Financial Transaction Tax 1782
Financial Transaction Tax 1782

Financial Transaction Tax 1782

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  • Pages: 7 (3509 words)
  • Published: November 1, 2018
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The soaring volume of international finance and increased interdependence in

recent decades has increased concerns about volatility and threats of a financial crisis.

This has led many to investigate and analyze the origins, transmission, effects and policies

aimed to impede financial instability. This paper argues that financial liberalization and

speculation are the most reflective explanations for instability in financial markets and that

financial instability is likely to be transmitted globally with far reaching implications on real

sector performance. I conclude the paper with the argument that a global transaction tax

would be the most effective policy to curb financial instability and that other proposed

policies, such as target zones and the creation of a supranational institution, are either

unfeasible or unattainable.


In this section I examine four interpretations of how financial instability arises.

The first interpretation deals with speculation and the subsequent “bandwagoning” in

financial markets. The second is a political interpretation dealing with the declining status

of a hegemonic anchor of the financial system. The question of whether regulation causes

or mitigates financial instability is raised by the third interpretation; while the fourth view

deals with the “trigger point” phenomena.

To fully comprehend these interpretations we must first understand and

differentiate between a “currency” and “contagion” crisis. A currency crisis refers to a

situation is which a loss of confidence in a country”s currency provokes capital flight.

Conversely, a contagion crisis refers to a loss of confidence in the assets denominated in a

particular currency and


the subsequent global transmission of this shock.

One of the more paramount readings of financial instability pertains to speculation.

Speculation is exhibited in a situation where a government monetary or fiscal policy (or

action) leads investors to believe that the currency of that particular nation will either

appreciate or depreciate in terms relative to those of other countries. Closely associated

with these speculative attacks is what is coined the “bandwagon” effect. Say for

example, that a country”s central bank decides to undertake an expansionary monetary

policy. A neoclassical interpretation tells us that this will lower the domestic interest

rates, thus lowering the rate of return in the foreign exchange market and bringing about a

currency depreciation. As investors foresee this happening they will likely pull out before

the perceived depreciation. “Efforts to get out would accelerate the loss of reserves,

provoking an earlier collapse, speculators would therefore try to get out still earlier, and

so on” (Krugman, 1991:93). This “herding” or “bandwagon” effect naturally cause wild

swings in exchange rates and volatility in markets.

Another argument for the evolution of financial market instability is closely related

to hegemonic stability theory. This political explanation predicts a circumstance (i.e. a

decline of a hegemon”s status) in which a loss of confidence in a particular countries

currency may lead to capital flight away from that currency. This flight in turn not only

depreciates the currency of the former hegemon but more importantly undermines its role

as the international financial anchor and is said to ultimately lead to instability.

The trigger point phenomena may also be used

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as an instrument to explain financial

instability. Similar to the speculative cycles described above, this refers to a situation

where a group of investors commits to buy or sell a currency when that currency reaches a

certain price level. If that particular currency were to rise or fall to that specified level,

whether by real or speculative reasons, the precommited investors buy or sell that

currency or assets. This results in a cascade effect that, like speculative cycles, increases

or decreases the value of the currency to remarkably higher or lower levels.

Country after country has deregulated its financial markets and institutions. The

neoclassical interpretation asserts that regulation is thought to create incentives for risk

taking and hence instability. It is said to bring about what are called “moral hazards.”

Proponents of deregulation argue that when people are insured, they are more apt to take

greater risks with their investments in financial markets. The riskier the investment

activity, the more volatile the markets tend to be.

A closer look suggests that perhaps only two of these explanations are valid when

thinking about the origins of financial instability. The trigger point explanation seems to

be a misreading of the origins of instability. It is unlikely that a large number of investors

would have the incentive or operational ability in order to simultaneously coordinate the

buying or selling of a currency or assets denominated in that currency. If even there is

such unlikely coordination, the “existence of even a very large group of investors with

trigger points need not create a crisis if other investors know they are there” (Krugman,


The theory of hegemonic stability also overlooks a number of factors that can

provide useful insights in explaining the emergence of financial instability. Historical

precedence supports this assertion. For instance, Britains role as international economic

manager was very minor in the stability experienced under the gold standard. The success

of the standard can be attributed to endogenous factors such as the self adjusting market

mechanism and the informal discipline maintained by its rules. The destabilization of the

gold standard can be attributed to the extreme domestic economic and financial pressures

brought on nation states by World War I, and not solely on the industrial and economic

demise of Britain.

A valid explanation for the origins of financial instability are the speculative attacks

brought on by investors. Although similar in function to trigger points, these speculative

cycles cannot be mitigated simply by pure recognition. Rather than acting on the value of

the currency itself, speculators act on occurrences or policies that will alter the value of

the currency. Instability arises from the fact that these speculative cycles induce capital

flight and therefore a change in the value of that particular currency, whether or not the

decisions of these investors are based on market “fundamentals.” Futures, options, swaps

and other financial instruments “have given investors and speculators an unheard of

capacity to leverage financial markets. The greater the leverage, the greater the

instability” (McCallum, 1995:12).

If we examine the deregulatory process closely, it becomes clear that there is

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