I realise that high frequency trading does manage to get a lot of panties bunched but even so it's extraordinary, to me at least, to see the likely next President of the United States campaigning on the idea that Wall Street should be made more expensive for everyday folk to use. But that is indeed what Hillary Clinton is suggesting should happen. As such it illustrates nicely the vast gap between what the public, even the Very Serious People, believe about economics and what is true about economics. Of course, the same is true over what the public believes about physics and what is true about physics but no one campaigns for election on their misunderstandings of physics. But as the public proclamations of just about every candidate this time around (the last one to have been properly sound on the subject was probably our own Steve Forbes) show, that's the way that politics works these days. Misunderstand the economic point then campaign to mess it up further.
And yes, I am politically equal opportunity on this. Ted Cruz and the gold standard is just as much dreck as The Donald on Chinese currency manipulation is, Bernie on a $15 minimum wage and here Hillary on making Wall Street more expensive to use.
Here's what Hillary says:
Fourth, we need to ensure that everyday investors and consumers can trust that our financial markets work for them -- and not just for insiders with the most sophisticated, specialized and fastest connections. That is why we should impose a tax on the high-frequency trading that makes our markets less stable and less fair.
Note that that's a written article, not a speech where she might have "misspoke". And it really is true that the first and largest effect of such a tax on HFT would be to make financial markets work less well, more expensively, for everyday investors and consumers. Just for the avoidance of any doubt here, yes, I do know what I'm speaking about here, my one and only piece of peer reviewed research is on this very subject, HFT and the results of a financial transactions tax.
At the macroeconomic level an FTT to reduce the amount of HFT would simply shrink the overall economy. No, this isn't saying that the whizzing around of money HFT does disappears and this then comes off GDP. Rather, such transactions taxes reduce stock prices. And reducing stock prices is the same statement as making capital more expensive for companies to raise. Yes, this is true even if all public companies never do raise money on stock markets, only return it to stockholders in buybacks and dividends. For obviously the price at which a small company raises private money will be determined by the prices being paid on the public markets. This effect is large: the EU itself said that a 0.1% FTT on stock transactions would reduce GDP by 1.76%. It's just not a good idea.
But it gets worse than that when we go look at the detail. It's true that some worry that the liquidity that HFT provides won't actually be there next time we really want liquidity, in a crisis. I'm not that taken by that argument myself. However, the liquidity that is there right now very definitely has a beneficial effect, even if it might vanish just when we need it. And that's to bring dealing prices right down. If we've got million of algos and bots buying and selling stuff to each other every nanosecond then we really have got lots more liquidity in the markets. And that means that the prices we pay to buy and sell come very much closer together. As I mentioned last year:
For example, this slide set, Does Algorithmic Trading Improve Liquidity?, where the answer is yes, yes it does. Of particular interest is slide three, showing the decline in the bid ask spread over the years. From perhaps 0.17% in 1994 to 0.025% in 2004 or so. Yes, this was indeed a time when HFT was increasing and you can read through the rest of the set to see how they link the two processes. And, as I said yesterday, if the bid ask spread is reducing then this saves money for all investors. Simply because you’ve got to hand over less money to the middlemen when you buy and or sell.
Here is a quote about what has happened since that 2004 paper:
Bid-ask spreads have fallen by an order of magnitude since 2004, from around 0.023 to 0.002 percentage points. On this metric, market liquidity and efficiency appear to have improved. HFT has greased the wheels of modern finance.
Just in case you don't know, what we mean by that bid-ask spread (often called bid-offer in my native UK) is the price you get to buy or sell the same stock at any given moment. Obviously, the people on the other side of the market offer you a lower price when you sell than they will offer when you're trying to buy. And that difference between the two prices is how they make their living. Equally obvious that spread is the price we are paying to use Wall Street. And HFT has brought that price we pay to use Wall Street down by 90% in only the past 11 years.
So, Hillary's suggestion is that we should have a tax, that FTT, in order to stop people doing HFT. At which point the price we pay to use Wall Street goes back up to what we paid before HFT brought it down. That really is how it will work out. And that's what is so extraordinary about Hillary Clinton's suggestion. She really is campaigning for a law that would insist we all pay more money to Wall Street, would make using the financial markets more expensive.
It's a remarkably silly suggestion for public policy and whatever else I might think about Hillary I most certainly don't think she's dim. So I have to assume that she's simply extraordinarily badly advised on this subject. Not that that makes it much better because it still is a very bad policy idea.
