The trigger for this blogpost is a tweet by my favourite newsletter-writer Matt Levine. He wrote:
It is somewhat weird to think that the market for a good can be rational only if it’s easy to short. http://t.co/Q5OnEGv8Wb
— Matt Levine (@matt_levine) July 24, 2015
And followed up with:
It’s hard to short cars, or iPhones, or burgers. And yet no one thinks car or burger prices are in a bubble.
— Matt Levine (@matt_levine) July 24, 2015
I responded to him with a tweet but thought this is blogworthy so putting it here.
The essential difference between an iPhone and an Apple share is that in the short run, the supply of the former is constantly increasing while the supply of the latter is fixed (follow on offers, stock splits, etc., which increase the supply of shares, are rare events).
The difference occurs because the “default action” (which is “do nothing” – caused due to inertia) has different impacts on the two market structures. In a market with constantly increasing supply, if customers “do nothing”, there will soon be a supply-demand mismatch and the manufacturer will have to take corrective action.
When the supply of the commodity is fixed, on the other hand (like an Apple share), the default action (“do nothing”) has no impact on the prices. You need a stronger method to express your displeasure, and that method is the ability to short the stock.