it to pure bartering. That would end all global competition and division of labor and cause a catastrophic decline in living standards. A practical example of the great damage that would create is North Korea.
Of course, few outside North Korea actually favor the end of all currency trading. Instead, they argue for things like the Tobin tax to curb speculative activity. If a Tobin tax was implemented, it is claimed that this would minimize speculative activity while having little effect on “legitimate” cross-border transactions and at the same time bring in revenue.
No doubt it would bring in revenue and it would clearly also reduce speculative activities. Yet it would damage the people who engage in non-speculative transactions too. And this would not only be because they would have to pay the Tobin tax too. Indeed, even if there were some way to tax only speculators, those engaged in currency transactions for non-speculative reasons would still be hurt.
The reason for this is that without speculators, liquidity in the currency markets would be dramatically reduced. Lower liquidity would in turn mean that any large transaction would cause what is known as slippage. Slippage means that the price would fall because of the transaction and so people will always get a worse deal than the current quoted price, as any buyer would have to pay more and any seller would receive less. This will make people less willing to engage in these non-speculative transactions. This is a similar mechanism to the one described in the first chapter about how economic efficiency will be hurt if marginal revenue is lower than the price.
A Tobin tax would therefore limit globalization, which for reasons described in the second chapter will damage the economy. The damage will be particularly great in the case of small currency areas, whereas the damage will be more limited for greater currency areas like the United States and the euro area.