Monday, December 01, 2008

Dialectics of the Short Sell

My contention is that ideas matter. Before we constrict our financial system in a new straightjacket of regulations, we should engage in a debate about what ideas went wrong.

The western tradition appears to have created two fundamentally different views of the economy. I will call these the analytical and dialectical view.

The analytical view traces to the days of Pacioli and The Renaissance and is centered quite solidly in the analytic tradition of Aristotle. Luca Pacioli (1446-1517) was a Franciscan friar who codified the system of double entry accounting. The early Florentine Renaissance was centered on the process of the creation of assets. Florence produced a plethora of grand master artists, because the town saw the work of the grand masters as a valuable asset.

Pacioli's system of accounting would produce balance sheets and income statements for businesses. Investors could use these balance sheets and income statements to determine how best to invest their resources. The basic idea is that when businesses are using the same standards of accounting you can move to a higher level that lets you use the ancient tools of analysis to figure out what is best use of resources.

The dialectical view can trace its history through antiquity as well. Most modern thinkers are enraptured with Plato. The writings of Machiavelli clearly indicate that there was a change in thinking toward the waning of Florence.

The dialectical view really took hold in the wake of Kant … the 1800s.

The analytic view is that commerce is this thing where rational people are engaged in a process of analyzing their resources and engaging in trade with the goal of developing assets and improving their condition. IMHO, this is the soul of classical liberalism.

The dialectical view has an extremely dim view of the common man which they see as irrational creatures yanked about by hormones and impulses. The merchant class is nothing but a petty bourgeoisie incapable of rational thought.

The view has permeated the intellectual class for centuries is that bourgeoisie is this horrible group of people engaged in these petty business wars each seeking domination of the market.

Short selling is a creation of this dialectical view. Short selling is a regulatory measure put in place by central banks and brokers that allow them sell stocks that they do not own. The trader sells the stock with a promise of buying the stock back at some point in the future.

The regulations that allow short selling create a market where anyone is able to sell shares in an asset at any moment without actually owning the asset. The goal here is to create a dialectical process where the price of assets by a conflict between shorts (those who sell the asset without owning it) and the longs (the people who actually own the asset.

Short selling is antithetical to the analytic tradition that sees the economic process as a system where people improve the assets that they own.

Short selling directly hampers the development of equity by confusing ownership. A system of widespread short selling creates a situation where multiple people believe that they own the same share of stock.

It is common during a hostile takeover for the robber baron in the hostile take over to heavily short the company under business attack. A business warrior laying siege on a company can have an army of agents short the asset. For example, they may have their agents short 51% of the shares in a company while buying 51% of the company. The business pirate can leap over the railings, storm the boardroom and claim ownership when in fact the pirate had simply engaged in a trick to confuse title.

Ideas matter.

The 2008 market collapse (and other historic market collapses) was fueled largely by short selling (people selling stock they do not own). This market collapse pushed many companies out of existence. Pushed many families out of their homes, and yanked food from the mouths of children.

Short selling is part of this absurd dialectical framework created by the tradition of Machiavelli, Hegel and Marx which leads directly to unnecessary conflict and division in our society.

Conversely, I contend that short selling is diametrically opposed to the concepts of free trade and analytical tradition that produces wealth. This tradition has people tending and improving the assets that they own. Short selling is an anti-market mechanism dreamed up by a ruling class which wishes to enmesh the market in absurd business wars that create massive inequities in society.

END NOTE: Please note, elitists on both the right and left support short selling and the dialectical dreams inherent in the practice.


Scott Hinrichs said...

It seems that the problem with short selling, then, is a lack of clear title to the stocks being sold. It seems that some simple rule changes could remedy that problem.

Then short selling could continue to act as a price discovery mechanism, but there would be far more transparency in the transaction. Everyone would be fully aware of what is going on and who owns what.

I suspect, however, that rules such as this would be staunchly opposed by those that benefit from the current lack of transparency.

y-intercept said...

In this post I was trying to figure out how to make an argument about the foundations of reason.

The point I am trying to make is that the very desire for short selling is the product of ideology.

There is a chain of philosophers who believe that one must organize society around conflicts. In this ideology, one wants to organize the market so that it is dialectical conflict between two groups called shorts and longs.

Debates about short selling should recognize that regulatory regime that allows short selling is the creation of an ideology that society progresses by pitting groups within the society against eachother.

The Dialectics, of course, is the common thread between Communism and Fascism.

A debate on short selling really should start at the philosophical level by asking if this ideology is what we want as the foundation of our society?

I believe that we would be better off to scrap this ideology that sees the market as a dialectical conflict between shorts and longs, and to work to create an economy built on the development of equity.

Of course, there is nothing wrong with having more than one exchange. There could be the New York exchange built on the material dialectics, and independent exchanges around the world that prohibit short selling. By having more than one exchange, we could find out which system works better.

Scott Hinrichs said...

Madison argued that good government could only exist in a broad society when a large number of varied factions competed with each other in the marketplace of political ideas. In other words, he felt that good government could only exist in the presence of conflict between multiple factions.

My staunch libertarian friends argue to a degree against this philosophy. They suggest, rather, that society will do a better job of ordering itself and that conflicts will mostly disappear if we permit maximum individual freedom and allow free exchange however individuals wish.

This seems blissfully utopian. An authority would still be required to resolve the inevitable conflicts that arose and we'd be back to considering Madison's thesis.

Indeed, having multiple exchanges is itself a form of competition (a form of conflict). Such a system would produce superior options to what are now available. This is how markets function, and we are all beneficiaries of this type of functioning. So, while certain types of conflict are counterproductive, not all conflict is bad.