The Foreign Exchange Transaction Reporting System
Reducing the Risk of Bear Raids on Economies
March 18, 2009
Reforming the unregulated global casino must be addressed at the April G-20 summit in London, as I pointed out in a presentation in February. The Communiqué from the November 2008 summit of G-20 leaders in Washington, D.C., clearly cited increased cooperation between nations as essential, particularly oversight of global banks and other financial players. Cooperation is necessary to avoid "beggar-thy-neighbor" policies.
Yet, no mention was made at the November summit of the most urgent priority: tackling the up to $3 trillion of daily currency trading, over 90 percent of which is speculation. Bouncing currencies have caused much of the turbulence and excessive volatility in world markets as contagion spreads in minutes in this 24/7 around-the-clock trading. A small tax (less than 1 percent) on all trades has been advocated since the 1970s when it was proposed by economist James Tobin. The idea was also floated in 1989 by now National Economic Council head Lawrence Summers, who also attended the Washington summit.
Such a currency-exchange tax would be simple to collect using a computerized system, which can be installed on trading screens, such as the Foreign Exchange Transaction Reporting System (FXTRS). This system operates like an electronic version of Wall Street's venerable "uptick rule," enacted in 1934 but repealed during the George W. Bush Administration. Today's Wall Street traders themselves are calling for the rule's reinstatement to curb naked short-selling. The FXTRS computerized uptick rule would gradually raise the tax up to a maximum of 1 percent whenever a bear raid starts attacking a weak currency. Such bear raids are rarely to "discipline" a country's policies, as traders claim, but rather to make quick profits.
In the transparent FXTRS system, traders selling falling currencies begin to see that the rising tax is cascading into the country's currency stabilization fund and cutting into their gains. Seeing no further profit, traders can voluntarily exit the market and search for some other currency or arbitrage opportunity. The funds collected from such currency exchange taxes would raise hundreds of billions of dollars, which could be directed to health, education, infrastructure, and other public goods. The FXTRS was awarded a patent by the U.S. Patent and Trademark Office, but it was allowed to expire in 2008.
Background From the Original Paper (Alan F. Kay, coauthor)
Given the current financial meltdown, it is clear that the new global contagion and volatility can no longer be addressed by nations acting alone. The problems lie beyond the reach of domestic policymakers' unilateral efforts, and long-term solutions are to be found at the global systemic level—through harmonizing standards for disclosure, accounting, and risk-assessment, and via international agreements. The G-20 summit in London, April 2, 2009, at last will discuss concerted action.
Other familiar proposals have been advanced or tried: trading bands, crawling bands, currency pegs, crawling pegs, fixed parity, raising interest rates, traditional currency intervention, early warning disclosures, currency boards, as well as versions of Chile's successful use of partial controls on short-term inflows. China has more options, with its huge internal market and the limited convertibility of its currency. These tightly linked, real-time globalized financial markets and the contagion they create should have come as no surprise. These markets were deliberately deregulated during the 1980s and 1990s on advice of Alan Greenspan, Lawrence Summers, Robert Rubin, and Senator Philip Gramm.
Few heeded the admonition encoded in the 1962 Mundell-Fleming model, still valid today: Countries wishing to interlink their economies in world trade cannot simultaneously achieve fixed exchange rates, autonomy of monetary policy, and free global capital flows. Since 1972, when the Bretton Woods system collapsed, national policymakers have been confronted with this axiom that they can achieve two of these three goals.
Other proposals include investor George Soros's concept of an International Credit Insurance Corporation to undergird global markets. We agree with Soros's analysis, but an International Credit Insurance Corporation without additional restructuring of existing financial architecture might exacerbate current moral hazard problems. Indeed, Soros offers many other useful proposals to prevent what he sees as a "disintegration of the global capitalist system and the evident inability of the international monetary authorities to hold it together."
Alan Greenspan has said that an increase in volatility is good news for traders, who thrive thereby. Traders are playing by the rules of the current game and are not empowered to change it. In systems terms, the global economy, by virtue of its real-time technological inter-linkages, has become a de facto global commons, a common resource of all its users. Such commons require win-win agreements, rules and standards applicable to all users. If normal competitive behavior (win-lose) continues, the result is lose-lose as competition between players leads to sub-optimization and the system itself absorbs risks and eventually can break down, as witnessed in the current crisis.
The specific function of FXTRS we propose is targeted precisely to the more efficient, transparent function of foreign exchange trading. Its main advantage is that it can be developed and begin operation in the short-term, requires no additional bureaucracy or cumbersome international agreements, and helps stabilize FX markets. It can be licensed unilaterally to central banks. As it is installed as a superior operating system, the FXTRS can rapidly become a de facto technological global standard.
The most important aim of our research has been to present a technological structure that would reduce the likelihood, scope, and force of a massive bear raid attack on a weak currency. Such attacks have played a role in crippling the economy of the target, disrupting societies, impoverishing the middle classes, clogging trade pipelines, damaging international relations, and toppling governments. Globally, such attacks might play a role in a worldwide depression or set back for decades the hope for a satisfactory world order. We are trying in a fair, balanced, and logical manner to reduce their likelihood and severity.
Bear raids on weak currencies can be viewed as battles. On one side are the central banks, which are the only market players at times ready to sell low and buy high to protect their national economies. On the other side are all others, individuals and institutions, not just speculators or hedge funds, but indeed anyone who is ready to jump into the fray at some point in hopes of buying low and selling high.
Bear raids were prevalent prior to the 1929 crash. The collapse of the U.S. market and ensuing depression helped Franklin Roosevelt's campaign for president. Investment banker Joseph P. Kennedy was appointed by Roosevelt to head the newly created Securities and Exchange Commission. New regulations cleaned up the roles of bankers and brokers and made the stock market safer for investors. Based on his intimate knowledge of how the U.S. securities markets worked, Kennedy introduced a number of changes in the transactions process itself. One was the uptick rule, which prevented a broker from selling short if the last sale price of a listed stock was lower than the previous transaction price. This slowed the momentum of bear raids and they largely disappeared. Note that this rule utilized "ticker tape" action. The ticker was based on transaction reporting that we place at the heart of the FXTRS.
With technology undreamt of in the 1930s, a much smoother process can be implemented in the FXTRS to handle bigger foreign exchange markets. Technological provisions in the FXTRS will enable the relevant standards body to curb bear raids without impairing the functioning of the market in normal times, nor depriving the execution of any transaction desired by willing buyer and seller at a mutually agreeable price. The FXTRS would fulfill some of the needs cited by central bankers and finance ministers for a new global financial architecture.
Trade reporting itself in existing markets generally helps stabilize the market. When a market lacks information, participants can too easily vacillate between over-caution and recklessness, characteristics exhibited by the global currency markets and their recent volatility, over- and under-shooting. Nevertheless, even stock exchanges with last-sale tickers are not immune to destabilizing forces. Trade reporting will help FXE, but further stabilizing mechanisms are still needed.
All FXTRS fee rates of less than 1 percent will be so small as a percent of the transaction value that no transaction will be derailed because of fee resistance. Transaction fees constitute the main source of revenue from the system's foreign exchange transaction activity. There are potentially four considerations in determining the net total transaction fee: 1) the base fee, adjusted for size, 2) adjustment for trade purpose, 3) fortuitous timing component, and 4) emergency. The base fee, adjusted for size, is the same for both buyer and seller. The system will have a wide range of algorithms to handle a variety of fee structure components built into software.
A base transaction fee of a small percentage, like 0.001 percent of the value of a baseline trade of $1 million or its equivalent would yield $10 per trade. Without any other charges if all trades were of this size, the total system revenue, when all major currency countries were participating, would then be $10 million per day, or about $3 billion per year.
Finally, let us consider the most important case, the emergency. A weak currency is under attack and falling rapidly, say 50 percent in two days, and perhaps accompanied by some rapid gyrations in price during the two days. This situation illustrates the best case for large fees. Large fees could slow the attack and at the same time contribute substantially to funds for humanitarian aid or financial rescue of the country under attack. Fees might be allowed to rise as high as 1 percent, a thousand times larger than the basic fee, not enough perhaps to seriously affect the profits of the successful bear raider, but perhaps enough to wipe out the profits of a less successful one. The total range of emergency fees might be something like 0.01 percent to 1 percent of the transaction value (just above the timing fee range) and would be charged only to the party buying the B instrument.
The rules by which the fees are chosen should be made publicly and widely known, with one exception. Some key choices in the parameters of the timing fee should be revealed publicly only as they apply to trades that have already taken place. To do otherwise would be to invite game playing irrelevant to the operation of the market.
The opportunity for central banks to finance the risk capital of authorized market-makers as part of the agreement should not be overlooked and surely could accelerate the creation of the best marketplace in the world for the currency of each central bank and full control on the part of the central bank to achieve best-marketplace status when it seeks to protect its currency.
The advantages of the FXTRS include: 1) enhancing stability in currency markets via a technologically state-of-the-art trading system which will be widely adopted voluntarily; 2) technology that will be a de facto, global standard for currency trading, reporting, and supervision without legislation or cumbersome international bureaucracy; 3) provision of central banks with superior information and reporting, allowing levels of prudential supervision of currency markets which will be beneficial to all market players; 4) a "ticker tape" for currency trades; and 5) new revenues to the user-groups and vendors.