Yesterday, France, Spain, Italy, and Belgium banned short selling of financial stocks for 15 days. Regulators said they put the ban in place to "restrict the benefits that can be achieved by spreading false rumors."
As Dan said yesterday, "Blaming short sellers is the typical political move of people intent on sloughing off onto others the responsibility for the mess they created."
Last we checked, massive leverage and bad loans brought down financial stocks... not rumor mongering. Jean-Pierre Jouyet, head of the AMF, the French securities regulator, went so far as to make market manipulation seem patriotic... "[Investors] wanted to test French resistance. This is our response, as always very determined, and it will be so for all those who want to put us to the test."
The problem with this partial ban is it will simply redirect short sellers' efforts. Instead of shorting the troubled banks directly, they will look for other banks with heavy exposure to Italy, Spain, and France. Short-selling expert Jim Chanos, founder of Kynikos Associates, explained other consequences of the ban.
"EU policy makers don't seem to understand the law of unintended consequences," he told Bloomberg. "The vast majority of short-selling financial shares is by other financial institutions, hedging their counterparty risks, not speculators. The interbank lending market froze up completely in October to December 2008 – after the short-selling bans."
In other words, banks are constantly lending huge sums of money between themselves. And they sell short shares of banks they're doing business with for protection. If they can't hedge their risks, the banks will stop lending money.
European financials rallied on the news. Belgium bank Dexia jumped 14%. French bank Societe Generale, which is allegedly on the brink of collapse, jumped 3%. But the rally will be short lived. Today, Bloomberg noted the six largest U.S. money-market funds (which control $511 billion) have stopped lending to Italian and Spanish banks and are reducing their exposure to France.
Short-selling bans don't change fundamentals. As Dan pointed out yesterday, "During the U.S. Securities and Exchange Commission's (SEC) ban on shorting financial stocks from September 2008 to March 2009, financials fell 70%. The ban had no effect whatsoever, beyond a one-day 11% rally in financials."
It could be a good time to add to your European financial short positions.
According to the Financial Times, the SEC has asked credit ratings agency Standard & Poor's to disclose which employees knew of the U.S. debt downgrade before the announcement. The SEC suspects insider trading. Identifying employees with prior knowledge of the downgrade is a starting point, according to the agency source who spoke with the newspaper... The SEC is also investigating whether that information was leaked.
All you needed to have prior knowledge of the U.S. downgrade was an elementary knowledge of accounting. A glance at the U.S. balance sheet showed (and still shows) the country's inability to repay its debts. We've written about this topic ad nauseam.
Last June, Bob Prechter granted an interview to our sister publication, The Daily Crux. Prechter is an "Elliot Wave" theorist – meaning he follows a trading system based on the premise that the market is driven by waves of optimism and pessimism. At the time of the interview, Prechter believed the world was heading for a huge deflation and subsequent crash in equities and commodities (including gold).
In the June 11, 2010 Digest, Porter refuted Prechter's claims. Given the turmoil in the markets this week (loads of money printing, soaring gold, and a general distrust of fiat money)... we thought it would be fun to see whose ideas have held up over the past year...
Below is an extended excerpt from that Digest...
... In the interview, [Precther] explained why he thinks the world is heading for a serious deflation – a collapse in the money supply that will be catastrophic for the world's equity and commodity markets. Before you build a bomb shelter and start stockpiling dollar bills... keep in mind Prechter has been making the same forecast (more or less) for as long as I can remember. He did so most thoroughly in his book, Conquering the Crash, which was published in 2002, just before a huge wave of inflation swept through the world's stock, commodity, and real estate markets, sending all of them to new highs. He is also perhaps the most widely known "Elliot Wave" analyst – a trading system that incorporates the idea that markets are driven by waves of optimism and pessimism. To me, the two ideas seem related in this way: Anyone who believes in deflation will believe anything – including Elliot Wave analysis.
Let's go through the facts Prechter says support his thesis. First, his basic theory, in his own words: "[I]n the simplest terms, creditors will stop lending, which will keep the credit supply from inflating. And debtors will default, causing the supply of outstanding debt to deflate. This will overwhelm government and central-bank efforts to inflate, and will result in deflation. These trends have already begun."
But actually that's not true. Total new credit in our economy has continued to increase for the most obvious and basic of reasons: The U.S. Treasury is funding a $1.6 trillion annual budget deficit. Increases to government debt far outpace declines in private lending. This is a fact. And it means Prechter is wrong: Credit deflation in the United States has not begun. Nor will it ever, in my view, because our politicians would never allow it. They have a printing press. And they know how to use it. To believe in deflation is to believe in the soundness of the U.S. dollar and in the integrity of our government. Don't laugh. It's not funny. It's sad.
Prechter claims the debts being written off by banks (i.e. mortgages) are too large for the government to paper over. And he says: "The Fed and the Treasury have bailed out or guaranteed another trillion or two of bad debt and promise to do even more."
No, that's simply not true. The government and the Fed have bailed out or guaranteed at least $12 trillion in debt so far. In fact, the guarantees to Fannie and Freddie alone are larger than $10 trillion.
Prechter claims deflation is all around us. (We wonder who pays for his groceries, his gas, or his lunch... and we bet he'll never win a bidding contest on The Price Is Right.) Says Prechter: "The amount of money and credit in the system is contracting at its fastest pace since the 1930s. Interest rates on Treasury bills are stuck at zero. The CRB index of commodities is at half its value of just two years ago. The stock market is lower than it was 10 years ago. The PPI and CPI (measures of producer and consumer prices) have a zero rate of change."
Again Prechter's facts are simply wrong. Let's take the most obvious point: deflation in commodity prices. When Prechter's book came out in 2002, the CRB index (a big index of basic commodity prices) stood at about 180. By the middle of 2008, it had soared to 480 – an increase of 166%. But Prechter completely ignores this enormous inflation of commodity prices. Instead, he simply says commodity prices have fallen in half. Yes, that's true, too. During the global market crash, the CRB index fell substantially, but not enough to justify any claim of deflation.
Today, it's around 250 – still up 38% since he published his book. Likewise all of his other facts are simply wrong: Interest rates are low because the Fed sets short-term rates and has been buying bonds to force long-term rates down, too. This kind of debt monetization is inherently inflationary. And his claims about the PPI are misleading: They show small rates of change because the government has changed the way they're calculated. If you used the CPI of the 1970s, it would show a 9% annual rate of inflation right now.
But... beyond all of this tit for tat... just ask yourself (or your wife): Are you paying more for groceries, gas, travel, babysitters, etc. than you were 10 years ago? The answer is yes. And guess what... prices are still going up.
Here's my favorite line from the Prechter interview: He says that since his book came out in 2002, "The Fed has offered unlimited credit. It has been injecting money. Yet there has been no runaway inflation."
Those are his words. You have to wonder what planet he has been living on. Did he not witness the enormous inflation in real estate – perhaps the largest credit bubble in history? Did he not witness the price of oil going from $25 to $150 per barrel? Did he not see stocks double by 2008? It seems obvious to me that the only person in the world who didn't see the inflation between 2002 and 2008 was Bob Prechter.
And finally... the coup de grâce... Prechter says he'll admit he's wrong about this deflationary views "if the S&P 500 index, real estate, and the CRB commodity index all take out their price highs of 2006-2008, it would probably be enough to indicate runaway inflation." Ironic isn't it? All of those things happened within four years of his book being published – his book that forecasted a dire deflationary collapse. And yet... now he says they'll have to do it all again before he'll detect the mildest whiff of inflation.
Now... what's my view? How would I explain the massive collapse in stock, bond, real estate, and commodity prices over the last two years if I don't think deflation is possible?
It's simple. The history of paper money is filled with bubbles and crashes. Paper money eliminates the need for sound banking reserves, which allows credit to grow on an almost unlimited basis – up until the minute people begin to doubt asset values. And then they crash. But crashing asset prices doesn't imply that the value of the currency is increasing. In fact, crashing asset prices imply a fundamental weakness in the system of money itself.
Right now, people doubt real estate prices, stock prices, and commodity prices. Sooner or later, they will also begin to doubt the value of the paper bills that delivered them into debt and deprivation. When that happens, we will have a crisis – on that we agree.
Prechter recommends holding Treasury bills to safeguard your wealth. But those are the very instruments that will be destroyed as people finally abandon paper money. If you follow my advice, you'll be holding gold when this final crisis comes. You may notice gold hasn't suffered at all during the crashes of the last two years... and as governments (and their paper money systems) go bankrupt all around the world my bet is gold continues to soar.
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New 52-week highs (as of 8/12/11): None.
We received an overwhelming response to yesterday's question, "Do you still have money in the stock market?" Seems like most of you are sitting tight. Please send your feedback to feedback@stansberryresearch.com.
"I ABSOLUTELY have my money in the stock market! It's what funds both my traditional and Roth IRAs. I have to laugh when those of little faith panic like scared rats. That's one fundamental about stocks you have to wrap your head around if you're going to invest... stocks go up and they go down. Set your trailing stop losses and enjoy the ride. You guys rock!" – Paid-up subscriber Paul Radomski
"I ain't sold nuthin. Next bounce of the ball I'm going to buy sumpin." – Anonymous
Regards,
Sean Goldsmith
Baltimore, Maryland
August 12, 2011
European short selling ban in place... And why it won't work... SEC investigating the U.S. downgrade... Revisiting Prechter... Massive layoffs at the post office...