Germany's decision to unilaterally ban naked short selling of European government bonds and certain German financial stocks has ricocheted through global stock markets, leading to a global stock market sell-off. This adverse global response, though it may well have come as a surprise to the German administration, now adds to their already bad track record of misjudging the wider economic impact of their decisions.
It's useful to look at the background to Germany's decision, which has less to do with short-selling than political maneuvering. Germany, as one of Europe's leading nations, has been heavily involved in trying to resolve the region's debt crisis, which has meant gaining parliamentary agreement from its Bundestag to contribute to a vast rescue package.
Anyone who has been following the German media over the last few weeks will know that there is widespread public opinion in Germany that the previous pressures on European government bond markets, which led in part to Europe's debt crisis, were primarily caused by irresponsible overseas speculators rather than excessive government borrowing.
The closer observer can see then that this fairly ineffective ban was entirely domestically and politically motivated. It was put through ahead of the crucial government debate to pass the €750 million Eurozone debt support package. It was intended to shore up parliamentarian support by sending a protectionist signal to the speculative elements in capital markets.
However, this backfired because jittery markets around the world greeted it with suspicion. Ironically, this ban on financial speculation led to a great deal of political speculation, as markets guessed at a much more significant issue around European banks than what was just a domestic PR stunt. This went along the lines of ‘what does the German administration know that we do not?'
With markets still so sentiment driven, a positively intended internal message can swiftly become a very negative global one. Policy makers can learn from this outcome: every decision counts in the journey towards economic recovery. Before jumping to action, it's important to carefully assess how your message may be translated by market participants far beyond your own parochial horizon.
Let's hope that this time markets will discover their judgment error before declining asset prices again create a negative feedback loop in the real economy, an economy that is continuing to recover. Politicians meanwhile can be aware that, after two years of economic and financial upheaval, the margin for error has…
