Sunday, November 21, 2010

Shorting our Way Into Debt

We all know that America has a debt crisis. This crisis is not simply the result of borrowers. The debt crisis is the result of a financial system that floods capital markets with easy money.

Notably, the fractional reserve lending system of the Federal Reserve multiplies the amount of debt. Banks lend out multiple dollars for each dollar saved. The Fed works like a lens systematically magnifying debt.

Perhaps the most pernicious effect of short selling is that it contributes to this debt crisis.

A short sell is a similar source of easy money. Short selling is not an investment in production, but a financial tool derivative of other's productivity. It is a paradox-ridden kin to a margin play.

When a person shorts a stock, they borrow a stock then sell it at market prices. The person who lent the stock for the short sale no longer has an investment a company. The investor has a loan that tracks the price of the stock.

These loans often take place without the knowledge of the investor. So, you might think you have 100 shares of GM, when really you have a loan to a third party that tracks GM's price.

When a short seller sells a stock, the short seller gets money. This easy money floods into other investments. Short sellers often hold the money in tools like government bonds or mortgage backed securities ... creating an artificial demand for these financial products.

(Short selling feeds the beast that crashed our economy)

The amount of easy money created by short selling is phenomenal. It is second only to the amount of easy money created by the Fed.

Hedge Funds use a formula for shorting. For example, some hedge funds with have $30 in shorts for ever $70 in investments. The amount of money being shorted is massive.

Following the short interest on stocks, I find it common for the short interest to be 20%, 30% or even 40% of the float for long durations.

For a trillion dollars in investments, one might see short sellers generate $200 billion in easy money through shorting.

Free-marketeers should be irrate about short selling. This is not wealth created by the re-investment of surplus production (as was described by Adam Smith). It is vast quantities of easy money created by the financial regulations that allow short selling.

Short selling (selling stock that does not belong to you) is a direct violation of the principles of property rights. The system has numerous perverse effects that muck up the process of generating real wealth.

Tweet Button:

No comments: