A Tobin tax for Argentina

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A Tobin tax for Argentina
Cédric Coignard Deepan Dagur Sébastien Toma Yuriy
Vitrenko
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2001 OVERVALUED PESO HAS DRIVEN ARGENTINA TO
BANKRUPTCY
Exchange rate (/peso)
Supply of pesos

• Imports
• Capital outflows

Demand for pesos
Peg rate (1)

• Exports
• Capital inflows (FI)

units of peso traded
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2002 CURRENCY BOARD IS ABANDONED AND PESO PLUNGES

• Huge decrease in deposits (1.3bn withdrawn on a
  single day, on Nov 30th, 2001)
• Dec 2001 withdrawal restrictions on bank
  deposits (coralito)

Banking crisis

• Complete loss of confidence in the banks, the
  currency and the government
• Continuous bank run
• A likely run on the peso that will pressure
  strongly the exchange rate

• Default on debt eventually occurs in January 2002
• Currency board is abandoned and peso is
  devaluated by 30 on January 6th

Currency crisis
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SPECULATION MECHANISM AND DANGER
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THE TOBIN TAX
Definition

• A small transaction tax (e.g. 0.1) on purchases
  and sales of foreign exchange

• to throw some sand in the wheels of the
  international finance, i.e., to deter the
  speculation that causes steep exchange rate
  fluctuations, resulting in serious damage to
  economies
• Secondary objective raise revenue from a huge
  market (1.2tr traded per day), for international
  purposes or to insure monetary independence

Objective

• A small transaction tax would discourage
  short-term, speculative currency trades (that
  rely on very small margin) by making them
  unprofitable
• Long-term investments and trade financing (whose
  needs are estimated to be 60 times lower than
  forex market volume) would not be impacted

Rationale

• Controlled by IMF or BIS
• Operated through the centralized settlement
  system (CLS Continuous Linked System)

Implementation
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TOBIN TAX PROPOSAL FOR ARGENTINA

• Marginal speculators global banks, hedge funds
• Even a small tax (0,1-0.5) significantly
  increases transaction costs for daily traders
  it makes speculation too costly (Dynamic hedging
  requires daily portfolio rebalancing of the
  portfolio)
• For longer term investors the effect of the tax
  is negligible
• Asymmetric downside and upside risks in Argentina
  (due to higher default and expatriation
  probability) does not allow investors to access
  liquid derivatives market cost efficiently
  (anyway, only 8 of portfolio investors hedge
  forex risk)

Discourage speculations

• Lower pressure on exchange and interest rate
• Longer investment horizon
• Lower volatility
• Lower inflation and stagnation (stagflation)
  expectations

• Tobin tax can be an important source under
  recession conditions when other sources shrink
• Tax falls on richer market participants with
  lower MPC revenues can be distributed to higher
  MPC citizens
• Stimulate investments cement sustainable
  development and right expectations

Get new revenues
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RISKS AND ALTERNATIVES
Risks
Increased volatility

• Higher transaction cost for liquidity providers
  (big banks and hedge funds) may result in higher
  cost of liquidity and therefore higher volatility

Arbitrage

• Possible arbitrage opportunities with liquid
  assets (gold etc) can wipe out some benefits

Hurting non-speculators

• Although the effect of the tax on underlying
  transactions (equity, commodity trade) is fairly
  limited it can will increase cost for portfolio
  investors and high turnover commodity traders

Retaliation

• IMF does not like the Tobin Tax as well as some
  other international organizations and national
  governments

Alternatives

• Impose the Tobin Tax
• Indefinite and unconditional time horizon
• No other policies

• Do not impose the Tobin Tax
• Default on USD debt and do not buy USD
• Administratively limit demand for USD

• Do not impose the Tobin Tax
• Find liquidity provider (IMF) who would wait for
  PPP and CIP to hold
• Pay IMF in Peso

• Do not impose the Tobin Tax
• Reduce government spending
• Buy USD and repay debts

• Impose the Tobin Tax
• Only for period of asymmetric volatility and low
  liquidity
• Combine with other policies

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APPENDIX
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ACADEMIC DISCUSSION ON THE TOBIN TAX

• Supporters government transfer tax with a
  view to mitigating of speculation Keynes (1936),
  Tobin (1978, 1984), Stiglitz (1989), Summerrs and
  Summers (189), Eichengreen, Tobin and Wyploz
  (1995)
• Opponents Speculation is stabilizing rather
  than the reverse, though the evidence has not yet
  been analyzed in sufficient detail to establish
  this conclusion with any confidence Friedman
  (1953), Miller (1991), Schwert and Seguin (1993),
  Dooley (1996)

Economists are not unanimous

• Their studies focus on much more liquid markets
  (NASDAQ, Paris Bourse, Sweden etc) and symmetric
  limited volatility (differentiating underlying
  with Tick sizes etc) Mulherin (1990), Umlauf
  (1993), Hau (2003)
• They recognize microstructure imperfections and
  its influence Forex liquidity supply is not
  infinitely price elastic Hedging is incomplete
  Information is asymmetric Very high correlation
  between orders flows and contemporaneous exchange
  rate changes Hau, Rey 2003

Opponents reasoning is ambiguous

• Frankel and Rose (1995) summarize the situation
  by saying that no model based on such standard
  fundamentals like money supplies, interest rates,
  inflation rates, and current account balances
  will ever succeed in explaining or predicting a
  high percentage of the variation in the exchange
  rate, at least at short- or medium-term
  frequencies
• Devereux and Engel (2002) argue the one cannot
  match some stylized facts regarding exchange rate
  volatility and disconnect without adding
  ingredients such as noise traders to the standard
  models

Pessimism on macrovariables

• Vast majority of forex transactions is
  speculation (80)
• Information is asymmetric, especially in the
  emerging markets
• Emerging markets and exotic options markets have
  limited liquidity and asymmetric upside/downside
  risks
• Transaction tax will discourage speculators,
  especially with short-term horizon and need for
  dynamic (delta) hedging

Heuristic