The first necessary step is to read or know about the 1920 masterpiece by Ludwig Von Mises titled Socialism. In it he accurately predicted that the socialist economy of the Soviet Union must eventually collapse as socialism does not have the ability to create honest prices. by SovereignJim
(libertarian)
Thursday, December 17, 2009
The first necessary step is to read or know about the 1920 masterpiece by Ludwig Von Mises titled Socialism. In it he accurately predicted that the socialist economy of the Soviet Union must eventually collapse as socialism does not have the ability to create honest prices. Honest prices, in a free economic system, are what motivate people to do what is needed to supply goods to the public at lower and lower prices, assuming a stable value for money.
It is also true that if you do not have honest prices you do not have a free economic system or free market as it is called. Thus it is important to know exactly what is an honest price. An honest price results only by the free choice of a price for a trade or contract for delivery between, an owner or producer of product, and a buyer. Please note the definition makes a price, where the seller nether owns and can not produce the good, not an honest price because it is a price based on nothing and is thus fraud. The definition of liquidity is money available for purchase. A naked/frauduent seller, as opposed to a producing seller, sops up liquidity when he sells with no promise of a delivery of product to compensate for the drop in liquidity. Yes the naked seller provides extra liquidity for other sellers when he buys back his empty promise but the consequence, on balance, of his permitted fraudulent selling is never discussed.
Let's assume that we have an actual free market without fraud. A farmer likes the buying price for corn at his next harvest time. Thus he hedges his coming investment of land, labor, seed, etc. by selling a contract for an amount of corn he assumes he can produce. He is now safe from a drop in the price and gives up a possible bonus from a higher price. His only risk now is a failure to produce the crop which he can gamble on or insure against. The buyer of the farmer's contract now has the risk or bonus condition which he assumes will be bonus or he would not have bought, unless he is a hedging user. Now suppose the future delivery price drops to where no new farmers decide to plant and hedge corn production. The corn of existing contracts will eventually be delivered to a user of corn or delivered into storage if the buyer had been a speculator and there was an overabundance. The buyer could have been a user of corn, hedging against a higher price. Note that hedging eliminates both the bad result of an unwanted price change and the beneficial result of a good price change. In effect a hedger does not want to gamble. Today the term hedger is often misapplied to gambling frauds. Market gamblers using naked selling are like blackjack dealers dealing seconds and thirds because he has no constraint on the amount he may sell thus creating a false supply which drives the price down.
Now let's consider what happens in the honest price case when the corn price stays at a profitable price for a corn farmer or even goes higher prior to the planting deadline. In this case more farmers plant corn until hedging users and speculators decide to stop buying. Then the price drops and new farmers may not sell and plant corn if the drop precedes the time line for planting. Speculators eventually sell to hedging users or other speculators until harvest time. Any excess after harvest is sold into storage.
We now can discuss a few consequences of allowing fraudulent selling. Add to a free market some naked/fraudulent selling. This added selling by non producers can only depress the price. A lower than honest price will cause some farmers to grow something other than corn. This could result in a shortage of corn at harvest time. Fraudulent selling can result in shortage, never in surplus. Silver is in shortage today and will be for a number of years because of fraudulent but legal selling of paper silver. Even if the naked selling stopped now and the price rose to motivate more silver mining, the shortage of silver would persist for a long time because creating new production of new silver takes much longer than a crop season.
Advocates for fraudulent selling say that it keeps prices from getting too high and therefore is a good thing. This is a self serving claim. Consider a sustained high farmer profit price for corn that leads to an overabundance. The excess production will cause a price drop. The excess corn from a harvest will be stored. This stored overabundance will cause the next crop future price to be lower and thus many previous corn farmers will plant something else until the corn in storage is used up. With silos, future contract buyers will up the contract price to motivate farmers to plant more corn to meet an expected shortage. Note that price changes before planting may motivate producers to change what they will do. Price changes after planting cannot effect planting decisions. A corn market with honest prices will lead to stability from year to year with little deviation between user need and farmer production. In a steady state honest pricing corn growing and using system, suppliers of money to planting farmers will always buy contracts at a price determined to be a good return on their money. This can be done with assurance after there is solid year to year history of honest pricing.
It is fine for speculators to buy and provide liquidity by their gambling. However it is bad to allow a speculator to motivate a farmer to not plant corn by selling fraudulent contracts which drop the price and could lead to shortage and a final user/consumer higher price. The two recent price movements of oil future contracts from near $100 per barrel to over $145 was due simply to squeezes on naked short sellers. A short squeeze such as those can not occur in the absence of fraudulent selling. Also look at what has happened today by congress pandering for votes and causing a shortage with higher price for corn as food. Let our markets be free from fraud and politics and we will be just fine.
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Posted By: Jahfre Fire Eater
Date: 2009-12-17 09:09:18
Hi SovereignJim,
 I believe I agree with your position but I'm not certain because I couldn't follow some of your logic. You used the term "Short Selling" with many different adjectives, such as: "fraudulent", "naked", "producing" and "fraudulent naked". You also used the phrase many times with no adjectives...so it was hard to follow which variety you were referencing in those instances.
It is my understanding (I'm not sharp on this so if I'm wrong, oh well, please correct me.) is that there are two kinds of short selling, Naked and Covered. Naked is fraudulent and illegal, covered is honest and legal.
So, if your article was intended to point out the reasons naked short selling is fraudulent and illegal I think it fell short. If it was to debate whether or not naked short selling is fraudulent, then I wonder why you wrote it? That doesn't seem to be in dispute as evidenced by its illegal nature. If your article was intended to point out that even though naked short selling is illegal due to its fraudulent nature it still occurs and to explore why that is so and who benefits from it and whether or not making naked short selling illegal is enforceable...but that isn't what you were writing about. I'd find that more interesting than your belabored examples of why fraud is fraud.
