Markets and financial regulation expert Peter Wahl from Weed e.V. says liquidity is like water in a river.
Peter thinks sometimes, like now, there’s too much of it.
“I’m in favour of liquidity, but not an excess of it,” he told us.
“Sometimes there can be too much, and it floods the market.”
Weird. The argument we always hear is that liquidity is good, more liquidity is better. It’s an especially common argument to hear from high frequency traders.
Here’s why Peter thinks too much liquidity is bad:
- It provides permanent incentives to profit and trade. This means there is also a lot of pressure to gain profits. As a result, trade is increased just to find new opportunities everywhere. It pushes the machine to an extreme.
- When there is an abrupt change, liquidity is reversed. That’s a stability risk.
It’s funny because basically, this isn’t far off from the argument we’ve heard in favour of liquidity. But what Peter seems to be want decreased in the market all kinds of liquidity from high quality liquidity, which some argue is mostly added by longer-term investors.
Peter’s solution to the too-much-liquidity problem is a transaction tax, which he says is increasingly likely to pass in at least the Euro Zone. (Check out this letter we found yesterday – it supports his argument.)
He says obviously there should be a test period during which a very small transaction tax is implemented. And it should always be a flexible amount that changes based on how much liquidity is in the market and how healthy it is.
His bottom line: A transaction tax would provide an implicit ceiling on liquidity that would size down unhealthy overflow.