notice that while the US Dollar was busy declining against pretty much every other tradable currency that the Japanese Yen was doing the same? The Yen has remained rangebound against the Dollar for the last three months - the period during which the market rally and Dollar decline have taken place - which just by simple mathematics explains why it has also fallen to a seven-month low around the same time.

The same set of factors that caused the Yen and Dollar to move in lockstep prior to the credit crisis seems to have coalesced again in March. Specifically, investor comfort with risk-taking have combined with low rates to make both very attractive candidates for carry trade funding currencies.

Both countries’ Central Banks are holding rates close to 0% (for several years now, in the case of Japan) and appear unlikely to hike them anytime soon. Simply put, ” ‘Risk appetite is improving in the market, which has been attracting cash away from safe-haven currencies like the dollar’ and the yen. Investors are ‘searching for higher yields.’ ”

At the same time, both countries have been aggressive in using fiscal and monetary policy to tackle the economic downturn, both of which could be highly inflationary and lead to currency debasement. Then, again, nearly every economy has responded with the same policy measures, which suggests that low interest rates represent the most plausible factor.

It could, however, explain why the Yen is rising against the Dollar, and is closing in on the 13-year high recorded earlier this year. In other words, while both currencies are being sold in the short-term to fund carry trades, investors may have determined that the Dollar will remain weaker in the long-term, due to inflation problems.

On a certain level, this is somewhat baffling. Japanese economic indicators make the US economic recession look like an economic boom by comparison. “Preliminary figures showed the world’s second-largest economy shrank at a record 15.2 percent annual pace last quarter,” which would be the worst on record. Meanwhile, Japanese corporations saw so-called recurring profits fall by “69.0 percent from a year earlier to 4.27 trillion yen (44.35 billion dollars) in the three months to March…the sharpest drop since comparable figures became available in 1955 and the seventh straight quarter of declines…Combined sales reported by corporate Japan both at home and abroad caved by a record 20.4 percent.”

In addition, the US has recorded a net capital account surplus with Japan of late, which implies that Japanese are net investors in the US- not the other way around. The government of Japan is equally confused, and is “in the middle of analyzing what is driving the yen higher.” Still, it insists that forex intervention is not currently on the table. If Japan’s economy contracts by another 15% next quarter, however, I wouldn’t be surprised if it did an about-face.