Short-Sighted

by Don Boudreaux on March 18, 2014

in Myths and Fallacies, Prices, Seen and Unseen

Here’s a second letter today to the Washington Post:

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

Short selling (like long buying) causes asset prices to reflect underlying economic realities better and more quickly than they otherwise would. Still, many people object to short selling because short sellers borrow the assets that they then sell today – that is, that they then exchange today for some other assets. But if this practice is immoral, then the practice of many American homeowners in the 1970s and 1980s of taking out larger mortgages in anticipation of higher inflation was also immoral.

If you borrow more money today only because you anticipate a rate of inflation that makes the interest payments a bargain, you are shorting an asset (namely, money). And your hope – like that of all short sellers – is to profit from the decline you expect in the market value of the borrowed asset (here, dollars); your hope is to repay your creditor with assets that will be worth much less at the time of repayment than they were worth when you borrowed them and then exchanged them for another asset (here, a house). So unless Mr. Cohen also condemns people who borrow money in anticipation of higher inflation, he has no business condemning short sellers of any other assets.

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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