The long and the short and the fall

HANS Eichel, Germany's Finance Minister, has attacked hedge funds. They sell short, 'which in times of market turmoil can lead to a general price collapse'. In Japan, Finance Minister Masajuro Shiokawa claims his country has become 'a gambling den' where short selling is driving down the stock market.

Local regulators have been doing their bit to support him, penalising ING Barings, Goldman Sachs, Morgan Stanley and Barclays for technical violations when selling short. No major Japanese broker has been targeted. We must decide whether this is due to the high standards of local brokers or the low standards of local regulators.

The truth, of course, is the opposite of these finance ministers' claims. There is not too much short selling today, but there was too little in the good times. If Tokyo is a gambling den now, how would Shiokawa have described it when buyers drove the Nikkei 225 stocks average up to almost four times its current level?

Asset markets are important. When shares or house prices go bananas, their subsequent falls cause distress and affect the economy. Governments and central bankers should therefore discourage asset bubbles. There are many ways they could do this. Monetary policy, tax and stock market regulations have a role to play, but do not work in the right way - all are designed to encourage bubbles.

Central bankers habitually claim they cannot adjust policy in the light of asset price movements. They are telling porkies, or 'Byers' as they are now known. Central bankers frequently ease money when the stock market falls. The US Federal Reserve has done this many times - after Black Tuesday in 1987 and when the prominent hedge fund LTCM went belly up in 1998.

The truth is they only act in one way - to support bubbles. Capital gains tax works the same way. Selling at a loss is cheap, selling at a profit is expensive. Market regulations are also designed to push up prices. Selling shares you do not own is surrounded by regulations. Buying shares you do not own is not.

This is bad practice. Short selling is risky even if the analysis is sound. In the 19th century, when a US railroad was going bust, the Press asked its chairman if he was worried. 'No,' he said. When asked why not, given that he owned 90% of the stock, he said: 'I don't own 90%, I own 105%. It's the sellers who should worry.'

The nonsense about short selling is part of the general law of daft regulation. The hangover is awful after the party of a market bubble. Governments then wish to make regulations, but instead of treating the illness they target the symptoms.

Short selling did not cause the bubble, it is a symptom of the resulting bear market. To treat the illness we need better central banking, better tax systems and more short selling.

The chances are slim.

www.smithers.co.uk