Financial Markets, Money and the Real World

Financial Markets, Money and the Real World

Paul Davidson

Paul Davidson investigates why the 1990s was a decade of financial crises that almost precipitated a global market crash. He explores the reasons why the global economy still struggles with the aftermath of these crises and discusses the possibility that volatile financial markets in the future will have real impacts on whole industries and national economic systems.

Chapter 12: Exchange Rates and the Tobin Tax

Paul Davidson

Subjects: economics and finance, money and banking, post-keynesian economics


Eichengreen, Tobin and Wyplosz have argued that volatility in foreign exchange markets due to speculation can have ‘real economic consequences devastating for particular sectors and whole economies’.1 To constrain speculative behavior in exchange rate markets, Eichengreen et al. propose a very small tax on all foreign exchange transactions. At the same time that this proposal appeared in print in the winter of 1994–95, the Mexican peso crisis spilled over into the dollar problem. In international financial markets where image is often more important than reality, the dollar was initially dragged down by the peso while the German mark and Japanese yen appeared to be the only safe harbors for portfolio fund managers. Only after the Clinton administration bailed out the Mexican peso by providing a long-term dollar loan did the dollar recover on international foreign exchange markets. In April 1995, Federal Reserve Chairman Alan Greenspan testified before Congress that ‘Mexico became the first casualty . . . of the new international financial system’ where electronic global communication permits hot portfolio money to slosh around the world ‘much more quickly’. Keynes had likened the battle of wits among portfolio fund managers to find financial assets whose price would rise, to a beauty contest where [I]t is not a case of choosing those which, to the best of one’s judgement are really the prettiest, nor even those which average opinion genuinely think the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects average...

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