Selling something “short” means selling something you don’t have. You sell it now, pocketing the price, but you deliver it later (putting up collateral in the meantime to protect the buyer). If the price goes up before you deliver, you lose money, but if it goes down, you make money. Short sellers, therefore, are betting that the price will go down, just as “longs” (purchasers) are betting the price will go up.
It is popular for deposed CEOs and ousted or threatened political leaders to curse the “short-sellers.” They blame them for “unfairly” piling on and driving companies, or currencies, into the ground because, as the theory goes, by selling they create an artificial “supply” of the targeted shares or currency. Actually, short-selling is a beneficial action that forces the market to behave with more integrity. We are about to see that come into play with the euro.
Let’s start by taking a step back.
Governments love high stock averages. It increases the “wealth” effect and makes everybody feel better and spend more. Citizens who feel wealthy, like shareholders of a corporation whose shares are richly valued, are happy and do not look too carefully at the actions of their leaders. And this makes sense: why should you spend a lot of time scrutinizing the actions of someone making you rich? They must be doing something right. And it is exactly the same way with overvalued currencies. A richly valued currency allows citizens holding the money to buy more than they could with a poorly valued currency. They feel rich, and this means the citizens are less likely to scrutinize the actions of their leaders.
But suppose that the valuation is not a fair one, the stock is priced too high, or the currency is worth less than it appears. What that means is that government or management is not doing something it should be doing, and the longer the incorrect valuation persists, the longer the wrong things keep being done without question. On a company-wide basis this can destroy a company, and on a currency-wide basis it can make an economy progressively less efficient and competitive.
Again to use the European Union as an example, the Greeks are clearly not competing in the world economy, yet Greek workers (for example) enjoy better benefits and wages than people who are working harder and more competitively. Is that morally fair? Should it be permitted and encouraged to continue? The EU has just decided it should be perpetuated, but of course this was for the benefit of certain politicians and entrenched interests, not for the people of Greece, who are thereby doomed to more mediocrity followed by destruction.
Selling an overvalued asset creates increasing pressure on the currency to go down because it heightens the natural movement of the asset. Selling an undervalued asset can create some downward pressure, it is true, but not for long, because the “smart money” comes in and buys when an asset is underpriced. This is why appropriately valued companies have little to fear from short-sellers.
Now let us consider the euro. The euro is fundamentally unsound, being the currency of an unhealthy union of national economies. The difficulties became very apparent the week of May 3, 2010, when the Greek economy threatened to collapse and take the European Union with it. Instead of actually addressing the issues of the currency and the EU, the European Central Bank, aided and abetted by the U.S. Federal Reserve and the International Monetary Fund took action to prop up the failing individual governments and the euro by announcing a huge loan program. This makes it possible for the Greeks and other failing economies to continue doing what they were doing before, actions which will continue to weaken the euro in reality.
By artificially propping up the euro and allowing the structural problems of the European economy to continue and get worse, the banks have set up a short-sellers dream trade. What happens next is that the short-sellers will sell more and more euros (escalating a flight into more stable currencies and gold) until the banks give up and allow the currency to find its real value. When that happens, some people will make billions, and the public will blame them for hurting the EU. In reality, it is the bankers, now, who are hurting the EU. The short-sellers are hastening the day when the politicians and people who are weakening the economy must face the consequences of their actions and rectify them. The short-sellers are therefore helping to improve matters while the people attempting to prop up the euro are inflicting long-term damage on it for their own benefit.
Don’t let the rhetoric fool you.