Schäuble's poor grasp of liquidity puts markets at risk

German finance minister Wolfgang Schäuble has said that we have too much liquidity in the markets. This is a breathtaking demonstration that the politician does not understand the vital role that liquidity plays in smoothing markets and reducing volatility. It is this misunderstanding that has allowed many European Union officials to justify the Financial Transaction Tax (FTT) to themselves.

The FTT will see a levy on transactions in shares, bonds and derivatives. It is easy to illustrate the damage this could cause. Imagine a world in which each time you withdrew cash from an ATM there was a £20 tax levied on you. It is likely that depositors would withdraw money less often, choosing only to withdraw money in large volumes, taking out £200 rather than £10. These large withdrawals would cause the cash holdings of banks to vary wildly, and could induce bank runs and panic.
Markets with lower transaction costs are ones with smaller, more frequent and as such more predictable trading. A FTT could cause carnage as traders delay their trades due to higher costs, causing seismic shifts in markets rather than more controlled exit and entry. Our reporter James Waterson on the impact of an FTT:

City firms face paying billions of pounds in taxes to foreign governments if a proposed financial transaction tax is implemented, according to a damning report released yesterday by interdealer broker Icap.

“It is particularly ironic that London, as one of world’s leading financial centres, will generate the lion’s share of this revenue and act as collection agent despite the UK being outside the financial transaction tax zone and our government being vehemently opposed to the introduction of this tax,” said Icap chief executive Michael Spencer.

Separate research from Barclays suggests the tax will halve derivatives trading volumes, push business overseas and cut EU GDP by 0.28 per cent. Last night a Treasury source insisted that the “opportunity to influence this hasn’t passed” and discussions with other EU nations are ongoing.