Germany Takes Brave Stand Against Naked Short Selling
Posted by Michael A. Kamperman on May 19, 2010
Germany befuddled markets yesterday by acting unilaterally to ban naked short selling of all European Government Bonds and in the stocks and bonds of its 10 largest financial institutions. Angela Merkel has been behind the curve and wrong on most of the decisions she has made so far regarding the credit crisis. Finally, she shocked me and a lot of other people and did something right. Many hedge funds are screaming bloody murder this morning claiming banning naked short selling will solve nothing. They are only talking their book and their wallet. Banning naked short selling prevents people betting against something in quantities greater than the underlying asset itself. If their are 200 billion euros of Greek bonds, then the market can still short 200 billion euros of Greek debt. But it cannot short 500 billion euros of Greek debt creating an artificial market that overwhelms the long side of the traded and pressures it to the downside. Hedge funds will claim banning naked short selling hurts liquidity and increases risk. Then perhaps they should practice diversification and fundamental research if they want less risk in an asset. The bottom line is our societies need our governments to be able to access the bond markets on reasonable terms. Allowing speculators to raise champagne glasses in triumph while riots run wild in the streets is insanity. The German ban should become permanent and it should extend to all asset classes. And it should extend to all markets outside of Germany. The Germans acted unilaterally on their own for two reasons; the French refused to go along, and the Germans have the power to act without getting someone elses permission. This message will not be lost on the rest of Europe. Merkel has made the current crisis much worse than it should have been. It is about time she did something right.
Protecting the debts markets is one thing. Coming up with a strategy to repay the debts in a deflationary world is quite another. The April U.S. CPI just printed a negative .1% overall and a core rate of zero. Since the end of April oil prices have collapsed by 20%. The negative CPI was in spite of higher oil prices. Additionally, the mortgage purchase applications fell by 27% last week. The expiration of the first time home buyers tax credit will lead the housing market down once again. In other words, inflation was negative in April before the impact of these two very deflationary trends in May.
The ultimate solution to solving the sovereign solvency crisis and deflation is the same. The central banks of the world need to start printing money and start buying up their own government bonds in very large quantities. The deflationary environment is giving all of these governments a chance to hit the reset button. Yes, monetizing the debt is the solution to our credit problems and our deflation problem. To really defeat deflation we still may have to mail out money allowing the private sector to reduce its debt levels as well. While Germany has been right about naked short selling, they have been wrong that inflation is a near-term threat and that austerity is the solution to the crisis. As events over the last few weeks have shown the Euro is an ungovernable entity. Therefore, it is up to the Fed to step up in the midst of this new credit crisis and resume its quantitative easing program. Everyday they wait allows confidence to whither further away.
