Short on Economic Understanding

by Don Boudreaux on March 18, 2014

in Myths and Fallacies, Prices

Here’s a letter to the Washington Post:

Richard Cohen rightly defends charter schools against greedy teachers’ unions (“Illogical hostility toward charter schools,” March 18).  In doing so, however, he gratuitously condemns a useful financial practice, asking snarkily “tell me again what’s moral about short-selling stock.”

Because all parties to short selling participate voluntarily, the burden is on Mr. Cohen to tell us what is immoral about it.  Investors who lend their stocks to short sellers do so voluntarily; investors who buy these stocks from short sellers do so voluntarily; investors who later sell their stocks to short sellers do so voluntarily; and short sellers themselves sell short voluntarily.

When short sellers are correct in their belief that corporate shares are overvalued, they cause the prices of stocks to reflect sooner than otherwise more accurate information about the economic conditions of the corporations whose stocks are sold short.  These lower and more accurate stock prices, in turn, help protect other investors, big and small, from making poorly informed investments.  (Short selling also helps to discipline corporate managers, who know that if they shirk or otherwise act in ways that harm their companies’ prospects, their misbehavior will be more quickly revealed by short sellers.)  When short sellers are mistaken, they personally suffer losses, with their activities doing no more to disrupt markets than is done by investors who mistakenly sell their own stocks short or who mistakenly buy stocks long.

Unless Mr. Cohen can explain why, say, his sales of stocks that he owns is immoral, he has no basis for asserting that short selling more generally is immoral.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030​​​​​

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