Will Germany's crackdown backfire?

Will Germany's crackdown on speculators throw gasoline on the euro bonfire?

In a bid to tamp down speculation in volatile bond markets, Germany's financial authorities moved Tuesday to ban naked short sales of eurozone debt and the use of credit default swaps by those who don't hold the underlying bonds. Germany also banned naked short sales of the stock of 10 major financial firms, including Deutsche Bank (DB) and insurer Allianz.

Reports that Germany was considering such a move interrupted a mild euro recovery rally Tuesday, sending the European currency to a four-year low against the dollar at $1.22 to the euro. The selling resumed early Wednesday, with the euro hitting $1.21. Six months ago a euro fetched $1.51.

But by all accounts, the euro's decline is far from over. As Kit Roane pointed out Tuesday, a number of currency strategists are now predicting the dollar will reach parity with the euro by the middle of next year, which is based on the expectation that Europe will take years to bring its fiscal problems under control.

"We are becoming increasingly convinced that doubts about the long-term survival of the euro are not going to go away," analysts at Capital Economics in Toronto wrote this week. They too expect the euro-dollar rate to hit parity by the middle of next year, compared with a previous target of $1.10.

The question now is whether Germany's actions will increase pressure on the euro, by prodding those wagering against Europe to make those bets by selling the currency rather than by selling shares or bonds. "The euro will now stand-out even more as the most liquid euro instrument to short to express a negative euro-area view with less risk of political interference," said RBS currency strategist Alan Ruskin.

A short-selling ban gone awry would hardly be unprecedented. The U.S. ban on short sales in financial companies in mid-2008 and a later ban on all shorting were widely viewed as inconsequential at best and perhaps as an addition to the turmoil, by eliminating the purchasing power of short-sellers who would normally buy shares after they declined to book profits.

What's more, a crackdown on speculators reeks of desperation, at a time when investors would prefer to see signs that policymakers are coming to grips with euro area governments' debt, deficit, and competitiveness problems.

It is early yet, but a Reuters report from Asia late Tuesday suggests that the unintended consequences may have already begun to take hold.

"For today, the situation is that it's hard for us to take orders on European bonds," said Yasutoshi Nagai, chief economist at Daiwa Securities Capital Markets. "For clients looking to buy, we are asking them to buy Treasuries."

More fodder for the flight to Treasurys is definitely not what the doctor ordered for this patient.