Shorting which short changes the economy

Shakespeare wrote “Some rise by sin, and some by virtue fall”. In the modern economic context it would be appropriate to change this to “some profit by sin and some by virtue become impoverished”. It would do well for our politicians to understand this, particularly in understanding some practices of banking.

It is odd how overnight some activity deemed illegal and damaging can suddenly acquire the cloak of legality and respectability.

Exchange control is a case in point; many developed nations have abolished controls on exporting and importing currencies after years of all kinds of legal restrictions on currency export backed with the force of law and heavy fines and imprisonment for those who dared disobey.

When the laws were suddenly changed in 1979 in the United Kingdom what was illegal before – taking a few hundred pounds out of the country without the written permission of the Bank of England – became perfectly legal. From 1979 for many years you could walk out of the country with suitcases stuffed with cash (if you had it, of course) and no one would care. Today travelling the world with suitcases stuffed with cash is hindered not by exchange control designed to protect currencies and economies, but by money laundering laws designed to prevent tax evasion and terrorism.

Another activity that was thought to be sinful was the banking/speculation practice of “shorting” or “short selling” or “going short”. The old City of London proverb shows just how on the edge of proper behaviour this activity was once thought to be

“He that sells was isn’t hissen

Pays it up or goes to prison”

From that shorting you will understand is selling something that you haven’t got in order to buy it up at a later date hoping to profit from a decline in prices in the interval. The profit comes from a fall in prices which is the opposite of what any normal right thinking investor expects when he invests.

There are many types of devices that have been created to profit from decline in prices and like many such devices have high degrees of artificiality and a great remoteness from any connection with the things that are being dealt in.

A person may go short on orange juice, without ever having drunk it or bought or sold a drop of it for its intended purpose. Another person may sell shares in a particular company in the expectation that the company’s fortunes will decline, thereby giving that person a vested interest in the company’s fortune declining.

In 1992 when many of us were fighting for our survival in the face of a massive collapse of our currency in the United Kingdom, Mr George Soros bet against our currency declining and made a fortune for himself while at the same time, by the size of his bet (ten billion pounds) made the conditions almost certain that the currency would decline, as currency is about confidence and a large bet shows exactly where confidence is.

Throughout economic history short selling has probably played a major role in exaggerating the effects and extending the periods of recession and depression. It has from time to time been banned, the latest ban being only in September 2008 when the New York Stock Exchange banned shorting for three weeks. Other regulators have from time to time introduced some controls on shorting.

Unfortunately, as one of my friends (who carefully describes himself as not a banker) points out, Governments probably do not understand shorting. The ordinary person cannot go short without going into the markets, establishing and providing for his credit and then playing the game under the rules of the game.

Large institutions and hedge funds are not so restricted. First and foremost they do not play with their own money, but money that someone has given them to “invest”. It is wonderful if you can bet in the casino with someone else’s money and know that the only sanction against you if things go wrong is that you will not enjoy a bonus.

Secondly, rather as in the case of Mr Soros, there is an element of self fulfilling prophecy. Markets are built upon confidence and confidence requires a herd mentality. It matters not whether you are right or wrong; if you are confident and the herd follows you will make money when you short even if you are fundamentally wrong. Of course, it is always better to be right, because that way there is less risk, but when it comes to commodities, stocks, shares and currencies, being fundamentally right is less important that predicting the direction in which the herd will run.

Thirdly shorting encourages market manipulation. It is easier to spread doom and gloom about a stock or commodity, than it is to talk it up. There have been many examples of people going short in concert to manipulate a market; only a few have been caught.

Readers will gather that I am not impressed with the practice of shorting and with the economic damage it inflicts. I am uncomfortable with a bunch of people using money belonging to others to bet on things getting worse. I regard it as acting contrary to the interests of economies and acting contrary to the interests of those who entrust bankers with their savings to invest. Shorting is not investment, but gambling.

It is possible to make a case out for some limited shorting being permitted in circumstances where people want to cover risk or place a ceiling on loss. I accept that.

Therefore my proposal to curb the evils of shorting is that shorting should be taxed, as should all short term gains, at penal rates across the world. Taxation of profits would not hinder those who short in order to genuinely hedge against losses, because the purpose of the short is not to profit, but to prevent loss. High taxation would initially produce some tax income but more importantly as the rewards for shorting were remove would mean less shorting and more economic stability, so that investors have vested interests in their chosen investments prospering, rather than falling into ruin.

2 Responses

  1. Here !! Here !! I agree with what you say about shorting and sudden manipulation of currency exchange rates using deception and dishonesty.

    The £ this week continues to tumble after you published this article over one week ago, the explanations given by newspapers about the possibility of a hung parliament being a justification for all of this really does not hold water. Quite simply what is happening is a huge bank robbery Billions of £’s are being stolen to pay for bonus payments of workshy employees of the big banks and insurance companies and there will be no punishment for the perpetrators and no risk of a jail sentence. Read your local newspaper and look at the Before the Bench Anouncement of cases in the local Magistrates where petty theft is shamefull and those living in comparitive poverty to these bankers have stolen from the local supermerket or driving a car with no Tax or MOT.

    http://en.wikipedia.org/wiki/Black_Monday_%281987%29

  2. 2008 http://www.guardian.co.uk/business/2008/dec/10/pound-euro-record-low and the £ was at an all time low of €1.1391

    the news article even predicting a low of € 1.10 it seems this is a target mrate for the market looking at todays rate which almost exactly that because today 1st of March 2010 under another speculation attack the £ is at a low of €1.10587

    Currently €1 = 91p maybe the market aim is parity of £1:€1 ? !

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