The Capital Letter

Putting the Grift in ESG

BlackRock CEO Larry Fink at a conference in New York in 2017 (Lucas Jackson/Reuters)
The week of March 15: ESG’s new clothes, tax troubles ahead, inflation ahead (or not) and much, much more.

On the whole, I would prefer to live in a society run by cynics rather than saints—cynics tend to be less intrusive. However, when cynics pretend to be saints, they are playing a dangerous game, as many of those on Wall Street now peddling “socially responsible” investment (SRI) may soon discover. To be clear, I have no doubt that some of those pushing for more SRI (or the closely related concept of stakeholder capitalism) are true believers. Others, perhaps the smartest, are jockeying for positions of power — and the perks that come with it — under a corporatist regime (stakeholder capitalism is essentially an expression of corporatism). Still others are simply following the ancient Wall Street practice of repackaging nonsense and selling it at a profit.

The idea that companies which are run not for their shareholders, but for a somewhat arbitrarily selected group of “stakeholders” and/or goals that someone, somewhere, has determined to be good for society will be more profitable (or less risky) than companies run with a keen eye on shareholder return is, on the face of it, absurd. Even if it were not absurd, the extra fillip that would come from doing well by doing good would be quickly reflected in the share prices of those supposedly virtuous companies, sharply reducing the potential upside for those who got into the game too late (which will likely be most investors).

Nevertheless, turning to Jason Zweig’s The Devil’s Financial Dictionary (a recent, and entertaining purchase, from which I plan on quoting fairly frequently in the next few months), I see that the first line of Zweig’s definition of a stock market is this:

A chaotic hive of millions of people who overpay for hope and underpay for value.

Harsh, but often true.

And so we come to the bubble in stocks that are considered to score highly against certain environmental (“E”), social (“S”) and, rather more rationally, governance (“G”) benchmarks. To be clear, this bubble, like all the most dangerous bubbles, has some logic behind it. There is no doubt that the actions of activists, governments and regulators can create an environment in which such stocks will do better than they would in a market without such distorting factors. And momentum, of course, helps. Jumping on a bandwagon can make sense, so long as you know when to jump off, but picking that moment is rather easier said than done. As the saying goes, no one rings a bell.

Valuations can only go so far, and even the supply of “greater fools” is not infinite.


It might seem surprising that there could ever be a shortage of fools in this world, but if you count on always finding one just when you most need to, you will wake up one day to find that everyone else has suddenly smartened up and the greater fool is you.

And so to the selling of ESG, and this piece by Michael Wursthorn in the Wall Street Journal:

Sustainability has been good for Wall Street’s bottom line.

Exchange-traded funds that explicitly focus on socially responsible investments have 43% higher fees than widely popular standard ETFs.

The environmental, social, and governance funds’ average fee was 0.2% at the end of last year, while standard ETFs that invest in U.S. large-cap stocks had a 0.14% fee on average, according to data from FactSet.

“ESG creates a fantastic revenue possibility for large firms,” said Dr. Wayne Winegarden, a senior fellow at the Pacific Research Institute.

Asset managers are among the biggest cheerleaders for sustainable investing. Their efforts are all aimed at capturing some of the tidal wave of money that has flowed into funds that promote things like clean energy or diversity. As a broader fee war has narrowed profit margins for money managers over the last decade, firms are looking to wring more revenue from the surge.

Even a seemingly small increase in fees can have a big impact at scale. A firm managing $1 billion in a typical ESG fund, for example, would garner $2 million in annual fees versus managing the standard ETF’s $1.4 million.

“It’s fresh, feels good and new,” said Andrew Jamieson, global head of ETF product at Citigroup Inc., of ESG. “But it’s not any different than anything else. These things aren’t any more expensive to run.”

Nearly $8 billion has flowed into a host of U.S. ESG-themed funds in just January and February, according to FactSet, putting the first two months of flows roughly on par with all of 2019 . . .

Money managers launched a record 71 sustainable mutual funds and ETFs last year, according to Morningstar.

Asset management giant BlackRock Inc. pulled $68 billion into its sustainable products last year, representing more than 60% annual growth, with more than two-thirds of that money going into its iShares ETF business.

In many respects, Larry Fink, the chairman and CEO of BlackRock, has made himself the face of ESG, issuing increasingly imperious directives setting out what he expects from the companies in which BlackRock, the largest asset manager in the world, invests or might invest.

Now’s not the time to go through his latest “letter to CEOs,” although I appreciated the customary, if perhaps debatably scientific, shout-out to the “mounting physical toll of climate change in fires, droughts, flooding and hurricanes” and Fink’s (professed, if implicit) faith in Xi, the Chinese dictator, someone who no one should trust.

In 2020, the EU, China, Japan, and South Korea all made historic commitments to achieve net zero emissions.

It is, of course, only a coincidence that BlackRock sees China as both a business and investment opportunity.

Then there was this (my emphasis added):

There is no company whose business model won’t be profoundly affected by the transition to a net zero economy – one that emits no more carbon dioxide than it removes from the atmosphere by 2050, the scientifically-established threshold necessary to keep global warming well below 2ºC. As the transition accelerates, companies with a well-articulated long-term strategy, and a clear plan to address the transition to net zero, will distinguish themselves with their stakeholders – with customers, policymakers, employees and shareholders – by inspiring confidence that they can navigate this global transformation.

For the CEO of the largest asset manager in the world to include “policymakers” (in other words, the state) as one of the “stakeholders” in private companies is an indicator of how far and how fast the corporatist advance is proceeding, an advance that bodes ill for shareholders and, for that matter, democracy.

But back to the Wall Street Journal:

For sustainability-focused investors, long-term returns aren’t certain. Last year, three out of four sustainable funds beat the averages for their broader categories, Morningstar said in a research report in January.

Much of that outsize performance owes to sustainable funds being populated with technology stocks, a general stock-market favorite in 2020 that outperformed nearly all other sectors. History suggests that performance may be more of an outlier than the start of a permanent trend.

Technology stocks happen to have, on some measures, a light environmental footprint, but that’s not why they outperformed.

Pacific Research Institute’s Mr. Winegarden crunched some numbers in 2019, finding that $10,000 in an ESG fund would be about 44% smaller compared with an investment in an S&P 500-tracking fund over a 10-year period.


And a purely opportunistic embrace of ESG may well backfire. Not only does it help shift the parameters of debate in a direction that is unlikely to favor either shareholders or prosperity or free markets, but it also may well leave those who have embraced it open to some . . . embarrassment.

Take this article, published in USA Today:

The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not. In essence, Wall Street is greenwashing the economic system . . .

In many instances across the industry, existing mutual funds are cynically rebranded as “green” — with no discernible change to the fund itself or its underlying strategies — simply for the sake of appearances and marketing purposes. In other cases, ESG products contain irresponsible companies such as petroleum majors and other large polluters like “fast fashion” manufacturing to boost the fund’s performance. There are even portfolio managers who actively mine ESG data to bet against environmentally responsible companies in the name of profit, a short-selling strategy.

In that last case, I can understand why, and not just because many of these companies are currently traded at bubble prices. A company that is making a great show of the emphasis that it puts on ESG is unlikely to be focusing as much as it should on delivering a return to shareholders. This is even more the case where management is financially rewarded for the progress it makes in delivering ESG-style objectives, something that is becoming increasingly popular in C-suites, both as a public gesture of piety and as a means of diluting the tougher discipline imposed by financial targets.

Back to USA Today (my emphasis added):

As disheartening as this reality is, claiming to be environmentally responsible is profitable. Last year alone, ESG mutual funds and exchange-traded funds nearly doubled. The investment community understandably reacted to this with cheers. But those cheers were only for fund managers and their bottom lines. No matter what they tout as green investing, portfolio managers are legally bound (as well as financially incentivized) to do nothing that compromises profits. To advance real change in the environment simply doesn’t yield the same return . . .


In early March, my sentiments were echoed by the U.S. Securities and Exchange Commission (SEC), which announced it was creating a Climate and ESG Task Force to “proactively identify ESG-related misconduct” such as inaccurate or incomplete disclosures by funds and companies — an unprecedented move that suggests there might be abuses that have gone unaddressed.

That is a part of what has attracted the SEC’s attention, yes, and it may well cause some difficulties for companies that have either been mis-selling themselves or their investment products. But the SEC’s initiative is a part of a more far-reaching process. First the agency would like to bring some order into how E, S, and G are defined and measured. That makes some sense. Investors who wish to base their decisions, whether it’s to buy or  to sell (including selling short), on these issues ought to know how much they can rely on claims of ESG compliance and on what those claims actually mean. Those who have been so loudly touting their ESG credentials will find any arguments made by the SEC to that effect extremely difficult to resist.

Sadly, the SEC appears to have wider ambitions that that. Please note this comment:

Proactively addressing emerging disclosure gaps that threaten investors and the market has always been core to the SEC’s mission.

What that will come to mean is that every company, whatever its previous stance on, say, climate change, will be required to disclose what it is doing in this area, a disclosure that will be used by activists as a cudgel to bring miscreants into line. But the ratchet will not stop there. What will begin as mandate to disclose will end up as an obligation on all companies to achieve certain standards — and those standards will inevitably become tougher as the years go by. To repeat myself, that is not good for shareholders, free markets, or prosperity.

That would not, I suspect, worry the author of the USA Today article overmuch:

Imagine the planet is a cancer patient, and climate change is the cancer. Wall Street is prescribing wheatgrass: A well-marketed, profitable idea that has no chance of curing or even slowing down the cancer. In this scenario, wheatgrass is the deadly distraction, misleading the public and delaying lifesaving measures like chemotherapy. But like giving false hope to unproven cures in the midst of a pandemic, the consequences of such irresponsibility are all too obvious. And motivation for why the industry continues to greenwash is all too obvious.

I believe we are doing irreversible harm by stalling and greenwashing. And all in the name of profits . . .

We’re running out of time and need to accept the truth: To fix our system and curb a growing disaster, we need government to fix the rules.

Once again, those who have been pushing ESG so hard (particularly where climate change is concerned) may find themselves on tricky ground if or when they dare to argue back.

So, who wrote the USA Today piece? Well, his name is Tariq Fancy, and, in the article, he explains his background:

As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.



The Capital Record
We recently launched a new series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which will appear weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.

In the ninth episode, David Bahnsen interviews Father Robert Sirico, founder of the Acton Institute. The conversation goes deep and wide around economic history and is entitled Ayn Rand Meets Religion.

And the Capital Matters week that was . . .
Perhaps appropriately, given the assumption of regulatory creep contained in the first section of this Capital Letter, we began the week with the Manhattan Institute’s Randall Lutter noting the use that President Biden will make of regulation to push through his agenda. Lutter wonders who will regulate the regulators:

The Biden administration, supported by thin Democratic majorities in the House and Senate, may soon begin issuing regulations to achieve its policy goals. A presidential memo from last month outlines the administration’s plan for modernizing the federal regulatory-development process within the executive branch. It calls for rulemaking-process improvements to promote goals such as public health and safety, economic growth, social welfare, racial justice, environmental stewardship, human dignity, and equity.

But a close reading of Biden’s memo raises questions about whether the process improvements that it envisions will suffice to provide necessary transparency and accountability in rulemaking. In fact, Congress should consider taking additional steps in order to ensure transparency and accountability and to help make regulations authorized by existing statutes more efficient and cost-effective . . .

In 2000, Congress authorized but did not fund an office of regulatory analysis that would have been housed in the General Accountability Office. Congress should now authorize and fund such a body, either as a part of the GAO or as a stand-alone organization.

An independent office of regulatory analysis would surely not prevent all federal regulatory excesses, either those that go beyond existing statutory authority or those that are legally sound but burden families and small businesses and curtail innovation without commensurate benefits. But it would help protect the impartiality of estimates of the economic effects of federal regulation and thereby enhance serious deliberations about specific federal regulations and the regulatory process generally. And in a troubled world in which legislative action by our elected officials may be limited and new regulations abundant, this modest step is well worth taking.

It is indeed, but I am not holding my breath.

PERC’s Brian Yablonski argued that private landowners ought to have a role to play in Biden’s plan to conserve 30 percent of all U.S. lands and waters by 2030:

There will be a push to use old, divisive tools on public lands to score easy gains, such as designating new monuments or banning fossil-fuel development. But conserving land does not necessarily require a heavy hand from the federal government. The administration should use this moment to explore newer, more-creative market-based solutions. Indeed, whatever its instincts to the contrary, this would be its best chance of success . . .

Private landowners play a vital but often overlooked role in sustaining much of what many Americans want to conserve — abundant wildlife, clean water, and vast open spaces. Altogether, private lands are home to 75 percent of the nation’s wetlands and more than 80 percent of its grasslands. Two-thirds of all threatened and endangered species depend upon private lands for the majority of their habitat.

But getting landowner buy-in for a federal initiative won’t be easy in our current “red-county–blue-county” political climate. A recent survey from Duke University found that only 25 percent of rural Americans believe that the federal government, rather than states, should “take the lead” on environmental issues. To address these concerns, the Biden administration should come out strongly against the use of regulations or restrictive designations on private lands to reach its target of 30 by 30. Even the progressive Center for American Progress — in an article published in 2019 that argued for protecting 30 percent by 2030 — said that such policies “need not and must not infringe upon private property rights.”

Instead, innovation and incentives should take the lead. Private-land innovators are already harnessing markets for large-landscape conservation . . .

It is fair to say that Daniel J. Pilla did not like the look of Elizabeth Warren’s tax plan, which has implications that go far beyond a wealth tax, bad enough as that would be:

The merits of the tax itself have been discussed at length. What has not been discussed is the new IRS-enforcement scheme that the bill would create, which would include a staggering increase in the size of the IRS, a substantial expansion of the IRS’s already-oppressive information-reporting requirements, and many more audits and collection actions.

Let’s examine these elements more carefully.

The bill proposes to increase the IRS’s funding by $100 billion over the next ten years. To put this in perspective, the IRS’s FY 2021 budget is $11.92 billion, up by $409 million from FY 2020. Warren’s bill would nearly double the agency’s funding for FY 2022, and leave it nearly ten times bigger by 2031.

What’s more, the bill stipulates that 70 percent of the new money must be used for tax-law enforcement, compared to just 10 percent allocated for “taxpayer services” such as pre-filing assistance and education, filing and account services, and taxpayer-advocacy services. Again, for perspective, the IRS’s FY 2021 budget allocates $2.556 billion for taxpayer services and $5.213 billion, or just about twice as much, for enforcement activities such as audits, collections, litigation, and criminal investigations. Warren’s bill would give the IRS seven times more money for enforcement than for taxpayer services . . .

It gets worse. But then you knew that.

Charlie Cooke meanwhile didn’t think that Joe Biden had been entirely straightforward about his tax plans.


Joe Biden will not raise taxes on anyone making less than $400,000. Period.


Psaki says potential tax increase on those making $400,000 or more means that income threshold applies to “families.”

One cannot square “anyone” and “families,” writes Charlie. Indeed. “Watch this space,” he adds. I think I know what will fill it.

Phil Klein, meanwhile, the new editor of National Review Online (welcome!), disapproved of the fact that Chuck Schumer “is pushing Biden to remove the $10,000 cap on deducting state and local taxes from federal taxes (known as the SALT tax cap)”:

The Tax Policy Center has found that were the cap lifted, a majority of the benefits would go to the top 1 percent of taxpayers, and 96 percent of would go to the top 20 percent of taxpayers. Virtually no middle-class taxpayers would benefit from the repeal, which would reduce revenues by about $327 billion over the next five years.

One effect of the tax cap was that it allowed liberal states such as Schumer’s to hike taxes while minimizing the fallout from doing so. It’s no surprise that since the cap was put in place, people have been fleeing New York and California in droves for lower-tax jurisdictions — a trend that was accelerated by those states’ abysmal handling of COVID-19.

I shall say nothing. (Don’t @ me.)

Tax week continued with Kevin Hassett and Matthew Jensen adding up all the stimulus packages and then running some numbers.

Brace yourselves:

It is possible that lower spending will eventually offset the debt from all this stimulus, but what if, as the Biden team signaled this week, the stimulus bill is paid for with tax hikes? Just to make it personal, wouldn’t you like to know what your tax bill will be for all the stimulus packages, so you can, with your usual rational panache, save in order to finance your new liability just as Friedman suggested all rational people would do?

To find out, we relied on a methodology that was developed by one of us (Jensen) and his coauthor Aspen Gorry in a 2011 article. The idea is that the current distribution of taxes paid is the result of a political process that has evolved in almost Darwinian fashion over time and thus is likely to persist. Tax hikes come and go, but the basic distribution of taxes paid varies much less than you might think, with the wealthiest paying the vast majority of taxes under both Republican and Democratic administrations. It is highly unlikely that a bill as high as $5.3 trillion will be distributed differently from today’s taxes. The richest of the rich simply don’t have that much money. Once we accept that assumption that the future tax hike will be distributed according to today’s distribution of taxes, we can estimate the tax bill for each income level.

How are taxes distributed? According to calculations based on the Tax-Brain software available at we found that in 2020, individuals with incomes below $75,000 paid about 12 percent of total taxes, while those with incomes between $75,000 and $200,000 paid about 34 percent of taxes, and those with incomes above that paid the rest.

Assuming that pattern holds . . . [we can see] how a future tax bill associated with COVID-19 relief would be distributed. Even with the high progressivity of the current tax code, the bills are extraordinary. For those with incomes between $30,000 and $40,000, the tax hike needed today to pay for the combined stimulus packages would be about $5,000. Those with incomes between $40,000 and $50,000 would pay about $9,000, while those earning between $50,000 and $75,000 would have to fork over $16,000. That rises to $27,000 for incomes between $75,000 and $100,000, and $51,000 for incomes between $100,000 and $200,000. For higher earners, the bills climb so fast that they jump off the chart. The average for Americans with incomes between $500,000 and $1 million is $304,000. A typical American family, with $88,000 of income, faces a bill near $27,000.

And speaking of stimulus, Veronique de Rugy didn’t see too much of it coming out of the latest $1.9 trillion:

Even if you are sympathetic to the idea that government spending can stimulate the economy, there is no way to justify the size of the American Rescue Plan, a plan that has little to do with rescuing us but is a first step toward a progressive paradise á la Bernie Sanders, at least with the tradition tools used by Keynesian or even neoliberal thinkers.

That level of spending has nothing to do with the traditional justification of filling the economy’s output gap, the difference between actual economic activity and potential output in a normal economy, unless we are willing to recognize that the economic return on this government spending (the spending multiplier) is ridiculously small — much smaller than 1.

Let’s do the math: The Congressional Budget Office projects that the output gap will be $700 billion through 2023, the period when most of the $1.9 trillion in spending will take place. It means that $1.9 trillion is two or three times more than needed to fill the gap. Unless one is willing to say that the multiplier is roughly 0.37. For each dollar the government spends (and takes from the real economy), it gets $0.37 in growth. Not too glorious . . .

But $1.9 trillion isn’t the end of the binge. Robert VerBruggen warned that another $2–4 trillion might be on the way, this time largely on infrastructure.

There might be some projects that justify additional federal spending — which, at about $100 billion per year, already covers about a quarter of American infrastructure costs — but most infrastructure improvements can and should just be left to state and local governments. These entities can decide for themselves whether to pony up, and with an overly generous handout from the COVID bill, they’re in good financial shape.

Meanwhile, there is no guarantee that infrastructure will “pay for itself” any better than tax cuts do. One can find studies claiming that every dollar of infrastructure investment creates several dollars in economic growth, but as Duranton et al. explain, the overall literature is “mixed,” with results that are sensitive to the statistical techniques used.

But free-market conservatives might not have a veto here. In that case, what should they do with what leverage they have?

As much as they possibly can, they should seek to include reforms that bring prices down. Infrastructure is way too expensive in this country, and if conservatives can’t prevent trillions in new spending, they should at least try to make the spending more efficient . . .

Philip Cross doubted whether higher minimum wages would reduce poverty:

Most studies conclude that minimum-wage hikes result in job losses, especially among the younger generation, while doing little to reduce poverty. The failure of minimum-wage laws to achieve their intended goal of helping low-income families is not surprising. Minimum-wage laws are designed to use employers to achieve a social goal at minimal cost to the government, but they incentivize firms to lower total labor costs in ways that frustrate that goal. This is because minimum-wage laws have contradictory effects: They help a small number of full-time workers at the expense of others, especially those who lose job opportunities . . .

Almost all the evidence for the impact of higher minimum wages on jobs is based on the relatively small increases that historically have been the norm. The Democratic proposal is more in line with the sizable increase made by Canadian provincial governments in Ontario (32 percent) and Alberta (36 percent) when, a few years ago, they boosted their minimum wage to $14 and $15 an hour, respectively. Economists expect these very large hikes eventually will result in disproportionately more job losses because outsized increases give employers more incentive to cut costs while unable to make the subtle adjustments to lower nonwage benefits or higher labor productivity that help firms control overall costs. One mitigating factor for the proposed U.S. federal minimum-wage increase is that it starts from a much lower initial wage rate than in either Ontario or Alberta. This also, however, magnifies the shock of moving to a $15 an hour wage.

So far, the sharp hikes in the minimum wages for Alberta and Ontario in 2018 have had a negative impact on youth employment. The youth-employment rate fell by a full point in Ontario between late 2017 and early 2020 (before the pandemic began), while in Alberta it dropped by half a point over the same period. By comparison, the youth-employment rate in all of Canada rose by nearly 2 percentage points over the same period.

Not having a job lowers the earnings profile of young people for years . . .

The CEI’s Iain Murray argued that decentralizing social media was the way to approach the current conundrum over Big Tech and its control over speech:

Before the “great de-platforming” following the events at the Capitol on January 6, defenders of a laissez-faire approach to social media were able to tell those unhappy with Big Tech’s content moderation decisions to simply switch platforms. But when Amazon Web Services removed Parler from its cloud hosting, making the app impossible to access, the case against a government crackdown became less convincing. But if given some time to innovate in an environment free from stifling regulation, the market may yet produce a solution in the form of decentralized social media.

It seems everyone is concerned about “Big Tech” these days. The Left is worried about its role in spreading misinformation — both actual and perceived. The Right is worried about what they see as anti-conservative bias on the part of tech companies. Even libertarians, who regard these two concerns as misplaced, worry about cronyism and a disturbing tendency to cozy up to authoritarian regimes. And the Big Tech firms themselves say they need to be regulated — on their own terms.

But compelling companies to quiet the “hate speech” du jour will displease conservatives and libertarians. Forcing companies to carry all speech will anger the Left and libertarians. And doing nothing will annoy the Left and Right alike.

The good news is that we already have a possible path out of this impasse: disintermediation. In practical terms, that means replacing the current generation of social-media platforms, such as Facebook, Twitter and Parler, with decentralized social media — a different infrastructure where there is no central server. Instead of a company owning and controlling the site, the users themselves would control content moderation and other management of the network . . .

Glenn Hubbard, a former chair of the Council of Economic Advisers under President George W. Bush, asked how to “build back better”:

Policy-makers are often impatient with the extended time it takes for bridges to make a difference. If a community is hurting because of imports or technology, why not just put in temporary tariffs or other protections (e.g., a wall)? Very simply, because to do so would be to postpone the inevitable work that all communities must do in order to participate in a dynamic economy.

More important, walls are almost always inequitable. Tariffs on steel might temporarily help a few steelmaking towns, but they ultimately operate at the cost of many more manufacturing towns with falling revenue because of higher prices for a key input. Protections usually favor well-connected groups at the expense of underprivileged communities trying to make it the usual way.

Adam Smith, the father of modern economics, understood this dynamic as well as anyone did. In his day, mercantilist thinkers thought that the wealth of nations consisted of stocks of gold or silver. They wanted to increase those stocks, the better to fund wars and explorations. They convinced kings to intervene in markets to limit competition at home and abroad for favored activities. Trade surpluses were good, trade deficits bad, and state-sanctioned monopolies generated more revenue for the crown.

For Smith, the wealth of a nation lay in its potential for consumption by the great mass of ordinary people. He wanted to make the economic pie as large as possible. The consumer, not the crown or court, was Smith’s economic king.

To expand this wealth, Smith promoted free markets and competition guided by the invisible hand. These forces reconciled self-interest with the expanding pie for everyone. He wanted everyone, even those without connections, to be able to compete, so he encouraged education and other kinds of preparation. Mass flourishing was his goal.

Today’s economy is more complex and disruptive than that of Smith’s day, but we still need broad participation. That’s the only way to keep raising living standards for more people, and bring economic justice to formerly marginalized groups.

Participation is also good for its own sake. Think of mass flourishing as being “in the groove” of the dynamic economy, akin to psychologists’ concept of flow. Like flow, flourishing requires individuals who can raise their game to keep up with wherever the economy goes. People feel a sense of belonging in the economy when they work in open markets.

They don’t get that sense when we try to protect them with walls. Well-connected workers will get those protected jobs, while other people will remain stuck. It’s far better to let consumers’ tastes and incomes shape the opportunities for firms and the employment patterns that follow. And once you start a bit of tinkering in the economy, everyone wants favors, and pretty soon you’ve smothered the economy’s dynamism inside a series of well-intentioned walls . . .

Jimmy Quinn described how the Beijing regime had used capital as one of the ways in which it reined in Hong Kong:

Even in the earliest years of the period following the city’s 1997 handover from the U.K. to China, the Chinese regime’s willingness to use flex its financial muscle as a way of asserting control over the life of the city was already apparent. As a result of the 2003 Closer Economic Partnership Agreement, trade between Hong Kong and the mainland tripled over the ensuing decade. The growing influx of mainland cash degraded Hong Kong’s financial regulations, allowing Chinese firms to take charge of its capital markets. In 2004, mainland corporations accounted for 31 percent of Hong Kong’s stock market by market capitalization; by 2019, that figure had risen to about 71 percent.

Naturally, Beijing turned its increasing control of Hong Kong capital flows into a political weapon with which it would eventually beat down the city’s pro-democracy opposition. The report notes that as the regime gained greater clout within Hong Kong-based multinational corporations, it installed party loyalists in key positions within them. And not coincidentally, during the protests against an extradition law proposed by the city’s chief executive in 2019, a number of businesses restricted the political speech of, and in some cases fired, employees for supporting the democracy movement, while banks, such as HSBC, closed accounts used to support the protesters . . .

Steve Hanke and Robert Simon argued that:

Bitcoin clearly falls short of meeting the four standard criteria to be designated as a currency. Accordingly, it should not be viewed as a currency but as a speculative asset with a fundamental value of zero.  That being said, Bitcoin does have an objective market price. That price is determined by speculators operating in a whirlpool in which they are purchasing an asset with very little or no utility in the hope of selling it later at a higher price: greater fools and all that . . .

Thanks to ease of entry and competition, inferior cryptocurrency products will struggle, in the end, to survive. Just look at Bitcoin. Although its market capitalization has skyrocketed, Bitcoin’s share of the total crypto market has fallen from 94 percent in April 2013 to 61 percent today. Eventually, Bitcoin’s current limited use value will likely be eclipsed by the offerings of superior challengers. So, just what might an effective competitor look like?

It would be in the form of a private cryptocurrency board. A traditional currency board issues a currency that is freely convertible at an absolutely fixed exchange rate with a foreign anchor currency or gold. Therefore, under a currency-board arrangement, there are no capital controls. The currency issued by a currency board is backed 100 percent with anchor-currency reserves. So, with a currency board, its currency is simply a clone of its anchor currency. Currency boards have existed in about 70 countries, and none have failed — including the North Russian currency board installed on November 11, 1918, during the Russian Civil War.

What all currency boards — past and present — have in common is that they are public institutions, but there is no requirement that currency boards be publicly owned. A private cryptocurrency board would be the ideal institutional arrangement for the crypto world.  For example, its home offices and reserves could be located in Switzerland, a safe-haven financial center, and it could be governed under Swiss law. It could be operated with a small staff, as is the case with all traditional currency boards. As for its anchor, it could be a currency issued by a central bank, or gold, which is not issued by a sovereign. Furthermore, given its digital nature, the balance-sheet information of a private cryptocurrency board, including its reserves, could be publicly available and audited by independent auditors on a regular basis.

With such a system, the crypto world would finally have a product that is more than just a speculative house of cards.

Our chart guy, Joseph Sullivan, suggested that our understanding of the growth in international trade owed more than is understood to the growth in international borders:

As empires crumble, new sovereign states with new national borders of their own are born, and trade across national borders increases accordingly. In 1920, the Austro-Hungarian and Ottoman Empires had recently collapsed in the wake of World War I. While the empires of Western European powers such as the United Kingdom and France would not start their collapse until the 1950s, the collapse of the USSR in the early 1990s triggered the most recent of the upward waves in national land border visible on the chart. All in all, miles of land border slightly more than tripled from 41,920 in 1920 to 132,940 in 2019, as international trade’s share of GDP slightly less than tripled from 21.7 percent in 1920 to 60.3 percent in 2019. The broad similarity in the size of their increase — both roughly tripled — suggests their rise together is no coincidence.

But stability, once variation in the quantity of national land border is factored in, may be the most remarkable attribute of international trade’s role in the world economy. In the 100 years that span 1920 to 2019, international trade’s share of world GDP never dipped below 0.21 percent or above 0.51 percent. These upper and lower bounds have also been retraced with a regularity that suggests they may be more than coincidence. The border-adjusted low of 0.21 percent of world GDP per 1,000 miles of national land border was reached in the Great Depression of 1932 as well as at the height of the Cold War in 1967. The overall series high of 0.51 percent came in 1920, when far less national border existed than today. Since 2000, the quantity of border has stayed roughly stable, and international trade’s share of world GDP per thousand miles of national border has not budged above the 0.46 percent it registered in four separate years, including in 2019.

Some today worry about this lack of new growth in international trade’s share of world GDP. If history is any guide, their best bets for unlocking that growth would be for secessionist movements in places like Catalonia or Scotland to succeed. But many proponents of deepening international trade are also opponents of new national borders. They may have, then, an internal contradiction to resolve: If you’re applauding the growth of international trade over the last 100 years, you have the birth of new national borders to thank.

Jerry Bowyer pointed out that the Fed’s “no change” stance was really a change:

The Fed is moving the goal posts, giving itself more permission to keep the game going. Gold, crypto, forex, and inflation-protected treasury bonds all were up in response, though there were reversals subsequently, especially on Thursday when markets reacted to other news, including an unexpectedly weak jobless-claims report and rising concerns about global supply chains. Markets sifted through the new data and sold off treasuries (raising yields) and stocks, particularly tech stocks that tend to be more interest-rate sensitive because of long time horizons. Perhaps investors are looking at both the Fed and the economy and realizing that there are limits to how much real economic good money creation can accomplish.

I think that, in making their initial reflationary bet, the markets had things right and may even be underestimating the radical nature of the Fed’s policy agenda. The Fed made it clear last year that it intended to keep “inflation moderately above 2% for some time.” It also reiterated this week that it “will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time.” In other words, the goal isn’t just to get PCE inflation above 2 percent, but also to raise the average above that level. That average includes the past two years of PCE inflation averaging only 1.3 percent, and only 1.5 percent since the end of the Great Recession.

The math is pretty clear. If the Fed aims for four years of average PCE inflation of 2 percent, and the past two years averaged only 1.3 percent, then the next two years will have to average 2.7 percent. And to add fuel to the fire (or is it firewater to the punchbowl?), that target is a PCE target. But CPI inflation runs about one-third higher. So, if the Fed is giving itself permission for a PCE party of more than 2.7 percent, it is giving itself permission for a CPI party of more than 3 percent “for some time.”

And all of that just includes the inflation it wants, not inflationary policies foisted upon it by the implications of yet more Biden spending, or, for that matter, possible minimum-wage-hike effects on unemployment that will force the Fed to adjust its policies to accommodate the NAIRU jacket in which it has now wrapped itself . . .

Jon Hartley and Andy Puzder were more sanguine about the inflationary prospects:

Inflation has begun increasing but, to this point, only nominally so. It is important to keep in mind that the Fed recently shifted its monetary framework to “flexible average inflation targeting” over the long run. Since we’ve seen drops in inflation over the past year, we think that the Fed’s current accommodative policies are the right framework to make sure inflation runs at an average of 2 percent over the long run.

Recently, we have seen little increase in core inflation rates, which exclude gas and food prices. U.S. core CPI year-over-year inflation has been running at 1.3 percent through February compared with the 1.7 percent headline number, which includes oil prices. Rapidly rising oil prices (Brent crude-oil prices rose from about $50 per barrel at the beginning of the year to $70 per barrel as of this writing) are largely responsible for the nominal increase in headline inflation.

Core year-over-year PCE inflation (the Fed’s preferred measure) has been running at 1.5 percent through January, still well below the Fed’s 2 percent long-run target.

Expectations for future inflation also remain low. Real yields on ten-year Treasury Inflation-Protection Securities (Treasury bonds indexed to inflation to protect investors from the negative effects of rising prices) have risen by 0.4 percent since the beginning of the year, reflecting improved U.S. investment prospects while also suggesting that headline ten-year inflation expectations have increased by only 0.3 percent.

The M2 money stock (a measure for the amount of currency in circulation) has increased by a meaningful 20 percent since the passage of the CARES Act, understandably raising inflation concerns. But, it has leveled off since, suggesting a one-time increase. A one-time increase shows up more meaningfully in five-year inflation expectations (which are up 0.6 percent since January 1) compared with ten-year inflation expectations (which have risen only 0.3 percent).

This is not to downplay the potential for inflationary pressures down the road. With the passage of the Democrats’ recent $1.9 trillion so-called COVID-relief American Rescue Plan Act, there is certainly a risk that the economy could overheat. The fact is that the economy would have substantially improved this year — and may well have done so without dramatic inflationary pressure — if the Biden administration had done nothing. Unfortunately, it likely did too much in its effort to “go big.” . . .

Finally, we produced the Capital Note, our “daily” (well, Tuesday–Friday, anyway, though this week Friday Note mysteriously went missing). Topics covered included: China’s tech crackdown, Dalio’s dollar doom, Ashworth’s response, a look at China’s advantages in entrepreneurship, the FOMC meeting, tech stocks tumble, Treasurys climb, the risks of forward guidance, priorities, priorities, and Danone’s management change, priorities, priorities, genocide and climate change, earmarks, bubble watch, and price to story ratios.


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