Re: Volatility and the market

[jackodonnell <jackodonnell@xxxxxxxx>]

Paul Davidson wrote:
>
> At 09:38 AM 12/18/98 -0800, jod wrote:
> >Paul Davidson wrote:
> >>
> >> Trond and David's concerns has to do with volatility in financial markets.
> >> Trond's bond would not necessarily solve the problem.  There have been
> >> periods when price fluctuations in bond markets clearly were much larger
> >> than in equity markets-- e.g., during the early Volker years.
> >>
> >> The question is how to stabilize the movement of financial assets whether
> >> they be stocks, bonds, foreign exchange, etc.  (What Trond and David forget
> >> is that in an open economy even if you restrict the domestic price of
> >> securities to plus or minus 20 %, the exchange rate permits wider
> >> fluctations in the value of these stocks in terms of another currency.)
> >
> ><<snip>>
> >
> >Addressing the desirable goal of reducing "irrational exuberance" in
> >markets should not ignore the reality that there are occasional large
> >changes in value occurring over short periods of time that simply
> >reflect realistic changes in tastes and / or technological developments.
>
> Not if markets are efficient -- for then the market would have seen the
> change coming and discounted it accordingly. In an efficieht market there
> can not, be definition, be irrational exhuberence.

You can define away reality in models, but markets tend to be what they
are and not listen to those who choose to describe the degree of
efficiency as controlling. Irrational exuberance, unfortunately for
those so excited, tends not to be separable from rational exuberance
until after the fact. Did I hear someone say "non-ergodic" in the
background?

> If markets are not efficient, then a sudden change in tastes, e.g., a
> sudden rush to be more liquid, can cause a catastophic collapse of
> financial asset prices which can have some devestating effects on the real
> economy.  Should we allow people to express this sudden "change in tastes"
> instantly and without limit and merely tax a portion of the capital gain (I
> assume you would not tax a capital loss ) even if this causes the death of
> enterprise [and is therfore economic murder in the first degree for which
> O'donnell would only have the "perp" pay a progressive fine] and others to
> lose their livelihood?

A "sudden rush to be more liquid" is but one of many possible reasons
for exuberance that include such trivial fads as hula hoops and pet
rocks to the yet to come more significant cure for cancer. "Catastrophic
collapse" of asset prices can be but realization that something
significant has changed to affect the value of a product [e.g. --
Discovery of a workable cold fusion reducing the need for fossil fuel.]
or they can be a society's preference for clean air and water over the
use of products products that tend to destroy the environment.

Should people be reasonably free? Or must we have the experts decide for
us what is proper taste? I vote for freedom!

Paul, you really should read the details of my proposal before you make
assertions about the consequences of its implementation. For starters,
you would realize that "capital gains" and any other transaction tax
would be lessened or eliminated entirely with my monopoly tax proposal
and the method of determining the amount of tax is to optimize the
growth rate of the underlying assets, a procedure that is far from your
assertion of economic murder or fining the perps.

> >A progressive tax based on market valuations provides an impetus to
> >reduce the volatility of the exuberance of bubbles by reducing the value
> >itself as prices rise and reducing the loss of value as prices decline
> >while at the same time collecting the society's share of the value
> >created by its contribution of a viable market. I call the proposal a
> >"monopoly tax" and the details are available at:
>
> The problem with this taxation is the same as with the Tobin tax (see my
> 1997 EJ paper and my 1998 address to the Royal economic society).  The
> basic problem is that any sort of transaction tax on financial markets
> reduces volume and therefore , ceteris paribus, must increase measured
> volatility -- so jod must be in error when he argues it reduces volatility.
>  As I show in my lecture to the Royal Economic Society every empirical
> study of transactions costs and financial markets has shown that any
> increase in transactions costs SIGNIFICANTLY increases market volatility.
> (For example see Jones and Seguin study in the September 1997 AER). So
> jod's claim that his tax will reduce  volatility is in conflict with the
> statistical facts.

Paul, I have not proposed a "transaction tax" which, as you note above
reduces volume. In fact, that is one of the reasons I propose that all
transaction taxes be replaced with a progressive asset based tax with
rates set to optimize the growth rate of the underlying assets. Your
complaint of reduced volume in financial markets applies just as much to
other markets so why are you so resistant to eliminating all such
transaction wedges from market prices? Could it be you are wearing the
same blinders as all the others who read "tax" as only applicable to
transactions such as wage payments and sales events?

> Secondly such a tax has depresing effects on the real economy -- and these
> effects can be severe.

The tax you describe does, the tax I propose does not.

> finally O'donnel's tax is misnamed it has nothing necessarily to do with
> monopoly per se.

It progresses on the basis of size and is defended on the basis of the
price setting ability of such large concentrations of productive
capacity which are some of the more significant characteristics of
monopoly. That is, under my proposal a large corporation such as General
Motors would have a higher marginal tax rate on its Chevrolet assets if
it chooses to maintain its price setting ability rather than lowering
its marginal tax rate by divesting itself of Chevrolet and letting Chevy
compete on its own. Likewise other large concentrations of production
that allow producers to be price setters rather than price takers must
justify their large scale on the basis of economies of scale rather that
their ability to control alternatives. [i.e. -- Since the rate
determination method of my proposal is based on the growth rates of the
underlying assets then if the economy of scale is such that large is
needed the advantage of such scale will be preserved but if it is not
then the tax will encourage divestiture to create greater competition.]

> Accoirdingly, I see no redeeming value in this tax proposal -- except that
> it teds to have a greater incidence on the rich who are more likely to be
> able to "play the market".  But what about pension funds?. Would they be
> hit too?

I quite agree, there is no redeeming value in the tax proposal you are
refuting. However, there is substantial advantage to my proposed
monopoly tax that might open your eyes if you bothered to look.

> (By the way would jod include a progressive tax on one selling one's
> residence?  Now that might hit the middle class pretty hard!!)

No, but I would apply the same procedure I propose to the asset value of
real property over and above a reasonable exemption for private homes.
It is a bit like the taxes we now pay for our living quarters but
because of the exemption all can own a sufficient home without fear of a
tax sale while none can monopolize great quantities of land to force the
less fortunate to engage in urban sprawl. This part of the proposal is
located in the chapter _From Here To There_ at:
http://www.geocities.com/CapitolHill/1067/c05r4a.html

--
			-- jbod

		Tax Privilege, Not People
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