Proponents of a tax may well contend that they are not trying to interfere with
free markets, but only to prevent excess volatility. However, we do not know how
much volatility is excessive or irrational. It’s true that economists cannot explain all
exchange-rate volatility in terms of changes in the economic fundamentals of
nations, but it does not follow from this that we should seek to regulate such fluctuations.
Indeed, some of the volatility may be produced by uncertainty about government
policies.
There are other drawbacks to the idea of taxing foreign-exchange transactions.
Such a tax could impose a burden on countries that are quite rationally borrowing
overseas. By raising the cost of capital for these countries, it would discourage investment
and hinder their development. Also, a tax on foreign-exchange transactions
would be difficult to implement. Foreign-exchange trading can be conducted almost
anywhere in the world, and a universal agreement to impose such a tax seems
extremely unlikely. Those countries that refused to implement the tax would become
centers for foreign-exchange trading.