Reason No. Eleventy Gajillion Why We Need a Transaction Tax

A while ago, I discussed the observation that seventy percent of stocks are held for eleven seconds (yes, you read that correctly). It’s absurd, since there’s no way that the status of the underlying companies has changed (and that information has been made public) in an eleven second time span. This is nothing more than speculation which provides no useful purpose. A transaction tax would penalize this behavior and make it unprofitable.
Along come more examples of how this flash trading is leading to more insanity:

BlackBerrys were buzzing inside Progress Energy in Raleigh, N.C.: in a blink, the 102-year-old utility had been virtually wiped out on Wall Street.

For no apparent reason, Progress’s share price had plunged almost 90 percent. In a matter of seconds, a company with 3.1 million customers and 11,000 employees had all but vanished on the nation’s stock market, and Progress executives had no idea why.
In the anxious hours that followed, the answers began to come clear: the harrowing plunge in the early afternoon of Sept. 27 had been a mini flash crash — a small-time version of the stock market’s wild day last spring.

Crashes like this have happened at least a dozen times. Prices of stocks have very little bearing on the underlying financial status of the traded entities:

The Investment Company Institute, which represents investment companies like mutual funds, said it was concerned by the “market inefficiencies” revealed by May 6 and wanted regulators to look at what it called abusive practices, like using technology to detect trading of large blocks of shares by investors like mutual funds and trading ahead of them.
Others are far more blunt. “I am very upset by the flash crash,” said George P. Schwartz, who manages the Ave Maria mutual funds. “I am upset by how high-speed traders have taken over the market. They make a mockery out of capitalism.”

Given that everyone seems to be so keen on closing the budget deficit, a transaction tax would be a really good way to do it: if you’re not flash trading, the costs are minimal.

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11 Responses to Reason No. Eleventy Gajillion Why We Need a Transaction Tax

  1. Nick says:

    Then when you discover that you can’t trade when you want to because the speculators have gone, wait for the complaints.
    e.g. The price is dropping I want to sell. No one is buying. So the price drops, and drops and drops.
    You can only get large falls when there are speculators willing to buy.
    Don’t forget, even though the price went down, for every stock traded, there was one being bought.
    Now, let me ask, how did all those shares being bought, drive the price down?

  2. NJ says:

    Wow, a rare find of a mint-condition self-refuting argument!
    Nick @ 1:

    The price is dropping I want to sell. No one is buying. So the price drops, and drops and drops.

    (emphasis added)
    Nick @ 1:

    how did all those shares being bought, drive the price down?

  3. D. C. Sessions says:

    “The invisible hand,” when acting in its role as arbiter of resource allocation, has considerable latency built in: it takes time to assess the performance of a stock, etc. You see this all the time in “market sectors” for instance: Intel announces good earnings, and every other semiconductor stock rises; Intel has a bad quarter and every other stock falls. It was especially amusing when AMD was winning business from Intel, because an announcement that AMD had scored a win away from Intel drove Intel down and AMD dropped even more.
    Speaking as an engineer who produces closed-loop controls, this is no way to run a feedback loop.
    The thing you have to look out for in setting up a stable control system is that you have to run the loop gain to zero at a frequency below the one where enough lag has built up in the loop to reverse the phase of the response from negative to positive.
    SO what does flash trading do? You got it: it speeds up the response time and cranks up the gain so that the system becomes wildly unstable. Which is fine for the flash traders, of course, since they’re the ones leading the market. Lots of money to be made there — from someone.

  4. william e emba says:

    This is nothing more than speculation which provides no useful purpose.

    This is not true. Speculation in futures markets and the like acts as a break on price changes on consumer goods. In theory, the price of bread should plummet soon after the wheat harvest and climb again long after. Farmers would have no year-to-year stability: a good harvest could actually be devastating. And so on. (And this does happen in countries without appropriate speculation.)
    What happens to the supply of wheat, for example, is that most of it is bought up by speculators who are making humungous bets on the exact price of bread a few months down the road. The supply that makes it to the grocery store is evened out as a result, and so too is the price.
    As to flash trading being too fast: well, in the not-too-distant future, smart pricing is going to be everywhere. Without somebody else absorbing the second-by-second price optimization that will be ubiquitous, it’s going to be the consumer.
    There’s an old New Yorker cartoon of a grocer and a shopper racing to the same pile of fruit, he with a new price sticker, she trying to get the fruit at the old price. We laugh because our world simply doesn’t work that way, nor does it occur to us that it may do so within our lifetimes.

  5. panacea tax says:

    Oh the humanity. Please help us with more taxes. Progress
    Energy closed at 44.56 on Friday Sept. 24th, closed at 44.43 Monday Sept. 27th on that so-called crash, and closed at 44.72 on Sept. 28th. Stocks held for 11 seconds? Market makers have never been long-term investors. Their competitive trading activity lowers the cost for long-term investors that today pay one cent or less per share. A transaction tax would eliminate competition and bring back the market gougers so we would go back to paying 50 cents per share. That’s a 2% upfront loss on a $25 stock.

  6. megan says:

    I’m for VAT and corporate earnings and capital gains taxes.
    Thus eliminating any individual income taxing. The majority of citizens will never have enough to invest or own a corporation and apart from local taxing for munical services and infrastructure don’t put a stress on the national socio-economic structure to warrant taxation.
    The VAST easily created NPOs popping up like weeds around the US, recognized by states are the main sucking entities, paying nothing back (tax free status) while local property taxes go through the roof. No business pan is required to apply for a Non-Profit 50c.3 tax status. No over sight and cooking books and tax forms, mixing personal and organization funds are rampant, nepotism in hiring and management is also.

  7. Nomen Nescio says:

    Market makers have never been long-term investors.

    that is the problem, exactly. why should the market get to be “made” by people without any long-term interest in its stability and sensibility?

  8. Nomen Nescio says:

    it just occurred to me that in #7, i — the token socialist commentator on various scienceblogs — effectively called for a more conservative approach to stock market regulation. i’ll swallow the irony if it lowers the risks of good companies being wiped out by irrational flash crashes.

  9. panacea tax says:

    Nomen: …good companies being wiped out by irrational flash crashes.
    What companies are being wiped out? I can understand why the socialists would want most of the market makers gone with only a few left to corner the market, ka-ching. Get rid of the pesky independents.

  10. llewelly says:

    Nomen Nescio | November 17, 2010 10:06 AM:

    it just occurred to me that in #7, i — the token socialist commentator on various scienceblogs — effectively called for a more conservative approach to stock market regulation.

    Does that really surprise you? If you think about it, you will realize you have known for years that most of those who travel under the moniker “conservative” in the US are not interested in conserving much of anything. Roughly half of them are radical reactionaries who are striving to send the US back to an imagined golden age. The rest are radical reformers, attempting to transform the US into a perceived “libertarian” paradise, for which no historical analogue exists.

  11. Twenty years of experience trading stocks and futures in both extremely active, liquid markets and non-liquid markets tells me a transaction tax would be absolutely horrible for U.S. markets. A transaction tax would put every day trader out of business overnight OR they switch to other markets overseas to trade, that don’t have a transaction tax. What happens then…..immediately the bid-ask spread of every U.S. market has a huge gap, because of the lack of liquidity from active, short term traders. What does that mean…..all of sudden, every middle class guy with a few thousand dollars to invest in Home Depot over at ETrade is going to have to pay for that huge spread. Every day from then on, everyone pays more for their stock transactions, whether at their broker, in their 401(k) or pension. Its a really, really bad idea. And for those that love taxes, how ’bout all the taxes that wouldn’t be collected from all the big swinging hedge fund traders and day traders in NY & Chicago. Lots of tax dollars gone.

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