A lesser evil of a transaction tax

You know where I stand, I hate the very concept of a transaction tax, but if we were to have one, then let me go the "lesser evil" route. Because as it stands, what's been proposed will not work. First the guy who posted about financial markets was spot on. You'll kill what's good about the markets along with bad. Companies need capital, hell the government now needs a stock market because it owns so much stock (as citizens, it would be nice if Uncle Sam made a profit on that stock so it could redeploy that capital to say infrastructure, I'm just saying.). Robert challenged me to come up with an alternative to meet his objections, so I will give it a go.

With regards to markets, you have the institutional players, the commercial traders, the independent traders, and lastly retail. This is tax will kill the independents like myself, many of the commercial traders (lets just say the smaller weaker market makers). This then puts institutional players like the largest banks and funds to the largest commercial traders like Goldman (despite they're recent classification, they're NOT a bank). And then you have you, the retail trader who doesn't actively trade. But at the end of the day, the folks you hate the most will have the ability to bear this cost. And then they will spend their days getting exclusions, and trust me given the corrupt nature of Congress, it would only be a matter of time.

Lastly, given that not everyone is on board with this, you will have a country that will benefit from this. You say it has to be global, well that isn't happening, and you have to accept that. At best, you could get the UK and the EU, possibly the US but I doubt it. But lets say, for arguments sake you get the UK, EU and the US, and I'll even add Canada. Capital will then flow to Asia, and within a couple of years new corporate filings will be established that would appear to severe ties with those above mentioned countries.

Ok, enough of the negative talk, lets talk something positive. Much ado about all that good stuff exchanges and traders like to play with. I will focus on exchange agreements, derivatives, OTC and futures and such. First and foremost, you have the Commodities Futures Trading Commission impose several new regulations.

1) Ban exchanges ability to sell those millisecond "previews." Exchanges like the NYSE and Nasdaq-OMX have made oodles of cash that way, and given folks like Goldman an unfair advantage. Trust me, a lot of us independents hate that as well.

2) Have the Commodities Futures Trading Commission ban all OTC derivatives contracts. All derivatives contracts trading must be on a regulated exchange with a mandatory clearing mechanism. If you can't get a CFTC approved derivatives clearing organization (DVO) like say LCH Clearnet, then the product cannot be traded. Impose penalties, in fact I would make it a federal crime to trade these "illegal" instruments. No clearing, no trading. The CFTC has several DVOs who have a long history of clearing, some going back a century. There really isn't an excuse to not find a clearing house. Lastly, the exchanges themselves will have to eliminate their OTC software divisions. Things like Clearport must end. If they don't wish to trade on electronic exchange platforms like Globex or the pits, then the products don't trade.

3) Have a clear cut mission for the derivatives contract, particularly geared towards hedging. You can allow others to speculate so long as the trades can be properly matched (See above on clearing). But if there is no proper hedger activity, then the contract should be nullified. Also, all derivatives products must originate from an exchange not an investment bank. If, for example, the CME Group will more likely find hedgers for a product than say Goldman who would just focus on their clients.

4) Black pools must be converted into an exchange. The reason a lot of black pools were formed was because 90% of the participants had block trades. Block trades are shares of stock if a factor much larger than the average shares up on the book. Those behind those block trades fear getting found out and getting screwed on a price. Remember, these could be an institutional player like a pension fund trying to unload 250 thousand shares of IBM at one time at a set price. If they posted that on the main book for "I-beam" every trading desk from Goldman to Merrill will be like wolves on a beached whale. Ironically enough, folks like Goldman use it for the same reason. Above all you get anonymity, all one sees is the trades. There is a myth that the shares on dark pools get a better price. That isn't true as the price feed is the same as the exchanges. Instead of several private dark pools, force such trades into a separate exchange like Instinet. You can keep the anonymity, but at least we will no there are all these shares out there. The key is that you're removing the trades from an over-the-counter setting to a regulated exchange setting.

5) Energy derivatives shouldn't have cash equivalents. We have energy contracts that do not deal in any physical product at all, these are called cash-settled contracts. In these situations, when expiration comes, cash is exchanged instead of the physical product. The bulk of cash settled contracts are normally in financial or index futures contracts, which in that case makes sense. This is not the case for energy futures! The reason why I think this is horrible is because you move away from the economic reality of the product and into some financial casino. It started with oil and now it is moving on to ethanol and gasoline and who knows what else. Look at it this way, if you had to worry about finding barrels of oil or ethanol (that's in barrels too, right?) then you won't put on as many trades. Try this as an exercise, look when the first financial oil contracts came out on the NYMEX (now CME) and correlate that with the activity in the price of the underlying. A futures contract should stick to the underlying economics for which it was originally created. It shouldn't be turned into a casino video game who's theme is oil but really isn't.

6) Raise margins on energy contracts. One of benchmark crude contracts is the Light Sweet Crude Oil contract, which represents 1000 barrels of oil, which at the latest prices means the contract is worth $74,500. The margin to open a trade and control one of these contracts is $5,400 or 7% of the value of the contract. You are given almost 14 times leverage for this product. Now yes when you see the price go up, margin rates as well go up, but the leverage tends to be about the same. That shouldn't be for a product like this. Even at $5400, you can get someone with even $10k to play with this thing, and if oil is jumping you'll get more gamblers. Oil shouldn't be gambled on, and also given such a low margin requirement, it also makes it easier to load up on more contracts. While outfits like Phibro (though I think they've dealt mainly in Spot) could still afford to pay a higher margin, they would not get as many. The main thing is to reduce the smaller speculator in this contract. Yes, that contradicts what I've said about liquidity, but oil isn't like the S&P or 10 Year contract nor corn. What the exchange should do is first raise the initial margin to 25% of the value of the contract, then install an automatic increase in margin at the same rate of growth as the underlying product. If oil jumps 25% in two months, so should the rise in margin. You see, eventually margin becomes too costly, and a lot of folks will be forced to liquidate. This starts adding a downward pressure in oil.

7) Rapid transaction trading should be allowed. I know you hate this, but if you implement what I've proposed above, rapid trading will lose most of it's advantages. Remember, it's fast to begin with because they get to look behind the curtain before you do. Take that away, and all you get is an algorithm box that simply is attempting arb situations or buying the bid or attempting to sell at the ask.

8) Establish global clearing and exchange partnerships. There are exchanges that trade similar products that are here, and vice versa. What we don't want is for some investment banker to skip town and trade the same thing in Europe but by different rules for the product. This is in regards to derivatives, they need to be fungible. So if one trades Brent oil on the ICE in Europe, it's the same product here in the US be it on ICE or the CME's Globex. Oh the exchanges will hate this, but it should be made clear with derivatives, the rules above apply to all and it should be global. If the Dubai Mercantile Exchange wants to come up with a sour crude contract for example, well if there is one trading in London or New York, it should comport to those, otherwise they won't get CFTC approval. Now hole in this idea is if say Goldman says screw you I'm trading it anyways and creates an offshore entity and that entity loses money. The only thing I can think of is going back to #2, and essentially charge Goldman with a federal crime.

9) Regarding energy and commodity ETFs, originally I was dead set against these and now iffy, but so far the latter is facing problems and many have actually shut down. GLD on the other hand I think is adding to the run up in Gold. See, it helps in liquidity, and opens the door for folks to buy commodities without actually getting into the futures market directly. GLD is actual physical gold. USO, the oil contract is really futures contracts (actually the front month one only, USL is better because you get the price change over 12 months). The thing is, both are adding buying pressure when the markets are going up, and selling pressure when it's a bear market. On top of this, folks investing in these aren't really getting stuff that 100% correlates with the underlying.

Ok, now on to revenue sourcing. If you do it the way it is proposed in the previous transaction tax proposals, at best you'll get a year's worth at that 100 billion mark. But like that smoker example I saw on here, you want them to keep coming. Add in the proposals above, and you will curtail a lot of the craziness while garnering revenue. To be honest, I hate paying a tax on transactions if I don't make a profit. But since Robert challenged me, I'm gonna grin and bear it and show you how I would do it.

First off, don't take off a percentage of the total of the transaction. You will discourage activity. What you want quantity. The only exemptions I have given is for hedgers in the futures , if you want to include retirement funds, be my guest. Just remember, any additional exemption you open the door of folks like the investment banks to try and get by.

For stocks, you need to adjust to certain price points without discouraging trading. What I would do is for the first and up to 100 shares of stock above $10/share, charge a flat fee of $.10. Now I know what you're saying "that isn't enough." True, but first the fee is virtually hidden, and secondly market makers won't bother gaming the bid/ask on such a low thing. So what's to stop them from buying 99 shares? They still pay it, every and up to 100 shares. Now when a stock reaches $50/share, I would say a flat fee of $.50. For stocks $100 and above, smaller traders will go towards the options, but for those that do trade then $1 flat fee. Now, if you want a higher turnover, those trading a 1000 shares or more would get a 50% discount. While on the face of it, you make the same amount, but if they think they're getting a deal, trust me they will actually trade more.

For options on stocks, same deal except you're tacking on the fee onto the premiums and not the strike prices. If you went for the latter, you may end up discouraging trading at certain strikes. Remember, you want quantity and turn over. Premiums at $.01 to $1 are the same as a stock trading at $1 to $100, the "fee" is a flat .10 cents/contract. For any premium above $1, a flat fee of $.50/contract. When and if they wish to exercise the options, it shall be regarded as a new stock transaction and the fees to that shall then be applied. With regards to stock index options with multipliers of $100 like the SPX and NDX , a flat fee of $.50/contract at all strikes; the newer mini stock index options with multipliers of $10 like the DJX, a flat fee of $.10/contract.

Now we get with futures contracts. With some contracts you get a lot of turnover, while others almost nothing at times. A flat fee of $1/lot, for front month or "actively traded" contracts (these could vary, for instance you have active contracts in the Eurodollar all the way into 2010). You could alter this for energy contracts, peg that fee increase to the increase in of oil for example. Outside of these, a flat fee of $.50/lot. Hedgers in agricultural products like corn, who make delivery (take note Goldman, you can't just buy some corn store it in a silo and call yourself a farmer) or use the product for commercial usage, can gain a tax credit on these "fees." I know some of you will not like the fact that Monsanto could take advantage of this, but I'm trying to avoid using these fees as an excuse to hike up the price of food.

Options on Futures are a flat $1/contract (Put or Call). If exercised, it will be treated as a new futures trade. Credit for commercial hedgers apply here as well.

Also, for options for stocks and futures, if you're attempting a covered call or a buy-write at once, the fee could be applied to whichever is greater. Or, you could apply it to both, even though many consider it a single transaction if done at once. I can see the legal challenges by brokers on that one.

Treasuries and bonds should also have a fee, I would say a sliding scale, the longer the maturity the smaller the fee, start at $1/bond or every $1000 worth of bonds. Yes, it may discourage some from participating, but there is still a ton of demand for government debt. Like the futures above, $1/bond for any maturing under 5 years. The reason why I picked 5, is our foreign creditors seem to be going for shorter term maturities, even the 10 year is getting the shaft. Nuts to them I say.

You may have noticed that I didn't separate things like credit derivative swaps or gold or the S&Ps. The fact is a derivative is a derivative, the only time I did any segregating was with the options. That was because they're priced differently. A credit default swap, if it is forced onto a regulated exchange, will be standardized. Thus one default swap contract is just about the same as one S&P contract, just the terms are different.

Forex/spot currency trading on the retail front have a weird setup with regards to units of currency traded. Outfits like Oanda let you pick the amount, even one unit (like one single Euro or Yen), while others like FXCM have set amounts. What I've noticed is that the popular amounts tend to either be 10k units or 100k units. For the retail FX trader, we need to enforce some standards here, I would go with a minimum of 10k units. There is also the issue of leverage, with the ranges being between 20x to 400x, though some let you even set it to 1x. Here again, the popular leverage defaults have been either 50x or 100x, there needs to be a standard but we can actually use this for the fee structure. It should be a tiered structured tied to leverage. Tier one (lev. at 20-50x) fees are $2 per 10k units, $20 per 100k units. Tier two (lev. at 50+x - 100x) fees are $4 per 10k units, $40 per 100k units. Tier three (lev.100+x - 300x) fees are at $10 per 10k units, $100 per 100k units. Tier four (lev. 300+) $20 per 10k, $200 per 100k. You can see here what I'm doing. I've seen a lot of retail traders fall for that ubber leverage and get wiped out. It's really a trap, and should be discouraged.

Hedgers get the exemption, but the CFTC will have to update what qualifies for such a title. The last thing you want is an investment bank, for example going out and buying oil on the spot market and storing it, operating the whole thing under a subsidiary "energy company." If said investment bank says it is working on behalf of a client, then the i-bank DOES NOT get the exemption nor the subsidiary, but the client itself.

Compared to the other transaction tax bills, on the face of it, the revenue generated is smaller. The thing is, here you maintain the capital markets. You won't get a collapse in liquidity because the fees are so small it's almost negligible. What you want is turnover, and so you want the cost of doing so to be very low. Under the other proposals, this would drop and then in the end you would not have revenue like you thought. My goal was for long term income streams. It is important that the first 9 regulations be met.

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Comments

Very good proposals!

and unfortunately I've seen much of these and guess what, our Congress is busy making swiss cheese instead of regulatory reform, esp. on derivatives.

I think you saw the 4 5 major loopholes which exempt 50% from clearing, 100% from trading requirements.

Supposedly this isn't enough and the lobbyists are gearing up for the Senate

But I especially like the scaled idea of a transaction tax. these absolutes Congress loves simply do not work in a real time dynamic economy.

On transaction taxes, they do have to be global or some sort of thing that stops a mass exodus. Sweden implemented a Tobin (transaction) tax and this is precisely what happened.

I don't have issue with "high frequency" trades but believe that technology itself, needs to be regulated. I said this on the mathematical models being used in derivatives as well. It's too easy to game the system with technology. (See GS Flash trading as an example, supposedly using fast routing algorithms).

I think different fees and scales for different types of trades is right on. I'm fairly certain one of the targets is that great gambling casino on critical commodities.
Oil is one you're talking about but another is Ag.

Food prices are set to skyrocket next year, so we know what that means in terms of "gambling casino" and on something like food, a bubble is really not a good idea for the globe.

When you say "hedgers" are you talking about the many companies that hedge or "hedge funds", because the later are getting away with murder, basically paying a 15% income tax de facto as base.

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Oh yes, I did read those

Oh yes, I did read those loop holes. And now I'm also hearing rumors that certain "banks" that provide liquidity of a certain caliber would be exempt. It is a rumor, but it's also on Bloomberg. As you can see, it's already starting on the hanky panky I warned about.

But anyways, back to your comments, my friend. Regarding hedge funds, no they would not qualify. As mentioned, if it is a financial firm working on behalf of a company who is actually in the commercial side of the underlying, then it is the latter that would get the credit not the financial firm. Hedge funds are just another trading desk in my book, and they would be excluded.

The scaling on fees is doable. especially on treasuries. If you think about it, if interest rates have to increase to sell bonds, this fee on treasury securities would sorta recoup that. I know it's a stretch.

Ag products have wilder swings, especially if you take seasonality into consideration. Scaling on these could end up hurting farmers, one can substitute various grains for another. You really can't say that about petroleum except for switching from that to say nat gas. But I highly doubt companies like United or even Virgin have the money to overhaul their fleets completely, let alone on the fly. The same with automobiles, you're not going to change your car overnight are you? But you can switch from one type of wheat to another if one is relatively cheaper. I'm reminded of a drought situation back in the mid 95-96, corn had skyrocketed from $2.40/per bushel to the mid $5.60. It had taken almost a year of constant upswings and limit locks. But when it hit that 560 mark it started falling and fast. By early autumn of '96 corn was back around 2.60.

Lastly, you're not going to get anything global with fees. If you make them innocuous enough, others may copy it. In the example I wrote, I had the US, EU, UK and Canada implement the fees (or their version). The only global agreements I see happening is between the exchanges on the products. Honestly, if you want worldwide, you have to go through the exchanges. Asia thinks itself as a growth economy and that "its their time in the sun now." They will hold any proposals like this as an attempt to stifle their chance at economic growth. Look at how China and India are reacting at Copenhagen. Thats another reason why I included the exclusions on economic players of the underlying. Asia either manufactures things or grows things. Give the rice farmer and the company buying the commodity a break, and you will get an agreement. Outside of Singapore and Tokyo, the financial sector is mainly geared towards aiding the export economy. In Tokyo, they've only now come around with stuff that doesn't involve export. So they don't care about fancy contracts like we do here. Hence you focus on the underlying. You see what I'm getting at here?

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Any other dictates?

Fortunately it’s unconstitutional for regulators in this country to arbitrarily and capriciously interfere with commerce.

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You're an idiot

miasmo.com

The Constitution grants the federal government the power to regulate interstate commerce, so what the fuck are you talking about?

And there is nothing about these proposals that is either arbitrary or capricious, so again, what the fuck are you talking about?

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hey, hey, hey

Let's be specific on EP and keep the insults off the site. Our motto is "when in doubt, use a calculator" and "be good to each other"...

so let's not resort to name calling please to make a point.

i.e. you're right and someone trying to claim any regulation "interferes with commerce" probably has been asleep for the last 2 years but... leave the rage for the ones in power, controlling legislation, policy. ;)

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What are we trying to accomplish?

What are we trying to accomplish with a transaction tax? Is it to generate revenue? Is it to punish the financial sector? Is it to make the financial sector smaller?

While the idea of a transaction tax is interesting we have to be cognizant of the purpose. If we are trying to generate revenue there are better ways of doing that - ie income tax code.

If we want to punish financial sector and/or make the financial sector smaller? There are better was to accomplish that - eliminate "too big to fail" concept and market transparency.

I agree with JV's points on regulation of markets but unfortunately that is not where we are heading with current bills.

I also believe that we need to decide if some of these derivatives really have value - particularly some social value or are they a means for some entity to derive more fees.

RebelCapitalist.com - Financial Information for the Rest of Us.

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It was my understanding from

It was my understanding from Robert's challenge that
1) establish a revenue stream to aid well...supposedly infrastructure and jobs (I'm dubious about this as I just don't trust Congress).

2) Curtail OTC activity

3) Attempt to rain in market malarky like the exchanges selling "previews."

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a few more

1. Highly Progressive tax structure
2. Stop speculators from distorting markets and creating bubbles (oil 2008).
3. curtail systemic risk with this sort of circle jerk derivatives trading (i.e. CDSes via AIG where GS is middleman game of hot potato).
3. Capture those corporations/hedge funds who are escaping any real fair share of taxes and not adding much value to the "real" economy.

I don't trust Congress either on revenues. So, odds are the tax would have to be allocated to something specific, say pay down the deficit. They already have raided SS repeatedly.

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meow meow meow meow (can't think of anything for a title)

1) You can't implement such a thing because the tax is automatically assessed at the time of the transaction. There is no way to know the income level of the client, as trades are handled by the brokers, who then later pass on the cost of the tax. The only possibility is to increase the fees at certain volumes of orders (i.e. 1000 shares to 10k shares pay one tier, etc). But here you will also invite hanky panky.

2) Oil trading on the spot market is next to impossible to regulate. Most deals are done over the phone or electronic on proprietary OTC networks. For example, some company, say Aramco could have sold oil to Phillips, but while the barrels are in shipment, they could have gotten an offer for that cargo. So Phillips simply orders the ship to go to whatever terminal that new owner uses. Spot oil isn't a derivative, it's the actual product.

Now regarding benchmark contracts like on the NYMEX, well I've already proposed scaling the margin. Also as oil grows in price, so do the trading fees. Eventually the smaller speculators won't be able to bear the costs and drop out. You could concievably raise margin levels to even 50%. If you outlaw financing such transactions if margin costs reach a certain threshold, then even Goldman wouldn't be able to hold on for long.

AIG and GS should be able to trade these things, but once more if it is on a regulated exchange, its rules that we play by. AIG got in trouble because essentially the over traded. Goldman didn't care. And the costs of putting on that trade actually was made easier at times. If, as proposed, these contracts were only allowed on the exchange, then you see where everyone is at. Think about it, this won't be over the counter, there will be an order book. Secondly, all parties must have put up the performance bonds (margin). There will be a clearing mechanism.

3) That's more of an income tax thing. I'm not sure what you want out of this by fair share. You want to raise corporate income taxes?

With regards to congress, I still don't believe the bill would go for so-call jobs creation. And lets be honest, it isn't a WPA we're talking here. What would end up happening is that the money would be taken from one constituency and then placed into the hands of another constituency. You take from a bank in a New York City congressional district, and give it to a construction company in say a Cleveland or Dallas congressional district. Let's be honest, that's whats been happening. Often it's to the backers of a given candidate, masquerading as public works.

Frankly, I would be more in support of this if it were legally binding to something specific, as you said. The only worthy things, in my opinion at least, would be for the following:

1) National Health Insurance
2) Deficit reduction
3) National debt reduction

It has to be for only one of the three to be truly effective, otherwise it's too watered down. Also, say it went to one of the second two, then Congress shouldn't realize it can still spend that amount and think the fee revenue will cancel that out. If you bring in 10 billion, for example, then Congress should cut 10 billion in spending. Make it count, don't replace one with the other. In regards to the first one, it could be used as a lock box fund to pay for subsidizing premiums for low income or what have you. You get the idea.

What you don't want, is the revenue stream to become another pork funding vehicle. Or say you saw an increase of 50 billion from this, that Congress now thinks it can increase spending by the same amount.

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bark, bark, bark

looks like we're stealing NC's theme.

Ok, the transaction tax is a transaction tax, not based on overall gross profits, income etc. of individuals or corporations. I'm referring to the fact many investment institutions pay zero corporate tax to hedge funds being able to manipulate income tax to a 15% capital gains tax through various loopholes.

Simply observing that their profits are made from markets hence a transaction tax would capture this area. I'm not confusing income vs. a transaction (Tobin) tax.

On spot oil, sure if they must take possession of the physical commodity, I don't see any issue here.

Not what I was referring to.

Yes I saw your scale but what I am saying is to just take one type of commodity, traded on the NYMEX for ex. oil futures, and on just that one element, try this tax. Instead of across the board on stocks, options, all commodities futures and so on. the reason for that is to test it, to make sure the tax doesn't have unforeseen consequences first.

As previously noted, much of your proposal is outside a transaction tax and as we know, while these are great ideas...from regulators like the SEC to Congress....they simply are not implementing or legislating these changes....

so in terms of modifying a transaction tax exclusively, don't bank on (ha ha) those proposals getting anywhere (although of course they should).

So, all I'm referring to is a transaction tax. Nothing else. Any other comments imply an effect but are not to imply other policy/regulatory areas.

On routing revenues to specifics, I think DeFazio has his legislation allocated to pay down the deficit exclusively.

That's fine by me, but just handing Congress funds, we know what they will do, dole it out to their favorite projects and favorite organizations and play political games...which most assuredly are not the most bang for the buck (as we saw from the 1st Stimulus) or really in the best national interest

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How about this?

This might be the wrong thread for this but oh well. This is very simple:

Ban all regulated financial institutions from trading derivatives.

If they want to trade derivatives then set up another company and they can do it with their own capital.

RebelCapitalist.com - Financial Information for the Rest of Us.

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another possibility

I've been wondering about test cases on such a transaction (Tobin tax) as well. I'm wondering if it's feasible to pick say just one type of option or one commodity and run some test cases on it. The reason I say this is I suspect such a tax (as you rightly point out) will need to be scaled and adjusted in order to not affect adversely the markets....
I was thinking oil futures is an obvious one, for the entire globe needs stability in energy prices since it can blast out entire economies (which are based still, on oil basically). From the initial test case, results, unintended consequences they could use this data to adjust.

I'm sure the market would hate unknowns, such as a tax with unknown or dynamic value....that wouldn't work at all if markets couldn't price in taxes...so it would have to be announced on effect dates but still do it in just one area initially so if it does have unintended consequences it wouldn't blast out the entire global trading system.

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