James Surowiecki sums up last week’s momentary free fall in the stock market:
But what does seem clear is that the plunge was exacerbated by the markets’ heavy reliance on computerized trades—both explicit “stop market” sell orders (that is, orders to sell a stock once it hit a certain price) and algorithmic trades that dictate buying and selling depending on different market factors.
I don’t think yesterday’s crash is evidence the market is irrational. It’s more that it’s a-rational: the computers aren’t panicking or herding. They’re just following simple rules. I think this is bad for the collective intelligence of the market, which really depends on diversity of thought and independence of action. But what happened yesterday isn’t, I think, quite the same as the crash of 1929 or the stock-market bubble of the late nineteen-nineties. It’s an example of the dangers of a-rationality (to coin a word) rather than irrationality.
Felix Salmon thinks this is an opportunity for a financial transaction tax
There’s a very sensible idea going around that a simple way to deal with nearly all of these problems, at a single stroke, would be to implement a tiny tax on financial transactions. Historically, people have complained that such a tax harms liquidity, which is true. But the fact is that it harms the bad kind of liquidity — the liquidity which dries up to zero just when you need it most. Liquidity, if it’s spread across multiple electronic exchanges and can disappear in a microsecond, does very little actual good, and in fact does harm during tail events like this. Let’s tax it, and raise some money for the public fisc at the same time as slowing down markets and making them think before doing a trade.
I think a financial transaction tax is a good idea. It is politically more doable at this time than any other time in the future. India already has one and it seems to do no harm to liquidity.
If you think about it, sales tax is a transaction tax. Why is it that there is no demur to a transaction tax on sales of goods (except on online commerce, which again is inexplicable), but financial transactions being taxed will bring about the end of capitalism?