Every day almost four trillion dollars changes hands in the international currency markets. It is the biggest and most active market in the world. It is here that national banks and investment firms buy and sell foreign currency, 24 hours a day. 70-90% of trading is done by speculators – those gambling on currencies. It is barely regulated, and no tax is paid.
The currency markets developed in the 1970s, after the US dollar parted company with the Gold Standard. Until 1971, the dollar was pegged to the price of gold, and all other currencies were able to work out their value relative to the dollar. In 1971 president Nixon printed more dollars than the US possessed in gold in order to finance the Vietnam war. From then on currencies became arbitrary, worth as much or as little as traders believed them to be. With the value of currency now mobile, investors were able to make a profit by speculating on whether their value would rise or fall.
Currency speculation is controversial. On the one hand, speculators add liquidity to markets, and liquid markets are more stable and easier for others to enter. Speculators also shoulder much of the risk in the currency markets, shielding those making more straightforward exchanges. However, speculation can also artificially boost values and create bubbles, or do the opposite, and devalue something suddenly. We’ve seen the effects of speculation in the commodity markets in 2008 with oil, rising to unprecedented highs, and then crashing back again.
In currencies, this can be devastating to economies. The crash of the Aisan Tigers in the late nineties was partly due to speculators trading on falling Thai and Malaysian currencies. The consequences for those countries were recession and mass unemployment.
Currency markets are also a serious obstacle to democracy. For example, in 2002 Luiz Inacio Lula Da Silva began to emerge as the frontrunner in the Brazilian presidential elections. Being a left leaning politician who had promised to take no nonsense from the IMF, he had publicly considered defaulting on Brazil’s debts. The better he did in the elections, the more the speculators bailed out of Brazil’s currency. The Real lost a third of its value, which forced Brazil to accept futher IMF loans. As it happened Da Silva won, and won again in 2006, but he did so at the expense of his radical ideas – Brazil has toed the line on debt. The Brazilian population may have voted in their president, but the currency speculators decided his economic policies.
More recently we’ve seen the collapse of the Icelandic bubble, its almost overnight switch from rich to poor due in large part to the collapse of its currency. Iceland’s three largest banks have been nationalized, interest rates leapt to 18% in October, and it will take a generation to pay off the economic damage.
Untaxed, these controversial trillions of dollars can make and break entire economies, without ever contributing anything back to the governments or the real economies that make them possible.
So how can the currency markets be controlled? And is it possible to raise any kind of tax revenue from them? The campaign for controlling and taxing currency transactions has come and gone over the last 30 years. It is more important today than it ever has been, but it seems to have petered out at just the wrong time. For more, read the second post on the Tobin Tax.