The Ethics of Short Selling

Is short selling ethical?

How much price discovery really occurs because of short selling?

Short selling occurs in margin accounts. What happens to credit expansion and credit contraction as short selling occurs?

Is short selling at the margin a run on the bank at the expense of legitimate shareholders to the enrichment of the short sellers?

Will the markets appropriately readjust to the emotional movements caused by runs on the bank?

Well, here is my opinion.

The benefit of short selling is the motivation that occurs on companies whose business models or ethics are questionable.

Most short selling is speculation.

Speculation is good when it enhances, or has a chance of enhancing, economic well-being.

Otherwise, speculation is bad. It has no economic benefit. Where speculation occurs in a credit based economy, the chances for credit expansion or contraction result from the gamesmanship of the combatants. Most of us don't play the game, so our livelihoods are left in the hands of the speculators. Most of us should not be speculating. We live in a world of specialization. It is not realistic that a majority of us can be good at speculating. The great thing about specialization, is that as we all work, produce and trade with each other, we are all better off. The so-called market economy. But when the actions of a few, impact the majority, like they do with speculation, intervention needs to take place.

In our current economy, where our economic well-being is built on a mountain of debt and inflated capital, short selling has the potential to collapse wealth as runs on the bank take place.

Short selling will allow so-called strong hands to buy equity at bargain prices after the collapses take place. Stronger companies will pick up business and capital. The strong will get stronger and the weak will get weaker. The inherent risk is the same one that is strangling our current economy. Too much money and wealth is being concentrated in too few hands, resulting in a propensity of that money to be hoarded in savings types of accounts. More money and wealth needs to end up in the hands of those that have a higher propensity to spend.

I guess I would support the following:

Naked short selling should not be allowed.

The manipulation of shares of stock, such that they are not available to be borrowed for short selling, should not restrict derivatives of those shares from being available for legitimate short selling.

When short selling causes a run on the bank, so to speak, a government equity or sovereign fund should be available to mitigate the action, so that the people in general have a competitive opportunity with those short sellers that are trying to monopolize equity positions.

At times of inappropriate economic stress, like with the Hunt Brothers trying to corner silver, or with a run on the bank, so to speak, the rules should be changed to protect the public against monopolistic activity.

With monopolistic price tendencies, such as in the oil markets, government activities should be available to mitigate the economic stress.

I guess that I am still favoring a sovereign US fund to compete with the Hedge Funds of the world. This fund would be owned by the people, managed by the best advisers in the world, for the benefit of the people. This fund would help fund the entitlements that will be increasing as time goes on. This fund would act as an endowment to fund America's needs, so as to mitigate the amount of funding that comes from taxes. Taxes tend to be a disincentive to work, whereas, wealth creation tends to incentivize us to work.

The bailout of Fannie and Freddie

The capital asset inflation of the past several years, particularly in real estate and commodities, resulted in part from a very weak US dollar. This inflation caused unrealistic expectations by individuals and government with respect to real estate and commodity appreciation. Debt borrowings and speculation created additional credit expansion and inflation. Now about 20% of all subprime mortgages are behind in their payments. Wages to pay mortgage obligations have not kept up with this inflation. The government reach to increase taxes on property appreciation has created additional unrealistic expectations, now by government, to fund public projects.

Was the thinking incorrect that increased asset inflation could finance these expectations?

The paradox of labor versus capital returns again. Which comes first, the chicken or the egg; or in this case, capital or labor?

It's time for government to master the paradox of capital and labor.

They are both important.

The proposed bailout of Fannie and Freddie has a chance to master this paradox. Part of the paradox is to enable individuals to make their mortage payments.

Since government needs to have sufficient revenue to meet their entitlements, national security and the freedoms of our people, that revenue is important also.

I would argue that a more balanced strategy employing both capital and labor can accomplish this goal.

I applaud the proposal by the government to make both equity and debt investments in Fannie and Freddie to solve this paradox. I'd propose starting a US sovereign fund, designed to own these kinds of equity and debt instruments, owned and managed by the people, with benefits going to the people, to fund entitlements, national security and freedom. Let the people have a vested interest in the long-term character and integrity of these investments. Instead of working for self-centered interests, if we work to help and support each other, good things will happen.

Tetons In the Evening

Here's a beautiful shot of the moon coming over the Tetons on a June evening. This picture was taken from a spot just south of the Mesa falls between Island Park and Ashton.

Commodity Speculators and Inflation

Let's think this through.

Why is gold worth $900 today when it was only worth $300 just 7 years ago.

Was gold really worth $850 in 1979 and then only $300 in 1982?

Is crude oil really worth $140 per barrel today when it was trading for $20 per barrel less than 10 years ago?

Why were the analysts incorrect a year ago when they predicted that oil would average about $70 per barrel this year?

Real estate prices changed dramatically over the past several years. Should the exact same piece of real estate, with no improvements, be worth 2 times or 3 or even more than it was several years ago?

Well, the answers are pretty simple.

As a people, we waste a lot of time and energy speculating, gambling, etc. We call it price discovery and entertainment, respectively.

First of all the dollar has depreciated by 100% (depending upon the currency in question and how you define percentages) over the past 8 years.

Second, the self-fulfilling prophecies of mass psychology contribute to the extraordinary movements in prices and production.

When self interests motivate price discovery, energy and production, volatility in price, energy and production are magnified in the directions of those movements.

It doesn't seem too unusual to expect what has befallen us.

The question now is where the next movements of self-interest, energy and production will take place?

Well, with interest rates low, borrowers will be able to reignite the acceleration of credit creation, thus causing prices to increase in about everything again, causing an increase in energy and production. It should be good for the economy. It should initially bring prices down.

Hopefully the central bankers will be able to successfully manipulate our psychology, so that we will mitigate the inflationary consequences of speculation and self-interest.

If we as a world population will put our focus, energy and production on things like education, healthcare, work and wellness, good things will happen, and speculation and inflation will moderate.

The ECB hikes interest rates

So, let's think this through. The ECB hiked interest rates today to curb inflation. This will shrink demand, but it will also shrink supply. Unemployment should go up. Productivity should stagnate because fewer people are being incentivized to work.

When Ronald Reagan was President, his philosophy was "supply-side" economics. In other words, President Ronald Reagan would have decreased interest rates to stimulate excess supply, thus decreasing inflation.

I guess that I am disagreeing with the move by the ECB. The good thing about the ECB or the FED raising interest rates at this point in time, is that we will all be less well off and more miserable. Theoretically, anxiety, fear and misery will motivate us to go back to work more effectively, thus keeping inflation low. Then we will all be better off.

Is there a better way? Anxiety, fear and misery motivate me, but it also makes me mad. It definitely makes others mad. Anger is definitely a motivating force. Some exibit their rage on the roads by driving recklessly; in the factory they throw wrenches into the systems; some take drugs, gamble, overeat and cheat to overcome these circumstances. At some point we will all go back to work to overcome our problems, but at what price?

Fear, anxiety, anger and misery are definitely motivating forces. So is greed. So is military force.

Why not try a new world experiment; the experiment that began with the Declaration of Independence. The motivating forces of life, liberty, the pursuit of happiness, freedom, kindness, love, hope, faith and charity are potentially the greatest motivating forces in the Universe.

Consequences still need to follow societal goals, but why not make those goals positive and good, instead of miserable and anxious.

I don't know who the author is, but the story is told of an old Cheorkee Indian Chief who was teaching his children about life. He gathered his children around him, at the campfire one night, and said, "There is a terrible fight raging within each one of us; a fight between two wolves."

"One wolf is evil," said the Chief. "He is fear, anger, envy, sorrow, regret, greed, arrogance, self-pity, guilt, resentment, inferiority, lies, false pride, idleness, competition, superiority, selfishness and ego."

"The other wolf," said the Chief, "is good." "He is joy, peace, love, hope, sharing, serenity, synergy, teamwork, humility, kindness, benevolence, friendship, empathy, generosity, truth, work, compassion and faith."

The children listened carefully and thought about what the old Chief had said. One of the children raised his hand and asked, "Which wolf will win?"

"The one you feed," the old Chief replied.

As a world economy, let's try a new experiment: Let's feed hope, faith, love, charity, sharing, peace, joy, kindness, generosity, empathy, truth, work, humility, benevolence, serenity, synergy, teamwork and compassion.

Providing veterans with an education meets all of those criteria.

Lotteries to raise dollars for municipalities does not.

Veterans were more motivated to fight for their "comrad in arms" than for any other reason. "Naechstenliebe" is one of the most powerful forces in the Universe.

What about the Olympics. I love watching the best athletes in the world compete. The Olympics in China will highlight the best that the world has to offer. It provides a measuring stick for each of each to compare our efforts to others. Competition is good when it takes place in a spirit of hope, sharing and betterment for all of us. It is an opportunity for the world to be good to each other. It is bad when it causes evil.

Dear Chairman Bernanke:

I think that you are doing a wonderful job. It is my opinion that you should not be persuaded by the world stage to raise interest rates yet. Inflation can be evil. But, as you have eloquently explained, some inflation can be good. It can cover a multitude of sins, but it can also cause horrible disruptions to the well-being of people, as the world economy is currently experiencing. The inflation of the past several years has created a lot of evil; a lot of greed, fear, anxiety, and anger. By holding interest rates steady today, with a goal of keeping inflation at 1-2%, and by targeting the 10 year treasury rates at a level that will strengthen the dollar, hopefully the world economy will work together to provide good for everyone.

Thanks for your good work. Best wishes to you always.

Thanks to all of those who have gone before us as we again celebrate the Independence of this wonderful country.