The Investment Currency Mechanism, the UK and the Financial Transaction Tax

3rd February 2012

When investments are made the currency the purchased asset is held in has to be bought by the investor, as it is the desired medium of exchange the seller has requested. Buying into a currency to invest in an asset increases the demand for the currency and artificially increases its purchasing power. This mechanism is what I call the "Investment Currency Mechanism" and is in my opinion the driving force of economic control on the international stage.

Investors seek security, this leads them to put their money where it is most likely to maintain its value and provide a steady return. The countries that can provide that security will generate demand from foreign investors, whose domestic economies are less stable. In short the more stable an economy is the more investment it will receive from abroad. This currency strength then enables the strong country to buy goods from other countries at lower prices due to the high desire to hold its currency as an investment vehicle.

This enables successful countries to enjoy an artificially strong purchasing power against other countries. However for this to happen, the country has to start with a certain level of stability to provide that security. America for example receives an additional artificial source of demand for its currency due to the standard medium of exchange for trading oil being the US dollar. Almost every time oil is purchased US dollars have to be purchased first to enable the transaction. This is partly because of the security the dollar has and the desire for the seller of oil to use the dollar as a safe investment vehicle in exchange for parting with the commodity.

The relationship with America and Oil is synergistic and perpetuating. It provides stability for the US dollar, which then provides a demand from the seller of oil to hold the US dollar due to its stability. It has been one of the main reasons for the economic strength of America for the last hundred years. The UK also has a commodity like oil that requires investors to purchase the British pound to obtain it. This commodity is not a physical commodity but the security of investment in itself. British investment products have a worldwide reputation for security and reliability that stretches over centuries.

The desire to hold British financial products creates demand for the British pound that gives the currency an artificially high purchasing power on an international stage. Therefore regardless of the commissions and bonuses the city earns and the amount the government receives in tax, the real benefit of the financial sector is the artificial purchasing power it creates for the British pound. The income generated in the city is only a small percentage of the total investments made. It is this investment demand that creates currency demand which creates the real benefit of the British financial sector to the rest of the economy.

If the financial sector in the UK declined not only would the income earned by banks and the government diminish, but the ability of the UK to purchase foreign goods would also fall. Anything that effects the operation of foreign investment in the UK will affect the currency value and thus the international purchasing power of the pound. I therefore believe the introduction of a financial transaction tax would be devastating for the UK, as it would act a repellent for foreigners to invest in the UK due to the increased cost of doing so.

Continue reading…

 

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20 thoughts on “The Investment Currency Mechanism, the UK and the Financial Transaction Tax”

  1. Jim M. says:

    Hi Sean,

    I know we give hurried typos a free pass here (and rightly so, imho) but this is too good to let go!

    ” Peddling faster to stand still…. ”

    Typo, biting satire or Freudian slip?

    I note that “peddle” acknowledges “piddle” in it’s back-formation, so we might add “taking the piss” to Mr Draghi’s list of achievements!

    Now that Bradley Wiggins… he knows about pedalling!

    1. The_forbin_project says:

       i think Shaun was thinking of a Red Queen race …

      Forbin

    2. Anonymous says:

      Hi Jim and welcome to my part of the blogosphere

      Apologies for the spelling error which looks so obvious now. I have come to the conclusion that when I type what I am thinking I then read what I thought I have typed rather than what is on the screen. I did read a report one time which showed how few letters we actually read on each line of writing and I guess the two things combine.

  2. Jim M. says:

    My bad!

    Make a comment about typo, best to spell our host’s name correctly!

    1. Guest says:

      You mean “My mistake” not my bad, which is not English

  3. DaveS says:

    Draghi is desperate to monetise the debt of the bankrupt countries. How many trillions will that take ? With fake low borrowing costs, he guarantees the deficits will continue – or more likely increase to promote “growth”. 

    The total debts will then increase until they can only be serviced at central bank manipulated rates. Should he ever stop QE, bond rates will explode upwards and immediately bankrupt the country. So once he starts he can’t stop – perhaps the maturing debt held by the ECB will one day just be swept under a carpet. After all its just numbers in a spreadsheet.

    Same thing is happening in UK. US will not control its deficits so it will do the same.

    What happened to their rules ? I sometimes wonder if the central bankers think about what the future might hold for their grandchildren.

    1. Anonymous says:

      Hi Dave

      I suspect he got reminded of the rules when he spoke to the head of the Bundesbank Herr Weidmann!

      As to Draghi’s words there was some sense and a danger. The sense was that the ECB would operate at the shorter end of the yield curve which in my opinion is where central banks belong. The danger is that by reducing yields there it makes it attractive for countries to issue debt and fund themselves there. In a continuing crisis this becomes a problem as the debt needs re-issuing quickly and is accordingly creates an unstable situation.

      If we look at Spain getting her 2 year yield below 4% was a success but if it persists it will tempt her to fund there. And as Carly Simon put it the debt will be “Coming around again”. And of course we saw the LTROs do this but the effect was temporary….

  4. Rods says:

    Hi Shaun,

    This fatal mistake Draghi has made with his hyperbole and attempted can kicking is that he should of gone into Sir Humphrey mode before opening his mouth and said the following: Several committees are active working on some bold solutions, which will work within our established remit and legal framework and will form the next phase in saving the Euro. Don’t under estimate our total commitment to saving the Euro. There is a real sense of urgency to this, so will be reporting back on their findings as soon as possible. I will then be discussing these bold plans with the heads of the relevant Governments. That way he could have kicked the can into September, and had an annual months holiday like the rest of Italy does in August.

    I used to do a lot of business in Italy and trying to get hold of anybody or achieve anything in August was a waste of time where companies had effectively shut down, where the majority were on holiday for the month.

    That way he could have had his month’s holiday and by making a token visits to the heads of different states, his holiday could have been a grand tour of European countries all at taxpayers expense. Now this Sir Humphrey would have been proud of.

    Now he will be stuck in his office for the month playing scissor, paper, rock with his senior colleagues as they wade though vast swathes of ruined paper and wasted ink that contain useless ideas and irreverent speeches, where they are frantically trying to keep the markets at bay.

    Make be he will turn to doing some real financial alchemy and will amaze us all, where he and his committees, involve CERN and between them they really prove that you can get 7 Euros to dance on a pins head!

    He could even try a philosophical approach and then deliver a paper and speech titled: “The Euro; Impossible answers to improbable questions!”.

    The only real world conclusion that I reached along time a go was the the Eurozone political fantasy and market reality are inconsolable. That most of the people in places that matter have their own domestic agendas and don’t understand the problem let along have any ideas on practical solutions.

    Draghi to me is a typical example of a Euro fool who is getting a good draw with his salary, expenses and future pension and he an his ilk, will do anything possible to keep and maintain their positions. Any sacrifices nations and individuals have to make to preserve the status quo is worth it on their terms. If the Euro disintegrates then there is no ECB and he has no job.

    Meanwhile in the real world, people are losing their businesses, jobs, homes and dignity, at much stress to themselves and their families or even worse they are ruined with a broken family.

    1. Anonymous says:

      Hi Rods

      “That way he could have kicked the can into September, and had an annual months holiday like the rest of Italy does in August.” Sir Humphrey would consider this to be amateurish as he would aim for September 2013 or more likely 2014 to make sure that by the time the committee reports everyone has forgotten why it existed!

      Meanwhile in a universe far far away the real economy weakens…

  5. The_forbin_project says:

    Hello Shaun,

    The Draghi factor or how to influence the markets ( usually measured in minutes…..)

    Beggars belief that the man still has a job

    but then gain I see no Bankers loosing theirs !

    well lets see is the good ol’ US of A can bring some relief ……

    Forbin

  6. Andy Zarse says:

    Sounding like ducks and all that. If Draghi sounds like a politician it’s not surprising since he spends most of his time associating with the politicians and doing their bidding. Same as Merv, Ben and the Chinese fellow whose name eludes me. Oh and Jens Weidboy at the Bundesbank, now there’s a polictical central banker if you ever saw one. Only difference being he seems quite competent, within his limited remit.

    And now back to Spain… on one hand it looks like Mr Ahoy is waiting for the ECB to get the EFSF in order so he can tell the world he’s asked for a bail out. On the other hand, Draghi says he’s waiting for Spain to make an approach. Meanwhile everyone’s just off on a month-long euro-peasant’s holiday. Seriously, how much time have they got to play with?

    1. Anonymous says:

      I’m afraid, Andy, that the time remaining can still be stretched quite a long way by using the wealth of the citizens in all manner of devious ways to avoid the obvious issues. No official wants to see his job disappear, and they all spend a lot of time denying that possibility. Hence the endless prolongation of the current agony. There is only upside for them, and downside for us.

  7. Andy Zarse says:

    It’s more like something out of Monty Python. The cheese shop sketch I think…. and seeing as it’s friday :-)

    Customer (John Cleese):
    Good Morning.

    Owner (Michael Palin): Good morning, Mein Herr. Welcome to
    the European Central Bank!

    Customer: Ah thank you my good man.

    Owner: What can I do for you, Sir?

    C: Well, I was, uh, sitting
    in the public library on Thurmon Street just now, skimming through The Lisbon
    Treaty by Herman van Rompuy, and I suddenly came over all skint.

    O:
    Skint, sir?

    C: Esuriant.

    O: Eh?

    C: ‘Ee I were all
    ‘insolvent-like!

    O: Ah, bust!

    C: In a nutshell. And I thought to
    myself, ‘a little fermented bond purchase will do the trick’, so, I curtailed my
    Van Rompuying activites, sallied forth, and infiltrated your place of purveyance
    to negotiate the vending of some bondy comestibles!

    O: Come again?

    C: I want to buy some money.

    O: Oh, I thought you were
    complaining about the bouzouki player!

    C: Oh, heaven forbid: I am one
    who delights in all manifestations of the Terpsichorean muse!

    O: Sorry?

    C: ‘Ooo, Ah lahk a nice tune, ‘yer forced to!

    O: So he can go on
    playing, can he?

    C: Most certainly! Now then, some monetary easing
    please, my good man.

    O: (lustily) Certainly, sir. What would you like?

    C: Well, eh, how about a little ten year Spanish?

    O: I’m a-fraid
    we’re fresh out sir.

    C: Oh, never mind, how are you on Greek T bills?

    O: I’m afraid we never have that at the end of the week, sir, we get it
    fresh on Monday.

    C: Tish tish. No matter. Well, stout yeoman, four
    ounces of Catalan, if you please.

    O: Ah! It’s beeeen on order, sir, for
    two weeks. Was expecting it this morning.

    C: ‘T’s Not my lucky day, is
    it? Aah, Irish potato bonds?

    O: Sorry, sir.

    C: Hungarian Paprika bonds?

    O: Normally, sir, yes. Today the van broke down.

    C: You do do Special Financial Vehicles, don’t you?

    O: (brightly) Of course,
    sir. It’s a central bank, sir. We’ve got-

    C: No no… don’t tell me. I’m
    keen to guess.

    O: Fair enough.

    C: Schauble?

    O: Oh! I thought you were talking to me, sir. Mister Schauble,
    that’s my name.

    (pause)

    C: Aah, how about Italian?

    O:
    Well, we don’t get much call for it around here, sir.

    C: Not much
    ca–It’s the second most popular bond in the world!

    O: Not ’round here,
    sir.

    C: (slight pause) and what IS the most popular bond ’round hyah?

    O: German sir.

    C: IS it.

    O: Oh, yes, it’s staggeringly
    popular in this manor squire.

    C: Is it.

    O: It’s our number one
    best seller, sir!

    C: I see. Uuh… German, eh?

    O: Right, sir.

    C: All right. Okay. ‘Have you got any?’ He asked, expecting the answer
    ‘no’.

    O: I’ll have a look, sir.. nnnnnnnnnnnnnnnno. All at negative
    yields Sir.

    C: It’s not much of a central bank, is it?

    O: Finest
    in the district sir!

    C: (annoyed) Explain the logic underlying that
    conclusion, please.

    O: Well, it’s so solvent, sir!

    C: It’s
    certainly uncontaminated by PIIGS.

    O: (brightly) You haven’t asked me
    about the LTRO, sir.

    C: Would it be worth it?

    O: Could be.

    C: Have you –SHUT THAT BLOODY BOUZOUKI UP!

    O: Told you sir…

    C: (slowly) Have you got any LTROs?

    O: No.

    C: Figures.
    Predictable, really I suppose. It was an act of purest optimism to have posed
    the question in the first place……. Tell me:

    O: Yessir?

    C:
    (deliberately) Have you in fact got any money here at all?

    O: Yes,sir.

    C: Really?

    (pause)

    O: No. Not really, sir.

    C:
    You haven’t.

    O: No sir. Not a scrap. I was deliberately wasting your
    time, sir.

    C: Well I’m sorry, but I’m going to have to shoot you.

    O: Right-0, sir.

    (The customer takes out a gun and shoots the
    shopkeeper)

    C: What a senseless waste of national economies.

    1. Patrick, London says:

      Wonderful start to the day. 

  8. Anonymous says:

    Shaun – good insight here. It looks to me as if Draghi is suffering from the usual political  disease of “foot-in-mouth” disease. Seriously, whenever a cabal of unelected “leaders” come together whether at a summit or ECB meeting, it does seem remarkable that for all the good that comes out at the end (?) the three witches from Macbeth could do an equally good job….. 

  9. Mike says:

    Meanwhile in the real world too, following a few ‘words’ from Draghi plus a tiny snippet  from US on jobs, and the Euro is up!!! The FTSE is rocketing and oil is exploding – up 5% on the day!!!!  All this is particularly damaging to struggling EU.
    The western economies will continue to sink while oil is so easily hyped. What in hell is going to happen to oil and other important comodities when there is real positive news coming through? I need advice!

    1. Anonymous says:

      Hi Mike

      Each time we see some “good news” we see a similar pattern of rising stock markets and more worryingly a rising oil price. I only put good news in quotes because the US employment news was okay rather than good as for example the underemployment measure  I follow (U-6) rose back to 15%.

      Whilst Brent crude (up just under 3%) rose by less than the West Texas benchmark it may catch up on Monday and if I had a choice I would prefer a lower oil price to give economies a boost to any further central bank action.

  10. El Nino says:

    Senor Draghi? True, perhaps, if he was Spanish (with a tilde).
    He is, however, Italian, so it’s Signor Draghi (no ‘o’ required).

    1. Anonymous says:

      Hi El Nino

      Apologies and of course apologies to Mario Draghi too.

  11. David Lilley says:

    Shaun,

    Another excellent blog and so many excellent responses. I particularly liked the cheese shop response.

    The BBC caught the Draghi action well with a clip from his “I will save the Euro” speech followed by a clip from his “I have said it several times, the politicians must move first” speech.

    We all hoped that he was serious with his first speech and “believe me the ECB has clout” (to paraphase). And certainly the equity markets believed him.

    But for all he hoped he could do, and might do in the longer term, the facts remain the same. Its a solvency issue and not a liquidity issue.

    It is fantasic that China and India are feeding our brothers and sisters in China and India. It is fantasic that our FTSE 100 earn 70% of their income abroad and although 50% of the FTSE 100 is owned by foreigners these earnings can prop up the benefit culture and the NHS.

    But we cannot prop up the PIIGS forever. Conditionallity must feature.

    They have disguised their uncompetitiveness by borrowing the difference between their income and expenditure for a decade. Now they cannot borrow and seek bailouts, many of which they will never repay.

    The answer is simple, call it austerity if you will, but the truth is that you can only live within your means.

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