Fisher Investments Editorial Staff
Politics, Alternative Investments

An Uphill Battle

By, 05/20/2010

Story Highlights:

  • German politicians recently banned naked short-selling of euro-denominated sovereign debt and bank shares—and European markets reacted negatively.
  • Banning short-selling likely won't make much difference to markets if history is any indication—US politicians banned short-selling in 2008 and stocks still tanked.
  • German officials blamed "speculative attacks" for the euro's demise, but it's likely the PIIGS' sovereign debt troubles are responsible for much of the currency's decline, not speculators.
  • Regulators can try to tame scary fluctuations, but markets will always find a way around regulations. 


In the latest euro hullabaloo, German politicians banned naked short-selling (selling securities short without borrowing them first) of euro-denominated government bonds, credit default swaps (CDSs) based on those bonds, and shares of Germany's top 10 financial institutions. It's yet another attempt by regulators to control markets but—like Sisyphus endlessly rolling that boulder up the hill in Hades—it's typically an exercise in futility.  

Why the ban? Short-selling (naked or otherwise) is a normal and useful market mechanism—it helps bring the actual value of stocks, bonds, CDSs, etc., to the fore quicker. And remember, short-sellers undertake huge—actually, unlimited—risks the price will rise. It's not outrageous to think more care may be taken on the short side than the long. Yet, short-selling still regularly comes under criticism. US politicians banned short-selling in 2008 to stem falling bank stocks, yet shares continued to decline. The ban didn't stop panicky selling. In fact, it might have contributed some to the black sentiment. (E.g., things are so bad they have to ban short-selling?!) And, of course, removing one method of expressing doubt about a company is not the same as removing all such methods—skeptical investors were going to sell bank shares, whether they were short or not.  

Germany claims the ban is to protect the euro from "speculative attacks," recalling George Soros' bet against the pound sterling on Black Wednesday in 1992. But it's a faulty comparison, if only because the euro's decline so far is nowhere near the speed of the sterling's fall then. And while speculators get a bad rap, their "attacks" often bring attention to inefficient or illogical policy—in Soros' case, the defective European Exchange Rate Mechanism (ERM). Who's to blame when such arbitrage opportunities exist—short-sighted politicians for creating them, or markets for pointing them out? But instead of taking the hint, policymakers frequently take the denial route—which can compound mistakes with another round of myopic, reactionary policies.  

Even so, it seems unlikely the euro is under broad speculative attack currently. The recent decline doesn't appear out of place given the overall level of nervous sentiment about the future of the common currency. And the weakening has been orderly for the most part. A weaker euro may irk the bigger, more stable countries (hence the disbelief it could be "naturally" losing value), but the currency doesn't only reflect German or French strength; its value is also tied to weaker countries like the struggling PIIGS. And while the PIIGS don't have the option to individually devalue their currency (as would normally happen in a fiscal crisis), this decline could represent a similar process, naturally compensating somewhat by making PIIGS debt more attractive outside Europe, boosting economic growth via exports, and perhaps making tough fiscal measures easier to bear in the long run.  

The ban likely does little to prevent the euro from falling further, and European markets didn't take too kindly to the announcement—they were down big. And unless other European countries follow Germany's lead in banning short sales (looks unlikely so far), investors need only short European bank or sovereign instruments outside Germany. Policymakers may have better luck pushing that boulder—markets usually find a way to roll around (or straight through) regulations. 


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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