A good example to see how effective a ban on short-selling would be is to look at the Chinese stock market, where shorting stocks is illegal altogether. You can't short at all. Until recently, China just had ridiculous stock pricing, and even with their permanent short-selling ban, it didn't stop stocks from falling a tremendous amount.
This all reminds me of a comment made by Charlie Munger a few years back. He said that England, after the South Sea bubble, made publicly held companies illegal. They made them illegal for 100 years. They thought, "It's a casino, it's all nonsense," and they just got rid of the entire system. There was no stock market for 100 years.
Here's what's important: when they got rid of publicly traded companies, it made no difference in terms of the way commerce progressed. The GDP of England grew dramatically during those 100 years. The English people weren't bad at forming companies -- businesses still flourished -- and entrepreneurs could still raise capital from private sources.
Anyways, what Munger's point was is that many of the financial instruments that we think we need, we really don't need. They don't make a positive difference in commerce.
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