U.S. policymakers are obviously willing to go to any length to avert a financial Armageddon, including changing the rules of the game in midstream. The latest, of course, was banning short selling in some 800 U.S. stocks, which effectively engineered a massive squeeze on the short sellers and produced a dramatic rebound.
The short sellers are right of course about the rot in the U.S. financial system but they are underestimating policymakers ability to pull rabbits out of the hat. And policymakers will keep on ignoring the rulebook and reaching for rabbits as long as it takes, because the alternative is worse. Short selling is a hard way to make money anyway in the stock market — if only because of the long run tendency of stocks to rise by some 7% to 9% annually on average.
Yet, the abolishment of short selling does not necessarily mean stocks can now only go up. Take China. Its stock market has had one of the steepest declines (over 50%) during the past year even though short selling was banned throughout. There was a recent rally in Chinese stocks but it was linked to announcements the Chinese government is now going to prop up the stock market by buyingstocks. Hows that for breaking the rules?
Many stock-market bloggers were outraged by the U.S. decision to ban short selling. But the preservation of free markets seems a lesser virtue compared to preserving the U.S. financial system, economy, and indeed, status as a world power.
Lets acknowledge it: the U.S. is in a desperate competition with upstart emerging economies. The latter have made major inroads by pegging their currencies, suppressing domestic oil prices, banning short selling, currency controls, prohibitions on derivatives/options, and a host of other market manipulations. They arent playing by the free-market rulebook either. The U.S. may need to untie the hand behind its back with some interventionist measures of its own — until stability returns.