The Week of November 7, 2022: ESG, the economy, energy, fiscal policy, student loans, and much, much more.
The growing annoyance felt by the climate establishment over ESG (measuring an investment against various environmental, social and governmental standards) finally attracting unfavorable attention from elected politicians has been as predictable as it is revealing. As I have noted before, ESG is a technique to bypass the democratic process by using corporations to pursue a political agenda. Of course, it’s not uncommon for businesses to become involved in politics, but they have typically done so through the political process (lobbying, donations to political parties/causes and so on). And when they have done so, it has been with the economic interests of their shareholders in mind, something that has historically kept their involvement within certain bounds.
ESG is different. It is an attempt by investment managers (sometimes with the cooperation of corporate managers, and sometimes not) to force through societal change by altering the way corporations conduct their business: They are attempting to advance political aims by going around, not through, the usual democratic process. Arguments that shareholders (a category that in this case should include investors in funds being managed on their behalf) should expect to benefit economically from ESG have, with some exceptions (depending, mainly on what the “G” — governance — means), either failed the test of time — check out, for example, the share prices of fossil fuel companies over the last year or so — or logic. To put it crudely, if companies with high ESG scores outperform, that will be increasingly reflected in more expensive share prices, reducing, after a while, the chances of further outperformance.
Enter Al Gore and David Blood (one of Gore’s business partners), writing in the Wall Street Journal.
No matter your investment strategy, timely access to accurate and comprehensive information is critical. Transparency enables investors to make informed decisions with a greater understanding of the risks and opportunities facing a company. Yet incredibly, some American politicians are now trying to pass laws to prevent investors from taking highly relevant information into account.
The first and second sentences, sure, but the third, not so much. During the Biden administration, the political pushback against ESG has taken two main forms (both at the state level), usefully summarized here (as of mid-October) by the law firm Morgan Lewis. The first, which is indirect, consists of states:
refusing to do business with “financial institutions” that “boycott” or “discriminate against” companies in certain industries and prohibit the state from doing business with such institutions and/or investing the state’s assets (including pension plan assets) through such institutions. Boycott Bills most commonly target “discrimination against” fossil fuel–related energy companies, but some states have also targeted companies that “boycott” mining, production agriculture, or production lumber.
This can be difficult to defend in certain instances. If boycotting banks that won’t lend to certain industries narrows the field of potential lenders a state can turn to, and thus raises its cost of borrowing, that’s not the way to go — unless, of course, that state can show that the effect of the banks’ refusal to lend to those industries is even more damaging to the economic health of the state and its taxpayers. Equally, boycotting an investment manager just because it invests some funds according to ESG principles, is a mistake so long as that investment manager is prepared to invest that state’s money with no regard to ESG. The more investment managers a state can choose from the better.
The second form that the pushback against ESG has taken, however, is not only desirable, but may also be necessary, if a state is to observe its fiduciary responsibilities. Broadly, it involves a state being prohibited from investing in ways or with investment managers that consider ESG factors for any purpose other than investment return.
In both these cases, the policy change (which may or may not be enacted into legislation) effects only a limited number of investors (certain state pension funds). Earlier rules introduced by the Department of Labor to protect a wider class of investors (participants in retirement funds subject to ERISA) during the Trump administration have been scrapped.
A third line of attack against ESG (or at least the “E”) rulemaking has been the debate over climate disclosures proposed by the SEC, which add nothing of value to investors (public companies are already obliged to disclose anything that might be material). Indeed, in addition to being a classic example of mission creep on the part of the SEC, such disclosures may well subtract value from companies by burdening them with substantial additional costs to generate data of no value to shareholders, but which will, doubtless, be helpful to climate activists and the litigation lawyers who feed alongside them.
Gore and Blood write:
Sustainable investing is about investing in businesses that are driving toward a world with low greenhouse-gas emissions that is also prosperous, equitable, healthy and safe. It is consistent with the fiduciary duty that investment professionals owe their clients. Those who don’t take sustainability factors into account aren’t fulfilling that duty.
But this definition is, whatever Gore and Blood may claim, inconsistent with the fiduciary duty that investment managers owe their clients. Gore and Blood are focused on investing in companies that are driving towards a world that satisfies their wish list. And if investors wish to put their money into companies that do that, it is, of course, fine. Likewise, if investors wish to let their capital be managed by investment managers who say explicitly that is what they are doing, that is also fine. For such investment managers to invest in that way would be entirely compatible with their fiduciary duty. But where investors have not said that this is what they want, investing in that way could easily constitute a breach of fiduciary duty. Investors are interested in the bottom line — not, so to speak, the “world” — and typically their investment time horizon for a given stock is relatively short-term.
Gore and Blood ask their readers to consider two examples:
If a company is at risk of having significant liabilities for its past practice of dumping toxic chemicals into a river, don’t investors need to know that? Or how about if a company is building gas-fired power plants or new oil pipelines that, as governments tighten their climate targets, may have to be shut down decades before their projected useful lifetimes expire. Isn’t that relevant information.
The answer to both questions is yes. But in the first instance a company would, on the assumption it is material, already be required to disclose that litigation risk. As for the second, well, some statement about possible future regulatory or legislative risk would indeed be wise. But there can of course — and as the events of the last year have shown — be no firm assurance about the timing, nature or direction of future legislation or regulation. The same can be said of such legislation or regulation’s financial effects, be they intended or unintended, harmful or, yes, beneficial. Indeed, disclosure of risk is rarely as clearcut as sometimes imagined. Equally — and I am confident that Messrs. Gore and Blood would agree — companies in (supposedly) climate-friendly sectors that have exposure to China (and there are a lot of them) must not fail to disclose the risks associated with their business there. Doubtless they do.
Gore and Blood also have this to say:
Since all businesses affect social and environmental issues, for good or ill, all investment must consider risk, return and impact as part of fiduciary duty.
Well, no. Businesses must follow the law (including environmental law) and ought, as Milton Friedman wrote, to observe rules “embodied in ethical custom.” But custom is a word that implies something that is long-standing, rather than the ragbag of demands and “ethical” imperatives cobbled together by those now busy making up ESG as they go along. The concept of “impact” provides one good example.
After all, if China continues its current course on the emissions side, how does an American company measure the real “impact” that its greenhouse gas emissions may have on the climate — and the effects that may flow from that?
In another potential blow to the climate, China has set 2030 as the date for peaking carbon emissions for building materials.
Although that aligns with the nationwide target, as recently as September the cement industry had proposed maxing its carbon footprint by 2023, while the building materials sector as a whole would reach its peak by 2025. It follows a similar retreat in the steel industry’s carbon goals, and plans for a massive expansion in coal-fired power generation.
In the penultimate sentence of their article Gore and Blood write that “the investment community is adapting for the next chapter of capitalism, in which sustainable investing is mainstream.” That’s true enough, but the way that the investment community, alongside many other rent-seekers — consultancies, accountants, lawyers, take your pick — are adapting is by offering a wide range of products and services that do little for the planet — or, for that matter, society (properly understood) — but which represent a useful opportunity for profit, influence, and power.
Gore and Blood are given the following byline:
Mr. Gore, a former vice president of the United States, is chairman and Mr. Blood is senior partner of Generation Investment Management.
Ah, well.
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 92nd episode David is joined by Andrew Stuttaford, the editor of National Review’s Capital Matters, to discuss the way that Britain’s former prime minister, Liz Truss, ended up serving a “Scaramucci term” in office (okay, maybe a little longer than that). The circumstances around her brief and tumultuous run as prime minister, however, are quite consequential. Did the talk of tax-rate cuts really tank the British economy? Do years of embedded leverage in the bond market really fall on her shoulders? What has happened in the U.K., and what can we learn from it here in the States? Andrew and David unpack the economic facts and lessons behind the abrupt ending to Liz Truss’s reign.
The Capital Matters week that was . . .
The Economy
Only once since World War II have we seen two negative quarters for GDP growth outside of a recession. While many economists have calculated that a recession is likely next year, for the most part there has been quite a bit of recession denial this year, especially by Democrats and members of the Biden administration. The denial chorus became Wagnerian after the release of third-quarter data, which showed that GDP had increased by 2.6 percent.
The problem is that the third-quarter report was worse — in terms of the state of the economy — than those of the first half of the year. Can a positive be worse than a negative? It can when the positive happens for bizarre reasons…
Energy
For oil companies to make the necessary investments in increased production that the White House claims to want (at least for now), it will need some reassurance that the administration is not ready to turn on them the moment it can. The threats against, and the conspiracy theories about, the oil sector are unlikely to be providing that reassurance…
Fiscal Policy
President Biden has been bragging that he “reduced the deficit by a record $1.4 trillion.” But this is grossly misleading. When the president was inaugurated, CBO projected that the scheduled expiration of pandemic spending would automatically reduce deficits to $2.3 trillion in 2021 and then $1.1 trillion in 2022. Instead, the president ran deficits of $2.8 trillion and $1.4 trillion, respectively — a cumulative $800 billion higher than projected. Most absurdly, the president pushed up the 2021 deficit with the American Rescue Plan and then took credit for “deficit reduction” when his own spending expired. This is like someone demanding credit for putting out a fire that he started…
Although President Biden told 60 Minutes the pandemic is over, his administration has once again extended the Covid-19 state of emergency. These repeated extensions are inflating the nation’s Medicaid rolls and steepening a potential fiscal cliff for states…
Markets
The recent (partial) recovery in the stock market owed something to hopes of GOP gains, or latterly, even a sweep, in the midterms. If so, investors will have been, at least in part, disappointed. Market weakness today (at least at the time of writing) reflects this disappointment, the (related) decision to take some profits, and, of course, continued uncertainty (something investors do not like), as this country’s incredibly sophisticated electoral machinery continues to dribble out results…
Markets liked what they saw in the inflation data on Thursday (the S&P 500 was up 5.5 percent, its best day for over two years), not only because of hopes that a corner may have been turned, but also because of increased confidence that the Fed would think that the numbers were good enough to increase rates by only 50 basis points next time after a series of 75-bp increases…
Student Loans
The Biden administration’s illegal student-debt “forgiveness” program will result in hundreds more dollars per month being freed up for those who currently owe money. What Biden calls “forgiveness” really amounts to a transfer of debt from the people who borrowed the money to people who did not. Taxpayers will be picking up the tab for borrowers whose debt is reduced, which means they are ultimately subsidizing the purchases that borrowers make. What kind of purchases will taxpayers be subsidizing?
China
China is no stranger to one-man rule leading to economic misfortune. Anyone doubting this needs only think back to the disastrous economic consequences of Chairman Mao’s Great Leap Forward and subsequent Cultural Revolution.
This history has to raise deep concerns about the Chinese Communist Party’s latest Congress, which granted President Xi a third five-year term as president and a total stranglehold on the Party’s Politburo. This is particularly troubling considering that China is faced with a host of deep-seated economic-policy challenges…
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Please note that there will be no Capital Letter next week due to travel plans