September 25, 2015

Is it Too Easy to Trade?

At MMI, we have heard several misguided arguments against High Frequency Trading (HFT).  From the blog that described it as a waste of fossil fuel, to the contention that it has “no social value.”  However, Douglas Cliggott, in his latest commentary supporting a financial transaction tax (FTT), took a stance against HFT we hadn’t heard before.  Putting aside for the moment his overstatement of the potential benefits of the tax, disregard for unintended consequences and his swipe at critical market makers working on razor-thin margins as “skimmers,” Mr. Cliggott’s reasoning for implementing a tax is:

– Our markets are highly efficient: “Low-priced easy-access trading makes stock flipping as easy as Tweeting”

– Because markets are highly efficient people trade too much: “We hurt ourselves by frequently flipping stocks”

– A tax (described as only an economist could, “intentionally adding meaningful friction to the market”) would dis-incent people from “wasteful trading.”

It’s not often we hear a “nanny-state” argument about market structure, so at first we struggled to understand the author’s reasoning.  But then we came up with a suitable analogy.

It turns out that eBay is detrimental to society because it lets people exchange second-hand goods more efficiently than they used to, so people end up wasting time and money trading knick-knacks and collectibles because it’s so easy!

And by Mr. Cliggott’s logic, televised sports is harmful to fans because it’s so much cheaper to watch a football game on TV than to trek out to the stadium, people spend way too much time doing it.

We can see the argument for imposing a tax or friction where there’s a suspected negative externality to certain behavior — like certain drugs or tobacco products (which jeopardize the health or safety of those nearby.)  But dictating what is and is not a waste of an individual’s time and money where there is no external impact is what fundamentalist governments are made of, not a capitalist democracy.

The fact is, a tax designed to obstruct the efficiency of our markets will also obstruct capital formation, economic growth and job creation.

Cliggott writes that the proceeds from the tax “could do a lot of social good” and references FTT advocate Bernie Sanders, who has proposed using the tax revenue to make college tuition-free.  While that is a noble cause, an FTT to fund it will hurt the economy and leave us with more college graduates competing for fewer good jobs.

“Numerous studies – including the recently released UK Foresight HFT project – have shown that transaction costs for both retail and institutional traders decreased substantially with the growth of high-frequency trading."

Larry Harris, former sec chief economist

Financial Times, December 27, 2012

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