Cyclopedia Of Economics 3rd edition

Short selling involves the sale of securities borrowed from brokers who, in turn, usually borrow them from third party investors. The short seller pays a negotiated fee for the privilege and has to "cover" her position: to re-acquire the securities she had sold and return them to the lender (again via the broker). This allows her to bet on the decline of stocks she deems overvalued and to benefit if she is proven right: she sells the securities at a high price and re-acquires them once their prices have, indeed, tanked.

A study titled "A Close Look at Short Selling on NASDAQ", authored by James Angel of Georgetown University - Department of Finance and Stephen E. Christophe  and Michael G. Ferri of George Mason University - School of Management, and published in the Financial Analysts Journal, Vol. 59, No. 6, pp. 66-74, November/December 2003, yielded some surprising findings:

"(1) overall, 1 of every 42 trades involves a short sale; (2) short selling is more common among stocks with high returns than stocks with weaker performance; (3) actively traded stocks experience more short sales than stocks of limited trading volume; (4) short selling varies directly with share price volatility; (5) short selling does not appear to be systematically different on various days of the week; and (6) days of high short selling precede days of unusually low returns."

Many economists insist that short selling is a mechanism which stabilizes stock markets, reduces volatility, and creates

In an interview he granted to Financialexpress.com in January 2007, Marti G Subrahmanyam, the Indian-born Charles E Merrill professor of Finance and Economics in the Stern School of Business at New York University had this to say:

But not everyone agrees. In a paper titled "The Impact of Short Selling on the Price-Volume Relationship: Evidence from Hong Kong", the authors, Michael D. McKenzie or RMIT University - School of Economics and Finance and Olan T. Henry of the University of Melbourne - Department of Economics, unequivocally state:

Similar evidence emerged from Australia. In a paper titled "Short Sales Are Almost Instantaneously Bad News: Evidence from the Australian Stock Exchange", the authors, Michael J. Aitken, Alex Frino, Michael S. McCorry, and Peter L. Swan of the University of Sydney and Barclays Global Investors, investigated "the market reaction to short sales on an intraday basis in a market setting where short sales are transparent immediately following execution."

They found "a mean reassessment of stock value following short sales of up to −0.20 percent with adverse information impounded within fifteen minutes or twenty trades. Short sales executed near the end of the financial year and those related to arbitrage and hedging activities are associated with a smaller price reaction; trades near information events precipitate larger price reactions. The evidence is generally weaker for short sales executed using limit orders relative to market orders." Transparent short sales, in other words, increase the volatility of shorted stocks.

Studies of the German DAX, conducted in 1996-8 by Alexander Kempf, Chairman of the Departments of Finance in the University of Cologne and, subsequently, at the University of Mannheim, found that mispricing of stocks increases with the introduction of arbitrage trading techniques. "Overall, the empirical evidence suggests that short selling restrictions and early unwinding opportunities are very influential factors for the behavior of the mispricing." - Concluded the author.

Charles M. Jones and Owen A. Lamont, who studied the 1926-33 bubble in the USA, flatly state: "Stocks can be overpriced when short sale constraints bind." (NBER Working Paper No. 8494, issued in October 2001). Similarly, in a January 2006 study titled "The Effect of Short Sales Constraints on SEO Pricing", the authors, Charlie Charoenwong and David K. Ding of the Ping Wang Division of Banking and Finance at the Nanyang Business School of the Nanyang Technological University Singapore, summarized by saying:

"The (short selling) Rule’s restrictions on informed trading appear to cause overpricing of stocks for which traders have access to private adverse information, which increases the pressure to sell on the offer day."

In a March 2004 paper titled "Options and the Bubble", Robert H. Battalio and Paul H. Schultz of University of Notre Dame - Department of Finance and Business Economics contradict earlier (2003) findings by Ofek and Richardson and correctly note:

But these findings, of course, would not apply to markets with non-efficient, illiquid, or non-existent options exchanges - in short, they are inapplicable to the vast majority of stock exchanges, even in the USA.

A much larger study, based on data from 111 countries with a stock exchange market was published in December 2003. Titled "The World Price of Short Selling" and written by Anchada Charoenrook of Vanderbilt University - Owen Graduate School of Management and Hazem Daouk of Cornell University - Department of Applied Economics and Management, its conclusions are equally emphatic:

"We find that there is no difference in the level of skewness and coskewness of returns, probability of a crash occurring, or the frequency of crashes, when short-selling is possible and when it is not. When short-selling is possible, volatility of aggregate stock returns is lower. When short-selling is possible, liquidity is higher consistent with predictions by Diamond and Verrecchia (1987). Lastly, we find that when countries change from a regime where short-selling is not possible to where it is possible, the stock price increases implying that the cost of capital is lower. Collectively, the empirical evidence suggests that short-sale constraints reduce market quality."

But the picture may not be as uniform as this study implies.

Within the framework of Regulation SHO, a revamp of short sales rules effected in 2004, the US Securities and Exchange Commission (SEC) lifted, in May 2005, all restrictions on the short selling of 1000 stocks. In September 2006, according to Associated Press, many of its economists (though not all of them) concluded that:

"Order routing, short-selling mechanics and intraday market volatility has been affected by the experiment, with volatility increasing for smaller stocks and declining for larger stocks. Market quality and liquidity don't appear to have been harmed."

Subsequently, the aforementioned conclusions notwithstanding, the SEC recommended to remove all restrictions on stocks of all sizes and to incorporate this mini-revolution in its July 2007 regulation NMS for broker-dealers. Short selling seems to have finally hit the mainstream.

They all sport the same shabby clothes, haggard looks, and bulging suitcases bound with frayed ropes. These are the shuttle traders. You can find them in Mongolia and Russia, China and Ukraine, Bulgaria and Kosovo, the West Bank and Turkey. They cross the border as "tourists", sometimes as often as 10 times a year, and come back with as much merchandise as they can carry in their enormous luggage. Some of them resort to freight forwarding their "personal belongings".

They distort trade figures, smuggle goods across ill-guarded borders, ignore international treaties and conventions and, in short, revive moribund economies. They are the life-blood and the only manifestation of true entrepreneurship in swathes of economic wastelands. They meet demands for consumer goods unmet by domestic manufacturers or by officially-sanctioned importers.

In recognition of their vital role, the worried Kyrgyz government held a round table discussion last summer about the precarious state of Kyrgyzstan's shuttle trade. Many former Soviet republics have tightened up their border controls. In May last year, Russian officials seized half a million dollars worth of shuttle goods belonging to 1500 traders. When two million dollars worth of goods were confiscated in a similar incident in fall 2001, eight Kyrgyz traders committed suicide.

The number of Kyrgyz shuttle traders dropped in 2002 to 300,000 (from 500,000 in 1996). The majority of those who remain are insolvent. Many of them emigrated to other countries. The shuttle traders asked the government to legalize and regulate their vanishing trade and thus to save them from avaricious and minacious customs officials.

Even prim international financial institutions recognize the survival-value of shuttle trade to the economies of developing and transition countries. It employs millions, boosts investments in transport and infrastructure, and encourages grassroots capitalism. The IMF - in the 11th meeting of its Committee on Balance of Payments Statistics in 1998 - officially recognized shuttle trade as a business activity to be recorded under "goods".

But there is a seedier and seamier side to shuttle trade where it interfaces with organized crime and official corruption. Shuttle trade also constitutes unfair competition to legitimate, tax and customs duties paying enterprises - the manufacturers of textiles, shoes, cigarettes, alcoholic drinks, and food products. Shuttled goods are not subject to health and safety inspections, or quality control.

According to the March 27th 2002 issue of East West Institute's "Russian Regional Report", the value of Chinese goods shuttled into the borderlands of the Russian Far East is a whopping $50 million a month. China benefits from the serendipitous proceeds of these informal exports - but is unhappy at the lost tax revenues.

EWI claims that Russian banks in the region (such as DalOVK, Primsotsbank, and Regiobank) are already offering money transfer services to China. DalOVK alone transfers $1 million a month - a fortune in local terms. But even these figures may be a serious under-estimate. The trade between Khabarovsk Territory in Russia and Heilongjiang Province in China - most of it in shuttle form - was $1.5 billion in 2001. The bulk of it was one way, from China to Russia.

Shuttle trade is even more prominent between Iraq and Turkey. The Anatolia News Agency expected it to increase to $2 billion in 2002. By comparison, the official exports of Turkey to Iraq amount to $800 million. The then prime minister Bulent Ecevit himself stated to the Ankara Anatolia news agency: "We have provided necessary support to increase shuttle trade".

"The Economist" reports about the flourishing "petty trade" between China and Vietnam. Western and counterfeit goods are smuggled to bazaars in Vietnam, owned and operated by Chinese nationals. The border between these two erstwhile enemies opened in 1990. This led to the rise of criminal networks which involve border guards and policemen.

Another hot spot is the Balkan. In a report dated July 2001, the Balkan Information Exchange describes the "Tulip Market" in Istanbul. Vendors are fluent in Russian, Bulgarian and Romanian and most of the clients are East European. They buy wholesale and use special vans and buses to transport the goods - mainly textiles - northwards, frequently to destinations in the Balkan. This kind of trade is estimated to be worth $8 billion a year - more than one quarter of Turkey's official exports.

Bulgarian customs officials, border patrols, and policemen form part of these efficient rings - as do their Macedonian and, to a lesser extent, Greek counterparts. The Sofia-based Center for the Study of Democracy thinks that a third of the Bulgarian workforce (i.e., c. 1 million people) may be involved. Many of the traders maintain mom-and-pop establishments or stalls in public bazaars, where members of their family sell the goods.

Some of the merchandise ends up in Serbia, which was subjected to UN sanctions until lately. Fuel smuggling on bikes and other forms of sanctions busting have largely ended but they have been replaced by cigarettes, alcohol, firearms, stolen cars, and mobile phones.

The Serbian authorities often round up and deport Bulgarian shuttle traders, provoking furious resentment in Bulgaria. Headlines like "(Serbian) Policemen take away our countrymen's money" and "Serbs searching (Bulgarian) women's genitals for money" are pretty common. The Bulgarians are embittered. They used to smuggle medicines and fuel into embargoed Serbia - only to be abused by Serb officials now, that the embargo has been lifted.

East European buyers used to reach as far as India where they shopped wholesale in winter. Russians used to buy readymade clothes, leather goods, and cheap jewelry in New Delhi and elsewhere and sell the goods in the numerous flea markets back home.

To finance their purchases, they used to sell in India Russian cosmetics and consumer goods such as watches, cameras, or hair dryers. But the 1998 financial crisis and sub-standard wares offered by unscrupulous Indian traders put a stop to this particular venue.

Governments are trying to stem the shuttle trade. The Russian news agency, ITAR-TASS, reports that Sergei Stepashin, the dynamic chairman of the Russian Audit Chamber (and a former short-lived prime minister of Russia) is bent on tightening the cooperation between member states of the Shanghai Cooperation Organization.

The audit agencies of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan will exchange information and strive to control the thriving shuttle trade across their porous borders. China and Russia are poised to sign a bilateral accord regarding these issues in October.

The WPS Monitoring Agency reported last November that the Economic Development and Trade Ministry of Russia intends to treat cargos of more than 50 kilos as a consignment of commercial goods, subject to import tariffs (on top of the current tax of 30 percent).

The Ministry claimed that shuttle trade accounts for up to 90 percent of all imported goods "in certain spheres" (e.g., furs). As late as 1994, Russians were allowed to import up to $5000 of duty-free goods in their accompanied baggage - a relic of communist days when only the privileged few were allowed to travel.

Up to 2 million Russian citizens may be engaged in shuttle trade and the value of "gray" goods may be as high as $10 billion annually. Goods from Turkey alone amounted in 2002 to $1.5-2 billion, according to then vice-premier Viktor Khristenko, but shuttle traders also operate in the United Arab Emirates, Syria, Israel, Pakistan, India, China, Poland, Hungary, and Italy.

A set of figures published for the first quarter of 2001 shows that shuttle trade amounted to $2.6 billion, or 8 percent of Russia's total foreign trade. Shuttle traded goods made up 1.5 percent of exports - but a full quarter of imports.

But the shuttle trade's coup de grace may well be EU enlargement. Already a new "iron curtain", comprised of visas and regulations, is rising between EU candidates and other East European and Balkan countries.

Consider the EU's eastern boundary. More than a million people cross the busy Ukrainian-Polish border every month. Enhanced regulation on the Polish side and new, IMF-inspired, tax laws on the Ukrainian side - led to a massive increase in corruption and smuggling. Truck owners now bribe customs officials to the tune of $300 per vehicle, according to a January 2001 report by CEPS.

The results are grave. Following the introduction of these new measures, cross border traffic fell by 50 percent and unemployment in the Polish border zones jumped by 40 percent in 2002 alone. It has since doubled. The IMF and the EU are much decried by the Polish minority now trapped in Western Ukraine.

The situation is likely to be further exacerbated with the introduction of a reciprocal visa regime between the two countries. Shuttle trade may be decimated by the resulting bureaucratic bottlenecks.

Still, it may no longer be needed now that Poland acceded to the EU. Shuttle trade thrives on poverty. It arbitrates between inefficient markets. It satisfies unrequited demand for goods. The single market ought to rid Europe of all these distortions - and, thus, most probably of this makeshift though resilient solution, the shuttle trader.

Skoda Auto, the Czech-based carmaker, is completing its transformation from manufacturer of smoke-belching, low-budget, communist-era clunkers to producer of upscale, affordable, BMW-alikes. "Skoda" means in Czech pity or shame - an apt moniker for the company's erstwhile products.

No more. In the British International Motor Show a fortnight ago, Skoda hired supermodel and heir to a chocolate dynasty, Alicia Rowntree, to launch its new Octavia vRS Estate, a 4X4, replete with a turbo-charged 1.8 liter engine producing 180 brake horsepower and a top speed of 146 miles per hour. The hatchback's price tag? Less than $24,000.

Seventy percent of Skoda were purchased from the Czechoslovakian state by Volkswagen in a controversial $650 million privatization in 1991. According to The Economist, Skoda has since tripled its annual production to more than 500,000 vehicles. It now employs directly and indirectly c. 4 percent of the Czech workforce, some 150,000 people. Skoda and its suppliers generate more than $4 billion of combined yearly revenues. Skoda reinvested $2 billion of its cashflow in its manufacturing facilities.

The domestic market accounted for three quarters of Skoda's sales in 1989. It now exports 80 percent of its production to more than 70 countries and constitutes one seventh of all Czech exports. Skoda Auto is a true multinational, with assembly plants in Bosnia, Poland, and India. A deal negotiated by Volkswagen to establish yet another workshop in Macedonia fell through in 1997-8.

But last year was not kind to Skoda. Sales tumbled. According to Skoda's chief executive officer, Vratislav Kulhanek, quoted by the Prague Business Journal, the company will sell 16,000 fewer cars this year compared to last year. Skoda plans to slash 2000 foreign workers - Slovaks and Poles - in its plants in the Czech Republic. According to Ananova, Skoda employs nearly 3000 foreign workers and 21,700 full time Czech staff.

Skoda can expect little support from its German owners. Volkswagen's profits in the quarter to September plunged by 51 percent. A combination of ageing models and weak demand in its core markets - Europe and South America - has affected the bottom line. In north America - which account for 40 percent of sales - Volkswagen failed to respond effectively to zero interest financing offered by major American manufacturers, such as General Motors.

The launching of new models next year, the weakening dollar and writing-off some portfolio investments did the rest. According to Interfax, this year, Volkswagen's was the second worst performance among European automotive companies after ailing Fiat's.

Relationships were further complicated by the nagging and emotionally charged issue of the Benes decrees - a series of statutes which led to the expulsion of 3 million Germans from Czechoslovakia after the war. Germany and Austria demand their revocation. The Czech Republic refuses to discuss the issue.

A bigger problem is brand confusion. Volkswagen shares its platforms - in other words, it uses the same chassis to produced different models. Bernd Pischetsrieder, chairman of Volkswagen (VW), is quoted in The Economist as saying, when he was still at BMW, that Skoda's cheap brands often cannibalize Volkswagen's more profitable ones. The result, according to Keith Hayes, a motor industry analyst at Goldman Sachs, is a poor return on capital of less than 3 percent. BMW's, by comparison, is four times that.

Volkswagen is in a quandary. On the one hand, models like Skoda's Octavia - and even Fabia - cannibalize the sales of models such as the Audi A3 and the Volkswagen Golf. On the other hand, Volkswagen's ability to charge more for its products due to an image of German perfectionism and quality has been adversely affected by the acquisition of the downmarket, central European, Skoda. Hence Skoda's sudden conversion to swankier models such as the Octavia.

In a bizarre realignment of Volkswagen's brands last year, Skoda was grouped with Bentley in the "classic" brands. Audi, SEAT, and Lamborghini formed the "sporty brands" cluster. Risking its Audi posh marque, Volkswagen launched the upmarket loss leading Phaeton saloon car with the express intention of reviving the "halo effect" and "adding emotion to the brand".

Not all is doom. Even as Western markets wither, increasing purchasing power in central and eastern Europe presents luring opportunities. Volkswagen's sales in Russia, for instance, shot up by 24 percent this year. According to Prime-TASS, Skoda increased its Russian sales by 41 percent in the nine months to September 2002.

Proof of the rising importance of the central European car market is the interest Western automakers are showing in Zastava. The carpet-bombed and obsolete manufacturer of the much-derided Yugo, it currently produces at a mere 9 percent of its pre-1990 200,000 vehicles annual capacity. A $50 million reorganization effort resulted in mass layoffs. Zastava - previously a cradle to grave conglomerate - has now attractively reverted to its core competency: car assembly.

If Dacia - the decrepit Romanian car maker - enticed Renault as a buyer, Zastava is bound to end up foreign-owned. With all central and east European brands in Western ownership, the real bloodbath will begin. Skoda is well placed to emerge triumphant.

Slavery

Spanish settlements in the territory of the current-day USA owned slaves as early as 1526. Twenty one African chattel slaves were first brought to British North America ( to Jamestown, Virginia)  in 1619. They joined white indentured laborers (servants) from all over Europe as well as Indian (Native-American) and Caribbean slaves. All the colonies legalized race-based (black) slavery and introduced "slave codes" by 1670. In total, 10-13 million Africans were abducted (mainly by other Africans and Arabs) and sold as slaves (mostly in the Americas) between 1620 and 1880.

The slaves were transported across the ocean in especially fitted ships. They were kept lying on narrow ledges, chained, but were brought above deck in good weather. Women and children were not shackled. Even these harsh conditions did not prevent the would-be slaves from frequently attempting to rebel, though, usually, unsuccessfully.

Overcrowding, minimal and monotonous diet (two meals per day and a pint of water), poor hygiene, epidemics, and lack of physical activity decimated, on each and every 1-2 months long trip, a whopping one seventh to one fourth of the "cargo" and one sixth to one half of the crew. Another 10% of the slaves died during the process of "seasoning" - getting used to local conditions in their destinations.

Initially, all types of unfree workers, regardless of color, were treated the same way: bought, sold, and worked, sometimes to death. Gradually, starting in the 18th century, light-skinned slaves ("house negroes") and whites were tackled more leniently. Surprisingly, slave rebellions were rather rare - perhaps because cruel slave-owners were socially ostracized and miscegenation (white-black sexual liaisons) was frowned upon.

Most slave-owners regarded themselves as custodians of their slaves. They properly fed the working adults (though children usually went malnourished), allowed them to grow vegetables in their own garden plots, provided them with clothing (four suits) and housing (one wooden cabin per family). In wealthier and larger plantations, the slaves were cared for by qualified physicians. The master felt it his obligation and right to constantly intervene, interfere, and meddle in the lives of his inferiors.

Slave life was richer than portrayed in literature and cinema. Slaves belonged to churches and were ordained as ministers and preachers. A few learned to read and write. Music was a favorite pastime. Understandably, so was drinking. Slaves were allowed to moonlight or work on their own free time.

Actually, only a minority of the white population in the south were slave-owners (347,525 out of 6,000,000 in 1850). Only 1,800 people owned more than 100 slaves. There were 250,000 freed slaves in the south by 1860. The average cotton plantation had only 35 slaves, about 50-60% of them engaged in the production of the immensely profitable crop and its processing.

Still, slaves constituted more than half the population in some southern states (South Carolina, Mississippi) and two fifths of the total southern populace (compared to an average of 5% in the north and 10% in New-York). Of the first 12 Presidents of the USA, 8 were slave-owners. Some slave-owners were themselves black and former slaves.

The Law, even in the Deep South, recognized slaves as both chattel and human beings. Slaves were held responsible for criminal acts they had committed, for instance, and enjoyed many human rights (e.g., the right not to be killed, tortured, or beaten brutally, to be cared for in old age or sickness, to receive religious instruction, to bring suit and give evidence in some cases). Case law and non-binding custom endowed them with additional privileges: the right to marry, own private property (peculium), have free time, enter contracts, and (if female or child) be consigned to lighter labor.

Still, a minority of slave-owners ignored these legal protections and social censure and indulged their sadistic urges and sexual appetites. In some plantations, nutrition was so lopsided or deficient that slaves resorted to eating clay to supplement their diet. In others mutilation, branding, chaining, torture, murder, and rape - all criminal acts prohibited by Law - were common.

But while individual slaves were, at least theoretically, protected by law and social custom - not so the negro family. The owner had the right to sell his slaves separately, regardless of their familial ties. Some states, like Louisiana in 1829, passed legislation prohibiting the sale of children under the age of ten. Others (Alabama and Georgia) forbade the separation of inherited slave families. But these were the exceptions to the widespread practice.

Though not recognized or protected by Law, many slaves accumulated property. A few hundred slaves even purchased their freedom from their white masters. Slave-owners in the USA usually retained ownership of sick, disabled, or infirm slaves and took care of them. Suicide among slaves in the USA was a rarity. Many slaves (especially in the coastal areas of Georgia and South Carolina) were free to do as they chose once they had completed their daily assignments (the "task system").

On the eve of the American Revolution, c. 400,000 slaves amounted to one fifth of the population of the rebellious colonies. Slavery in the USA was abolished in stages and decades after it was eliminated in Britain. Rhode Island banned it as early as 1774. Pennsylvania, New-York, and New Jersey followed suit. In 1787, the Continental Congress prohibited the practice in the Midwest. The slave trade - or, more precisely, the importation of slaves into the USA - was banned altogether in 1808. Even so, between 1808 and 1865, traders smuggled 270,000 slaves into the USA.

But the major engine of growth of the slave population was reproduction. Twenty thousand slaves were born every year during the 1790s - and 70,000 annually in the 1840s. As a result, the ratio between the sexes was equal and the slave population skyrocketed from 1.2 million in 1810 to 4 million in 1860. Some slave-owners even established "breeding farms" and sold the off-spring in the markets of "deficit" states.

Gradually, all the states north of the Ohio River and the Mason-Dixon line became slave-free. Northerners resented the presence of fugitive slaves (about 1000 per year) who crossed the Ohio River in what was known as the Underground Railroad, but they often clashed with federal authorities when the latter tried to extend their jurisdiction to the escapees under the Fugitive Slave Laws.

Most abolitionists - as well as President Abraham Lincoln (who was never one) - wanted to repatriate the blacks (return them to Africa) and, in any case, expel all free blacks from northern and, later, southern territories. The African nation-state of Liberia was established specifically to accommodate former North American slaves.

It was widely acknowledged that slave-owners should be compensated for the loss of their property. Not a single abolitionist supported or even discussed reparations (compensating the slaves for their free labor, denial of freedom, brutal treatment, and hardships). It was accepted wisdom that blacks - both slaves and free - should never be allowed to carry arms.

Slaves in the South (the Confederacy) were finally emancipated in 1863, during the Civil War. But, even then, Lincoln's Emancipation Proclamation did not apply to some states within the Union. These other slaves remained in slavery until December 1865, when the Thirteenth Amendment to the US Constitution was adopted.