Will trading rules work in curbing speculation?<\/p>\n
By Ngiam Kee Jin<\/p>\n
SINGAPORE: The currency turmoil in Southeast Asia has been
\nblamed squarely on excessive speculation and has prompted calls
\nby Malaysia for some form of trading rules to prevent wild swings
\nin currency values.<\/p>\n
The idea of currency trading rules is likely to be deliberated
\nat the meeting of Asian finance ministers and central bankers in
\nKuala Lumpur this month.<\/p>\n
At the moment, it is unclear what specific trading rules will
\nbe tabled for discussion. My guess is that Malaysia may advocate
\none or more of the following measures to curb currency
\nspeculation:<\/p>\n
* Tobin tax;<\/p>\n
* Control on leveraged trading; and<\/p>\n
* Shift currency trading to exchanges.<\/p>\n
Are these measures workable, and would they help reduce
\ncurrency volatility?<\/p>\n
James Tobin, a Nobel laureate in economics, has proposed a 1
\npercent tax on all foreign exchange transactions, in order to
\n\"put some sand in the wheels of international finance\".<\/p>\n
As Malaysia is concerned over speculation against the ringgit,
\nit might contemplate imposing a tax on those foreign exchange
\ntransactions involving its own currency. As the tax is payable
\nevery time the ringgit is converted into another currency and
\nvice versa, it would hurt short-run trading (speculators) more
\nthan long-run trading (traders and investors).<\/p>\n
It could contain fluctuations in the exchange rate of the
\nringgit as its trading would be based on the needs of the economy
\nand long-run fundamentals, rather than market sentiment.<\/p>\n
The tax, however, has a number of shortcomings.<\/p>\n
Firstly, if Malaysia were to act unilaterally, its foreign
\nexchange business involving the ringgit would simply collapse and
\nmove overseas.<\/p>\n
To be effective, a world-wide agreement is necessary. This
\nwill be difficult to achieve because there will always be free-
\nriders who will find it attractive not to participate in the
\nagreement, so as to gain a disproportionate share of the business
\nthemselves.<\/p>\n
Secondly, the increasing sophistication of the financial
\nmarkets now allows speculators to bypass the foreign exchange
\nmarkets and yet take a speculative position.<\/p>\n
Thirdly, the tax is too pervasive as it hurt not only
\nspeculators, but also traders and investors. By increasing
\ntransaction costs, it could also impose a cost on financial
\nmarkets by inducing investors to hold a less desired portfolio
\nand by potentially reducing stabilizing arbitrage.<\/p>\n
Fourthly, since no country has ever imposed a Tobin tax, there
\nis no evidence to suggest that it would be effective in reducing
\ncurrency fluctuations.<\/p>\n
Would the demand for foreign exchange be elastic enough to
\nmake the Tobin tax effective?<\/p>\n
Empirical observations suggest a week link between transaction
\ncosts and volatility.<\/p>\n
Take the case of the housing market. Despite its high
\ntransaction costs, housing prices appear to be highly volatile.<\/p>\n
The modus operandi of speculators is to engage in leveraged
\ntrading by borrowing in one currency and converting it into
\nanother currency, or by taking positions in derivatives.<\/p>\n
Any country may choose to control bank lending in its currency
\nto speculators to contain exchange rate volatility, as this has
\nbeen a long-standing practice in Singapore and recently in
\nThailand. This should squeeze hedged funds, which speculate by
\nborrowing the local currency and converting it into dollars.<\/p>\n
When the local currency devalues, they would make a profit by
\nselling dollars for the local currency at a higher price.<\/p>\n
While the activities of speculators should be curbed, those of
\ntraders and investors should be encouraged. The difficulty is how
\nto distinguish speculators from genuine traders and investors.<\/p>\n
Any curb on local currency loans may only slow down, but
\ncannot wipe out completely speculation of the local currency as
\nholdings of the local currency deposits can always be converted
\nto other currencies in a currency crisis.<\/p>\n
Moreover, speculators can always obtain the local currency
\nloans from other financial centers for speculation. These
\nconsiderations are especially important for economies which
\naspire to become major financial centers.<\/p>\n
Although derivatives are leveraged instruments, they are
\ninvaluable tools for hedging by traders and investors. Hence, any
\nimposition of quantitative limits on their forward or options
\npositions is bound to encounter resistance from them.<\/p>\n
To circumvent this ruling, traders can always take positions
\nwith several foreign exchange dealers and it would be rather
\ndifficult for the authorities to detect. If the control becomes
\ntoo tight, then the derivatives business would simply move to
\nother countries.<\/p>\n
Thus, like the Tobin tax, such a measure would require
\ninternational cooperation which, again, might be extremely
\ndifficult to secure.<\/p>\n
Unlike the stock market, which is traded on an exchange, the
\nforeign exchange market is essentially over-the-counter, dealer-
\ndriven and non-transparent. When a stock broker executes a trade
\non behalf of a client, the price and quantity are public
\ninformation. Foreign exchange dealers are under no obligation to
\ndisclose this information. In fact, their ability to earn a
\nliving hinges on their skills in gleaning information from other
\ntraders.<\/p>\n
New disclosures will obviously add to the costs of foreign
\nexchange transactions, but judging from the experience in the
\nstock market, are unlikely to curb currency speculation.<\/p>\n
The ability of the over-the-counter market to handle
\ntransactions worth about US$1.2 trillion (S$1.88 trillion) daily
\nrests on its low transaction costs and its highly-efficient
\ncommunication system, which allows currency trades to be arranged
\nand settled quickly.<\/p>\n
Although the size of the foreign exchange market seems
\ndisproportionately seems disproportionately large compared to the
\nactual trade and investment, much of these involve double-or-
\ntriple counting.<\/p>\n
For example, a Malaysian importer may buy dollar forward from
\na dealer in order to hedge his future payment in dollar. The
\ndealer who sells the dollar forward may cover his position by
\nfirst buying dollar spot and then performing a swap (selling
\ndollar spot and buying dollar forward). In this case, one
\ntransaction by the Malaysian importer has generated three
\nadditional transactions by the dealer.<\/p>\n
Unlike the exchange-traded market, the informal arrangement of
\nover-the-counter market allows contracts to vary according to the
\ndesires of the contracting parties.<\/p>\n
As the over-the-counter market has served the needs of market
\nparticipants well and has operated so efficiently for so long, it
\nwould be an uphill task to attempt to channel currency trading to
\nthe exchanges. Any impediment to over-the-counter trading by any
\ncountry would surely result in its currency trading moving to
\nother financial centers.<\/p>\n
Except for controlling the lending of the domestic currency,
\nall the other measures presented are unlikely to be put into
\npractice.<\/p>\n
Not only is it not obvious that these measures will reduce the
\ndegree of exchange rate volatility, the practical problems of
\nimplementing them in a world of increasing financial
\nsophistication are overwhelming<\/p>\n
The solution to currency speculation does not seem to lie with
\ncurrency trading rules, but rather, with building strong economic
\nfundamentals, such as high savings and fiscal prudence, coupled
\nwith some of exchange rate and monetary cooperation among
\nnations, such as the one between Singapore and Brunei.<\/p>\n
The writer is a senior lecturer in the Department of Economics
\n& Statistics, National University of Singapore.<\/p>\n
-- The Straits Times<\/p>", "url": "https:\/\/jawawa.id\/newsitem\/will-trading-rules-work-in-curbing-speculation-1447893297", "image": "" }, "sponsor": "Okusi Associates", "sponsor_url": "https:\/\/okusiassociates.com" }