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One more attempt to repeal the law of gravity

In a few hours, Germany will introduce a "temporary ban on naked short-selling and naked credit-default swaps of euro-area government bonds." Presumably, this move is meant to calm markets by protecting them from the predations of greedy speculators. Predictably, however, it only makes matters worse. In the wake of the news announcement, the euro dropped, gold rose, government bond yields fell, implied volatility of equity options rose, and equities fell—all classic signs of a market suddenly more concerned about downside risks to the economy and financial markets. And it stands to reason, because announcing you're going to limit the market's ability to express downside risks tomorrow, only increases the market's desire to protect against downside risks today.

The only good news is that Germany's attempt to repeal the law of gravity (by supposedly limiting negative speculation), can be easily reversed. That's likely not the case with Venezuela's decision today to attempt to put a band around its sinking currency. Venezuela has already made two fatal mistakes, first by printing money (and thus fundamentally debasing its currency), and second by devaluing the currency but establishing a dual exchange rate for imports and exports (thus encouraging all sorts of shenanigans, like the over-invoicing of imports, that effectively funnel capital out of the country). You either respect your currency or you don't; the more you try to prevent it from falling by diktat or by exchange controls, the more you undermine confidence in the currency.

Banning naked short selling may make it harder for speculators to speculate on a Greek default, but it does nothing to change the fundamentals behind Greek debt. It does, however, interfere with markets by making them less efficient, and it heightens investors' concerns: do the regulators know something we don't? Thus Germany is taking steps that could needlessly prolong the crisis. That's unfortunate, but it's not the end of the world. The fundamentals of global growth are firmly in place and likely to carry the day once the dust settles.

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