Tuesday, 2 March 2010

Liquidity fetishism

There's been a right old ding-dong over the Robin Hood Tax on t'internet. As I've blogged previously, I'm not convinced that an approach such as whacking up stamp duty on shares would do anything to counter speculative trading (not least because I don't know how you identify what counts as 'speculation'). But if the point, as is the case with the Robin Hood Tax, is to raise revenue I'm not sure if the fuss is isn't a bit overdone (provided the tax incidence point is acknowledged).

But there's one counter-argument that I don't like which is that such a tax would be bad because it would damage liquidity. Again proponents of a transaction tax need to acknowledge that reducing liquidity could indeed be a bad thing - it could easily make markets more volatile. But set at a low level that need not be the case. And equally opponents should admit that the benefits of liquidity can be over-sold, and that we can't assume that the existing situation is optimal.

Adair Turner gave this speech recently, and there's a section in it addressing precisely this issue titled 'A balanced approach to market liquidity'. Here's an excerpt.
scepticism about the limitless benefits of market liquidity and of the speculation required to make it possible, is justified on two grounds:

First, the fact that the benefits of market liquidity must, as already discussed, be subject to declining marginal utility. The benefits deliverable by the extra liquidity which derives from flash and algorithmic trading, exploiting price divergences present for a fraction of a second, are clearly of minimal value compared with the provision of reasonable liquidity on a day-by-day basis.

And second, the fact that, to a degree which is difficult to predict and unstable over time, greater market liquidity and a greater role for speculators can produce destabilising and harmful herd and momentum effects.
The whole thing is worth a read.

Wot Keynes said.


Nick Drew said...

yes well you know my view: liquidity is a Public Good, don't ever get caught somewhere illiquid ...

BTW, on the related topic of the importance of being able to short, have a read of this

reinforces my comment of many moons ago, that professionals will always find a way of going short, and it's best that this should be open to all

Tom Powdrill said...

Hi Nick

I agree with you it is a Good Thing but what frustrates me is the implication that 'all is for the best in the best of all possible worlds' and that any reduction in liquidity would be disastrous.

The shorting link is great!