The week of August 15, 2022: The ESG debate that was never meant to be, nuclear energy, China, climate, inflation, and much, much more.
The week of August 15, 2022: The ESG debate that was never meant to be, nuclear energy, China, climate, inflation, and much, much more.
T here have been, I have noticed recently, some signs of irritation, even anger, within the ecosystem that has flourished under ESG, that metastasizing investment “discipline” in which actual and prospective portfolio companies are measured against various environmental, social, and governance criteria. Normally, the ESG ecosystem is a placid, peaceful place where rent-seekers harvest fees they do not deserve, activists, corporate executives, investment managers, and regulators accumulate positions of power without the bother of being elected, and creative types dream up ever more terrifying ways to describe climate change/crisis/emergency/chaos/catastrophe/breakdown. But the calm has been disturbed by mounting signs of a political reaction against ESG and, less explicitly, stakeholder capitalism (the ideology with which ESG is deeply intertwined), a reaction that has not been well received.
Here, for example, is Mindy Lubber, providing Reuters with what is described as expert analysis via Sustainable Business Review, a part of Thomson Reuters, and a publication that appears to be part of the ESG ecosystem’s press corps. Her article is entitled: “The backlash to climate-smart investing in the U.S. is based on a blatant lie.” The headline might well not be hers (authors frequently don’t get much of a say in that), but it accurately reflects the tone of a piece that is, by any measure, angry. Lubber’s focus in this instance is, in effect, the “E” of ESG, and she is concerned about what she sees as a “bitter” backlash against it. “At the heart of [it] lies a blatant fiction: that climate-smart business practices are somehow a secondary, ideologically driven sideshow to the real financial concerns facing investors and companies.”
Her byline reveals that Ms. Lubber is herself a prominent figure within the ecosystem:
Mindy Lubber is CEO and president of the sustainability nonprofit Ceres, and a founding member of the global steering committee for Climate Action 100+ and The Investor Agenda. From 1998 to 2001, she served as the deputy and then regional administrator for EPA Region 1 (New England). Mindy was the recipient of the Champions of the Earth award, the United Nations highest environmental honor, for her leadership on climate change and sustainability. She has been named one of Barron’s 100 most influential women in U.S. finance for the last three years.
Or take a look at some comments by Hannah Wendland, writing in the FT’s Moral Money (another part of the ecosystem’s press corps, and, from the look of it, a promising business too) last month:
From Tucker Carlson to Mike Pence, bashing ESG investing has become popular sport among US conservatives. As worries about “woke-ism” proliferate, asset managers offering ESG products have found themselves at the centre of unwanted attention.
The criticism can be shrugged off as political posturing, but the anti-ESG laws being enacted in conservative states are adding significant risks for asset managers worldwide.
Pause to notice the vocabulary: “bashing,” “political posturing,” “sport.” These are all words chosen to convey the impression that ESG is not really a proper subject for legitimate political debate.
That’s not an argument that would impress Aswath Damodaran, a professor at New York University’s Stern School of Business, and an expert in the field of corporate finance and investment valuation. I have previously quoted from some of Professor Damodaran’s work here and here.
When it comes to ESG, he is not a fan:
I believe that ESG is, at its core, a feel-good scam that is enriching consultants, measurement services and fund managers, while doing close to nothing for the businesses and investors it claims to help, and even less for society.
As I said, not a fan.
A couple of weeks ago, David Bahnsen talked to Damodaran about ESG on the Capital Record podcast. Listening to the whole discussion is well worth your time, but the question of whether ESG is a fit topic for political discussion first comes at around the 18:58 mark (although you should listen to the runup to that moment too).
This is what Damodaran had to say:
I find it amusing when ESG advocates complain that this has become political, that this is the big thing in the last few months, that it’s become political, [that] the red states are pushing back. ESG advocates complaining about ESG becoming political are like pyromaniacs complaining about the fires around them. You started the fire, get ready to live with the heat.
He then follows that observation by referring to the “S” (social) in ESG, describing it as the centralization of “the measurement of virtue,” and he is right to do so. As currently defined, the “S” is driving an essentially progressive agenda, using, one way or another, corporate power and money to push through the equivalent of what many American legislatures would refuse to countenance. Critically, that power and money is being used in a way unrelated to the proper purpose of a corporation, which, except in very rare cases, is to be managed for the benefit of its shareholders, a term usually meant to mean economic benefit.
But as Bahnsen points out (and Damodaran agrees) the “E” can be political too, and they are both correct. It is not just about the #science. There are, to be sure, disagreements about how much of a threat climate change may be. But, beyond that, there is room for substantive debate about what should be done about climate change, such as over the role of “bridge” fuels such as natural gas, or the role of new domestic oil production in an age of increased geopolitical instability. These and many issues like them frequently involve trade-offs and the setting of priorities, the very essence of politics.
Even the “G” in ESG is politicized. Questions of corporate governance used to be, as Damodaran explains, focused on “making managers accountable to shareholders.” Certainly, in my decades in finance, that’s how I understood it. It could cover issues such as the desirability of splitting the roles of chairman and CEO, the acceptability of differentiated voting rights attached to shares in the same company (something that Bahnsen refers to) as well as countless reporting issues. But that, says Damodaran, “is not the ‘G’ in ESG.” As he sees it, the “G” in ESG is concerned with the accountability of a company to “society,” rather than to shareholders. Even if “G” might be wider than he maintains, with some room for more traditional elements of what “G” should be, there can be no doubt that the definition of governance has moved into territory that can clearly be described as political.
Judging by some of the reaction to the reaction against ESG, those using what is a variant of corporatism and corporatist techniques (an ideology and methodology with a distinctly mixed history) to pursue a profoundly political agenda thought they would get their way without too much of an argument, and are furious that a serious argument has now begun. Too bad: ESG and stakeholder capitalism are an attempt by elements within a nascent — or not so nascent — managerial class in the C-suite and in the investment business, in NGOs, in the bureaucracy, in the political world and beyond to harness corporate power and money to advance progressive objectives without the bother of fulfilling their obligations to those companies’ underlying shareholders (obligations that would put a brake on their ambitions) or going through the democratic process.
It says something — something good — about our democracy that politicians and political commentators are taking a stand against this project. To dismiss the arguments of ESG’s critics as ill-founded is, much as I would disagree in most cases, entirely respectable. To imply that they should not even be raising these issues is not.
It’s also telling, and understandable, that Wendland has characterized the attack on ESG as worries about corporate wokery. Some of ESG’s loudest opponents have indeed concentrated on that, even though that is only one element in, as described above, a far bigger story. Some have done so out of personal conviction, others, (and the two motives are not mutually exclusive) as a matter of tactics. It’s easier to gin up popular support for a campaign to oppose corporate wokery than to base it on a defense of shareholder rights or a rejection of corporatism, causes with possibly rather less immediate populist appeal. Something similar holds true for those in the opposing camp. It is far easier for defenders of ESG and stakeholder capitalism to frame the debate as another chapter in the culture wars than to address the serious threat to both property rights and to democracy that their efforts represent.
As for Wendland’s lament for the “asset managers offering ESG products [who] have found themselves at the centre of unwanted attention,” well, that attention might be unwanted, but it is not undeserved. And those asset managers — or some of them — are doing rather more than “offer” ESG products. There is nothing wrong with offering investors an opportunity to choose investment vehicles geared towards their ethical standards. There is something quite a bit wrong with promoting the dubious notion that ESG products are a way to do well by doing good (Damodaran has a few things to say about that). And there is something very wrong with sneaking ESG principles into funds that are not explicitly marketed as such, and then managing them on those lines without the underlying investors’ active consent. By underlying investors, I mean the bottom layer of investors from whom the money comes, rather than any vehicle that may come between them and the ultimate destination of their capital. The same principle applies when it comes to establishing who are the underlying shareholders in a company.
Then there is the small matter of when ESG turns from being an essentially passive way of investing (when the investment manager declines to invest in a company because it doesn’t meet the required ESG score) to taking an activist position in a way designed to pressure companies to fall into line with ESG objectives, whether it enhances shareholder return or not. Given the size of the funds these investment managers oversee, they — acting alone or in concert with their peers — might make that pressure hard to resist, which makes it a topic that’s worth a little more scrutiny. There are other issues as well, such as the mystery of how ESG funds, or investment groups purporting to be run on ESG lines (or something akin to them), can invest in Chinese companies.
The problem is not that ESG managers have had too much attention, but that they have not been subjected to enough of it.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears 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 the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 80th episode David is joined once again by monetary economist Judy Shelton for a conversation on the state of the Fed, the perpetually growing role in the economy it asserts, and the dangers that an excessively interventionist Fed represents for economic growth. David and Judy lack a fever-swamp focus on the Fed but hold nothing back in asserting a properly framed critique of what the Fed has become — and how it needs to be rectified.
The Capital Matters week that was . . .
Water Desalination
For all its potential, desalination has yet to be a game changer. Worldwide freshwater consumption is estimated at 7.5 billion acre feet per year. Of that total, roughly 20,000 desalination plants worldwide produce an estimated 30 million acre feet of fresh water per year. That’s an awful lot of water, but it’s less than 1 percent of global water consumption.
Nonetheless, desalination plays an outsized role in arid coastal regions around the world . . .
Nuclear Energy
The French have a nuclear problem, primarily of their own making. The Wall Street Journal reported recently on France’s energy woes, with reactor efficiencies dipping with rising temperatures, low water levels (necessary for reactor cooling), and maintenance troubles. The shortfalls are partly attributable to the reality that electronics and energy systems of all stripes do not function as well in extreme temperatures. Still, the evidence points more to man’s shortsightedness and political foolishness as the primary culprit of diminished French fission . . .
Housing
The median existing house price reached a new peak in June ($416,000), a 13.4 percent increase over the year. As Reuters notes, this was “the 23rd straight month of double-digit annual price gains, the longest such run since the late 1970s.” Interestingly, that was another period of high inflation: Make of that what you will . . .
China
China now seems to be facing a series of crises all at the same time, and they are mostly self-inflicted. The zero-Covid policies, which were unlike those of any other country in the world, hurt China’s economy. They put Xi Jinping in a tricky spot: stay the course and wreck the economy or change his mind and look weak. He chose to stay the course.
Then, there’s China’s foreign-debt crisis, which is a consequence of its Belt and Road Initiative. China is more exposed to developing-world debt that seems unlikely to be repaid than any other country in the world. The financial-system risks are made even worse by the Chinese Communist Party’s efforts in the Chinese housing market, which is in dire straits . . .
Supply Chains
It turns out that it’s really hard to make something in a different country just because government decides it wants it made there. “According to chassis manufacturers, the construction of a single chassis requires raw materials and subcomponents from between 20 and 30 separate suppliers,” the JOC story says. Those suppliers have been unable to meet producers’ needs.
Chassis manufacturers have been finding it difficult to hire and retain factory workers. “Many of the new employees the company [Pratt Intermodal] hired in 2022 quit after completing their training, and long-time veterans have become wary of rejoining a sector with a history of cutting jobs at the first sign of a downturn,” the story says. Politicians often yearn for the return of manufacturing jobs to America, but American workers seem less enthusiastic.
By sending the dispute to Congress, unions would risk what is already a sizable pay increase (Ferguson notes it would be the largest in 47 years) and the preservation of very generous health benefits for their members. But as Frank Wilner wrote for Railway Age in late July, union leadership has been whipping its members into a frenzy and it knows it has an ally in the White House.
U.S. freight-rail workers would also be joining a wave of transportation-sector strikes around the world this year. Unions have demonstrated time and again that even though supply chains are already stressed, they have no qualms making them worse . . .
Free Markets
The U.S. baby-formula market has long been insulated from foreign competition, through tariffs and regulatory policies, so much so that 98 percent of all baby formula consumed in the United States was produced in the United States. The reduced competition led to higher prices, just as economic theory would predict, which then led to calls to subsidize baby formula. The government created the WIC program to do that, initially for people in poverty, but it has since expanded to cover over half of all baby-formula consumption in the country. Now the industry is so brittle that it can be destabilized by a thunderstorm in Michigan.
Or consider the domestic water-transportation industry, which is subject to one of our most protectionist laws, the Jones Act. Foreign competition is effectively forbidden under the law, which was passed on national-security grounds, to protect our merchant marine. Not only has it caused American domestic shipping to be largely cost-prohibitive (leaving New England in the awkward position of being able to buy cheaper natural gas from Russia than from Texas); it hasn’t even secured its defense objectives, leaving the U.S. with a small and aging fleet.
Argentina
And so, as Russians did 30 years ago, Argentinians are turning to currencies they can trust, such as, in the country’s north, Bolivia’s boliviano (which has been pegged to the dollar for a while now, although there are — ten cuidado — questions as to how long that peg can be maintained), and, of course, the dollar, a well-established standby, given Argentina’s disastrous economic history, for decades. There are restrictions on how many dollars Argentinians can buy, and the official exchange rate (a bit over 130 pesos to the dollar, compared with the, ahem, unofficial rate, the dólar blue, of about 290) is, once again, an absurdity, giving a boost to a black market of considerable sophistication ($100 bills, I read in the Times’ report, carry a premium, as they are more difficult to forge) and size, with support systems to match. That’s needed as many large transactions are in cash, dollars that is. Among the people interviewed for the NYT piece is the CEO of Ingot, a safe-deposit-box company. Business, he says, is booming.
Inflation
You can pick any date you want as the starting point. Since April of this year, the CPI has increased by 2.3 percent. Since April 1999, it has increased by 78 percent. Those are also measures of inflation.
So when Biden said “zero inflation,” he was using political sleight-of-hand to get people to think that inflation went from 9.1 percent, the widely publicized number from the June report, to zero. But he’s conflating the month-over-month number with the year-over-year number. Using the year-over-year number consistently as the meaning of “inflation,” which is how the numbers are most commonly reported, Biden could have more honestly said that inflation declined from 9.1 percent to 8.5 percent between June and July . . .
The inflation that has marked our emergence from the pandemic began with a plunging dollar, soaring government deficits, and surging goods consumption. Now, with a soaring dollar, plunging deficits, and surging services consumption, this inflationary surge seems likely to follow an entirely different trajectory.
Based on the strong relationship between the dollar’s foreign-exchange value and inflation, shown in the chart below, an inflation uptick was predictable in mid-2021. The dollar initially climbed against foreign alternatives in a flight to safety at the pandemic’s onset but began sliding as the Fed flooded markets with surplus dollars . . .
Economics
The next time economists declare that they can project the economy’s performance far into the future, remember that the Federal Reserve recently failed to project even a current-year inflation rate within three percentage points.
Specifically, the Federal Open Market Committee (FOMC) forecasted in December 2020 that inflation (as measured by the PCE, the Fed’s preferred measure) would be 1.8 percent in 2021. The Fed hiked the current-year estimate during the course of 2021, but never above 4.2 percent. PCE inflation ended up at 5.8 percent for the year.
Then, the FOMC repeated the same error . . .
Economics and Law Enforcement
The authors write, “The United States is ridden with much more serious crime than other comparably wealthy societies. It responds to this exceptionally high level of serious crime with an exceptional combination of relatively small police forces and comparatively long sentences.”
It’s easy to see how that imbalance may contribute to our exceptionally high violent-crime rate. If people think they have a low probability of being caught, they are more likely to attempt violent crimes. The threat of severe punishment doesn’t deter criminal behavior if criminals don’t believe they will ever get arrested in the first place. The authors note that, “The empirical literature on deterrence is unequivocal that increasing the size of police forces is a much more efficient way to prevent crime than increasing the length of prison sentences for those who are apprehended and convicted. . .. Today in the United States, a single dollar spent on policing is almost sixteen times more effective at deterring crime than a dollar spent on incarcerating additional prisoners.”
The Economy
Late in July, Walmart cut its profit forecast, warning that inflation was squeezing household budgets, leading consumers to ease back on discretionary purchases. Making matters worse, the company, worried about the post-pandemic disruption in supply chains, had boosted inventories where it could, leaving it with a lot of merchandise that would now need shifting at sharply cut prices. I’ve posted about this issue, which has affected other companies (not least Target, as we see below) here and here.
Fast forward three weeks or so, and the picture appears to have brightened. Things were not as bad as thought back then . . .
Yesterday, I noted that Walmart’s new outlook was less gloomy than only a few weeks ago. That was the good news. The bad news was that the company was benefiting, in part, from the way it was attracting more affluent customers (who are — presumably thanks to inflation — not feeling quite so affluent as before), another sign of the way in which spending patterns are shifting in the wake of inflation.
Meanwhile, the news from Kohl’s today is not so great . . .
Climate
Our climate Metternich does not seem to be proving as effective as he might have hoped. A couple of weeks ago, angered by Nancy Pelosi’s visit to Taiwan, the Chinese regime made it clear that it was not too interested in cooperating with the U.S. on climate issues. In reality, that won’t make much difference; Chinese energy policy has long been driven by other considerations (its investment in renewables owes more to Beijing’s pursuit of self-sufficiency — and export opportunities — than concerns about the climate), but it will make it even more difficult for Kerry to claim that the ‘world is with us’ on our current climate-policy trajectory.
And so will this (via Bloomberg) . . .
Singapore
In this, we get to the heart of Singaporean social democracy. Rather than being based on taxation, Singaporean social democracy is based on getting the citizens invested as shareholders in the state as a profitable corporation, with each citizen gaining access to the welfare services provided by the state based on their individually accumulated savings. The idea behind the system is simple: If individual citizens use their own savings to gain access to the services provided by the state, they will be much more frugal in how they use the system, leading to less waste of resources. Similarly, while non-profit, tax-financed bureaucracies are often wasteful and inefficient — as they are punished with budget cuts whenever they manage to increase efficiency — the profit motive provides an incentive to Singapore’s state-owned corporations to be efficient, as well as an index of success and failure.
Thus, rather than taking citizens out of the market — by promising that everyone will receive the same welfare services regardless of their economic performance — Singapore’s social contract plugs citizens into the market, by qualifying access to the welfare sector based on individuals’ market participation . . .
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