The Ramifications of a Robin Hood Tax

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

Chief Justice John Marshall, in 1819, once described policymakers’ great influence, remarking, “The power to tax involves the power to destroy.” With rising fiscal deficits and a desperate need to raise revenue, many nations have come up with various tax solutions to raise billions of dollars.

One hotly contested idea in the U.S. and Europe lately, and once advocated by John Maynard Keynes during the Great Depression, is a financial transactions tax imposing a cost on buys and sells of stocks or bonds.

The latest proposal in the U.S. was introduced by Congressman Keith Ellison. His bill would add a tax of 0.5 percent onto the sale of stocks, 0.1 percent on bonds and 0.005 percent on derivatives or other investments. To put this in a buyer’s frame of mind, when an investor purchased $10,000 in stock shares, the financial transactions tax would tack on an additional $50.

Last year Congressman Peter DeFazio proposed a similar act, suggesting a tax imposition of 0.03 percent on financial transactions. The new tax was touted in its ability to raise $350 billion in new revenue over the next nine years, without acknowledgement of the drawbacks it might place on the economic system.

Proponents say a transaction tax would discourage short-term trading, with little effect on long-term investors. Keynes once argued that it would improve market quality by curtailing short-term speculation, according to Daniel Weaver, a professor of finance at Rutgers Business School.

Opposition to a financial transaction tax says the extra cost would undermine liquidity, adversely affect market quality and distort the value of a security. Whereas incentives act as a dose of Lipitor to today’s weak monetary system, unnecessary taxes add cholesterol, delaying a smooth economic recovery, or worse, causing the economic equivalent of a heart attack. In some cases, the Robin Hood deed of “stealing from the rich to help the poor” backfires and ends up negatively affecting all investors.

In his paper analyzing tax law reforms that affect the financial industry, Tulane Law Review Professor Richard T. Page comments on four proposals in the works throughout Europe and the U.S., evaluating them under the guidelines of what makes a “good tax.”

Page writes good taxes should be effective in raising revenues and addressing the U.S. budgetary imbalance. They should reduce undesirable behavior, similar to sin taxes on cigarettes. They should be fair, and finally, they should minimize reductions in desirable behavior. This means a tax should not discourage a desired behavior “to the point that the activity does not take place” because individuals change their behavior or the cost of compliance is expensive or time-consuming.

Page concludes that under these standards, “taxing financial transactions would just be foolish revenge, generating regrettable outcomes.”

For the Center for the Study of Financial Regulation, Rutgers’ Daniel Weaver analyzed the historical precedence of financial transaction taxes by reviewing the results of 11 research papers that looked at the relationship between a security transaction tax and market quality in terms of volatility or volume.

Weaver’s study looks at market quality to answer the following questions: Is a Robin Hood tax effective at reducing volatility and speculative trading? Does it affect volume across equity markets? How are stock prices affected?

Across 28 various security transaction tax (STT) changes in 11 countries, Weaver saw no significant relationship between the tax and volatility. In other words, short-term speculation was not diminished. Weaver’s team also found “an increase in the STT is accompanied by an increase in spreads” and that “volume moves in the opposite direction of the tax change.” He also found that there was a direct relationship between the tax and price impact.

Weaver says, “Taken together, our results suggest that the imposition of an STT will harm market quality.”

Eastern European Fund Portfolio Manager Tim Steinle has been following the correlation between Hungary’s banking system and its financial transaction taxes enacted in 2010. Intended to be a temporary measure for two years to help the country repair its finances, one of the levies included a 0.5 percent tax on banks’ assets.

By March 2011, OTP bank, Hungary’s largest lender, reported that it had a fourth-quarter profit decline of 15 percent. Trouble for the bank continued in the first quarter, with its net profit falling 12 percent year-over-year due to the impact of a special banking tax. Excluding the tax, the profit of OTP would have risen by 4 percent.

It wasn’t only one Hungarian bank that was negatively impacted. Bank credit growth rates across Hungary also plummeted due to the hefty bank levies imposed. In an earlier Investor Alert, we highlighted the chart below in May 2011, which shows a year-over-year credit growth rates across Eastern Europe in May 2011. Hungary’s household and corporate sector credit growth rates were anemic compared to other Eastern European countries.

Could a transaction tax have a similar unintended consequence for American banks? While the jury is still out on that answer, Hungary’s example is a reminder to policymakers to comprehensively consider the rewards of collecting a Robin Hood tax along with the risks.

 

 

Index Summary

• The major market indices fell slightly this week. The Dow Jones Industrial Average declined 0.10 percent. The S&P 500 Stock Index fell 0.38 percent, while the Nasdaq Composite lost 0.13 percent.
• Barra Value underperformed Barra Growth as Barra Value fell 0.81 percent while the Barra Growth index declined just 0.03 percent for the week. The Russell 2000 small capitalization index closed the week with a loss of 1.06 percent.
• The Hang Seng Composite rose 0.04 percent; Taiwan gained 0.21 percent, while the KOSPI decreased 0.26 percent.
• The 10-year Treasury bond yield fell 11 basis points for the week, to 1.75 percent.

 

Domestic Equity Market

 

The S&P 500 Index declined 0.38 percent this week, consolidating in the wake of the Federal Reserve’s decision to conduct open-ended quantitative easing via purchases of mortgage-backed securities and to keep interest rates exceptionally low through mid-2015 to boost employment. This week Japan followed bold policy actions of the European Central Bank and the Fed by expanding its own asset purchase programs to weaken the yen. So far we have observed concerted efforts by G3 countries to further expand the central bank balance sheet in a bid to stimulate economic growth.

 

Strengths

• The telecom sector rose 2.4 percent, the best performer, led by prepaid and postpaid wireless operators one week after Apple’s iPhone 5 release. MetroPCS and Sprint Nextel rose 9.4 percent and 7.4 percent, respectively, this week. Sprint’s CEO also predicted wireless industry consolidation in an investment conference.
• The healthcare sector was the second strongest performer this week, advancing 1.83 percent. Gilead Sciences was up 9.31 percent on positive survey reviews of its HIV single-tablet regimen. Tenet Healthcare climbed 7.29 percent on the prospect of improving hospital reimbursement rates from Medicaid.
• MetroPCS was the best performing stock for the week. The company, adding 300,000 LTE subscribers in the last two months, is launching voice over LTE service in all of its 14 markets in 4 to 6 months.

Weaknesses

• Cyclical sectors took a breather this week after surging last week in response to the open- ended quantitative easing announcement by the Fed. The financials, energy and materials sectors, the top three performers last week, ended up in the bottom three this week.
• The energy sector declined together with a more than 6 percent retreat in crude oil prices on comments that Saudi Arabia had raised production and speculation of a release in the U.S. strategic petroleum reserve ahead of the presidential election.
• Alpha Natural was the worst performer this week in the S&P 500, falling by more than 15 percent on concerns that the company’s credit ratings may be lowered by Standard & Poor’s due to closure of eight mines and production cuts.

Opportunity

• While debasing the value of their paper currency in the long term, renewed money printing in the developed world may have the ability to send asset prices higher in the near term.

Threat

• The market will now shift to earnings preannouncements and the upcoming elections, which could cause some volatility.

 

 

The Economy and Bond Market

 

Treasury yields rose for a fourth week in a row. Additionally, the benchmark 10-year yield is on the verge of breaking above the technically significant 200-day moving average.

 

Strengths

• Existing home sales advanced to their highest level since 2010, according to new data from the National Association of Realtors. The pace of sales jumped 7.8 percent in August to an annual pace of 4.82 million units, eclipsing expectations for a more modest 2.0 percent gain.
• The current account deficit in the U.S. narrowed more than forecast in the second quarter, helped by a pickup in exports and a bigger income surplus. The gap, the broadest measure of international trade because it includes income payments and government transfers, shrank 12 percent to $117.4 billion from $133.6 billion in the prior quarter, a Commerce Department report showed today in Washington.

Weaknesses

• The Empire Fed Manufacturing Index came in at its lowest level since April 2009, and was well below expectations. The report confirms the biggest 6 month drop since records began. Manufacturing in the Philadelphia region contracted in August for a fourth consecutive month as orders and employment declined.
• The index of U.S. leading economic indicators fell in August, led by a decline in new orders for manufacturing. The Conference Board’s gauge of the outlook for the next three to six months decreased 0.1 percent after a revised 0.5 percent increase in July, the New York-based group reported today.

Opportunity

• The European Central Bank (ECB) appears ready to implement further QE in the near future to improve financial stability in the region.
• With further weak economic data out of China, odds of additional easing measures continue to move higher.
• Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

 

Gold Market

For the week, spot gold closed at $1,773.10 up $2.70 per ounce, or 0.15 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 1.75 percent. The U.S. Trade-Weighted Dollar Index gained 0.61 percent for the week.

Strengths

• Gold prices remained firm, despite several bouts of inter-week profit taking that pushed gold lower at the market open. Sellers only found there were willing buyers to take the price higher upon their exit.
• Gold stocks also put in positive gains for the week with smaller miners and explorers outpacing their senior peers. Junior silver miners also outperformed their senior peers.
• Sales of the U.S. Mint’s American eagle gold coins climbed to 45,000 ounces according to their website. This exceeds the 39,000 ounces sold in August, so there is some pickup in momentum.

Weaknesses

• Platinum and palladium prices pulled back this week with the settlement of the Lonmin strike in South Africa.
• Lonmin agreed to as much as a 22 percent hike in wages, marking the single biggest wage spike by a mining company in South Africa.
• Credit default swaps for South African debt surged on the news. The platinum mines were making just enough money to cover maintenance at their operations with nothing left to invest in further mine development.

Opportunities

• Gold Standard Ventures reported another set of exceptional drill results at their Railroad Project’s Bullion Fault Zone. Results included 124 meters of 4.05 grams per tonne, including 16.5 meters of 15.1 grams per tonne. This step-out hole confirms the emergence of a growing high-grade core zone that is still open in all directions according to the company.
• Both Jim Rickards and John Mauldin were recently interviewed on Capital Account by Lauren Lyster. When talking about the U.S. debt problem, Jim Rickards outlined his view on what type of solution the Fed is crafting to solve this problem. He suggested a plan of targeting inflation at 5 percent for 14 years to cut the value of the dollar in half in real terms. China owns $3 trillion of our debt and this would effectively be a $1.5 trillion real wealth transfer from China to the United States. This is the easiest solution to our debt problem and is the most likely choice policy makers will take.
• Ray Dalio, who runs the world’s biggest hedge fund, told CNBC today that Warren Buffett is making a “big mistake” in not holding gold. He stressed that every investor should hold “some degree” of gold in their portfolio.

Threats

• Strikes at gold mining operations in South Africa are a concern. Gold Fields has already seen work stoppages at the KDC West operations. In response, the Chamber of Mines which negotiates on behalf of the gold miners is examining the option of bringing the upcoming wage talks forward to address the problem.
• According to analysts we spoke with this week, the fact that Gold Fields is already having problems is reflective of which company may have the least attractive labor relations going into the negotiations.
• As far as AngloGold’s and Harmony’s labor relations stand, Harmony has worked the hardest over the past four years with their employees to understand the economics of mining, and their workforce gets it.

 

Energy and Natural Resources Market

Strengths

• Chinese steel inventories decreased for its eighth consecutive week. Chinese steel inventories in warehouses totaled 13.7 million metric tons at week ending September 14, 4 percent lower than last week and the prior year, and now compare to a 12-month trough of 12.8 million tons in late December.
• China daily crude steel output for the first 10 days of September increased by 1.2 percent to 1.895 million metric tons per day (mtpd) versus 1.87 mtpd in the last 11 days of August. This latest figure annualizes to 692 million metric tons per year versus output of 680 million metric tons in 2011.
• Aluminium exchange prices have rallied almost 20 percent in the past month, with “net prices” now cresting almost $2,450 per ton outside of China.
• Argentina's 2012-2013 corn season, which many analysts think could yield a record harvest, has gotten off to a good start as moist fields spur seeding, the Buenos Aires Grains Exchange said.

Weaknesses

• Crude oil fell by roughly 6 percent this week as the market has been hit by fears of an Strategic Petroleum Reserve release and possible steps by Saudi Arabia to bring Brent prices back towards $100 a barrel.
• Chinese steel production came in at 58.7 million metric tons in August 2012, or 1.89 million tons a day according to China’s National Bureau of Statistics. The daily rate is down 4.8 percent month-over-month and down 1.75 from the prior year.
• Uranium’s recovery from the Fukushima nuclear accident may take one or two years longer than analysts estimated as stockpiles in Japan and Germany keep prices low and cause mining companies to defer new development. The price of uranium for immediate delivery declined to $47 a pound as of September 17, its lowest in two years according to Ux Consulting, a Roswell, Georgia-based uranium information provider.
• Australia revised down its revenue forecasts for the key steelmaking ingredient by a fifth this week, a fresh sign the industry is losing steam as a slowdown in top-customer China drives down prices. The Bureau of Resources and Energy Economics (BREE) forecast revenue from iron ore, Australia's largest single export, would fall to $55.83 billion in the current fiscal year.

Opportunities

• China’s Inner Mongolia region is said to plan the closure of nearly 2,900 mines over the next seven years, 900 of which will be smaller, high cost and less safety conscious mines.
• In a call hosted by the management of International Paper Inc., the CFO stated that they see a critical “inflection point” of profitability in the packaging industry given tight supply/demand fundamentals.
• The UBS mining team in Asia expects the recent bounce in the price of iron ore to continue into the fourth quarter based on favorable seasonal factors, an improved metal spread that has improved profitability for Chinese steel producers, and improved sentiment among buyers following the announcement of the Rmb840 billion urban rail projects in China.

Threats

• BHP Billiton Ltd., the world’s biggest mining company, said the pace of iron ore demand from China, the biggest importer, has slowed by more than half. “We’re already seeing the beginning of the end of the first phase of economic development in China,” Alberto Calderon, the Melbourne-based company’s chief commercial officer and manager of its aluminum and nickel business, said today at a conference in Canberra.

 

Emerging Markets

 

Strengths

• China needs more subways, highways and sewage plants, and construction of those infrastructures will help the economy, Xu Lin, the head of the planning department at National Development and Reform Commission said this week.
• Malaysia’s CPI stayed flat at 1.4 percent in August as in July.
• The Federation of Thai Industries reported solid August auto production of 210,333 units (up 37 percent year-over-year), driven by strong domestic sales.

Weaknesses

• HSBC September Flash China PMI was 47.8 versus estimate 47.6 for August, which, though improved on a month-over-month basis, indicates that the economic activities still are contracting. However, new orders overall increased to 47.6 from 46.1.
• Taiwan August export orders fell 1.5 percent year-over-year, improving from the contraction of 4.4 percent in July. The market expects export orders in tech products to revive going forward due to iPhone 5 and Windows 8 ODM plays.
• Turkey GDP growth, which was 8.5 percent in 2011 and 3.3 percent in the first quarter of 2012, slowed down to 2.9 in the second quarter.

Opportunities

• Foreign investors have consistently put more money in Asia equity markets, such as the Philippines as shown in the graph above. Particularly, Association of Southeast Asian Nations countries are on the rise in consumer spending and infrastructure investments helped by an increasing middle class and growing government balance sheet.
• India opened retail and aviation sectors for foreign investment, cut the fuel subsidy by 12 percent and cut the withholding tax on local corporate bonds held by foreigners 20 percent to 5 percent.
• In a separate move, India’s central bank cut its reserve ratio requirement for the banks by 25 basis points, setting the stage for a rally in financials.

Threats

• The tension between Japan and China over disputed islands in East China and North Taiwan is escalating with some possibility of trade and military clashes.
• Credit Suisse remains cautious on the Polish banking sector, and cut 2012 earnings forecast by 13 percent due to cyclical pressures from lower loan growth and higher provisioning charges.
• President Putin was critical of the proposed budget for not incorporating provisions for several of his election promises. This higher expenditure will have to be financed through borrowing and/or higher taxes.

 

 

© US Global Investors

www.usfunds.com