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The Fallacy Of Climate Financial Risk

The Fallacy Of Climate Financial Risk

Authored by John Cochrane via Project Syndicate,

The idea that climate change poses a threat to the financial system is absurd, not least because everyone already knows that global warming is happening..

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The Fallacy Of Climate Financial Risk

Authored by John Cochrane via Project Syndicate,

The idea that climate change poses a threat to the financial system is absurd, not least because everyone already knows that global warming is happening and that fossil fuels are being phased out. The new push for climate-related financial regulation is not really about risk; it is about a political agenda.

In the United States, the Federal Reserve, the Securities and Exchange Commission, and the Department of the Treasury are gearing up to incorporate climate policy into US financial regulation, following even more audacious steps in Europe. The justification is that “climate risk” poses a danger to the financial system. But that statement is absurd. Financial regulation is being used to smuggle in climate policies that otherwise would be rejected as unpopular or ineffective.

“Climate” means the probability distribution of the weather – the range of potential weather conditions and events, together with their associated probabilities. “Risk” means the unexpected, not changes that everyone knows are underway. And “systemic financial risk” means the possibility that the entire financial system will melt down, as nearly happened in 2008. It does not mean that someone somewhere might lose money because some asset price falls, though central bankers are swiftly enlarging their purview in that direction.

In plain language, then, a “climate risk to the financial system” means a sudden, unexpected, large, and widespread change in the probability distribution of the weather, sufficient to cause losses that blow through equity and long-term debt cushions, provoking a system-wide run on short-term debt. This means the five- or at most ten-year horizon over which regulators can begin to assess the risks on financial institutions’ balance sheets. Loans for 2100 have not been made yet.

Such an event lies outside any climate science. Hurricanes, heat waves, droughts, and fires have never come close to causing systemic financial crises, and there is no scientifically validated possibility that their frequency and severity will change so drastically to alter this fact in the next ten years. Our modern, diversified, industrialized, service-oriented economy is not that affected by weather – even by headline-making events. Businesses and people are still moving from the cold Rust Belt to hot and hurricane-prone Texas and Florida.

If regulators are worried even-handedly about out-of-the-box risks that endanger the financial system, the list should include wars, pandemics, cyberattacks, sovereign-debt crises, political meltdowns, and even asteroid strikes. All but the latter are more likely than climate risk. And if we are worried about flood and fire costs, perhaps we should stop subsidizing building and rebuilding in flood and fire-prone areas.

Climate regulatory risk is slightly more plausible. Environmental regulators could turn out to be so incompetent that they damage the economy to the point of creating a systemic run. But that scenario seems far-fetched even to me. Again though, if the question is regulatory risk, then even-handed regulators should demand a wider recognition of all political and regulatory risks. Between the Biden administration’s novel interpretations of antitrust law, the previous administration’s trade policies, and the pervasive political desire to “break up big tech,” there is no shortage of regulatory danger.

To be sure, it is not impossible that some terrible climate-related event in the next ten years can provoke a systemic run, though nothing in current science or economics describes such an event. But if that is the fear, the only logical way to protect the financial system is by dramatically raising the amount of equity capital, which protects the financial system against any kind of risk. Risk measurement and technocratic regulation of climate investments, by definition, cannot protect against unknown unknowns or un-modeled “tipping points.”

What about “transition risks” and “stranded assets?” Won’t oil and coal companies lose value in the shift to low-carbon energy? Indeed they will. But everyone already knows that. Oil and gas companies will lose more value only if the transition comes faster than expected. And legacy fossil-fuel assets are not funded by short-term debt, as mortgages were in 2008, so losses by their stockholders and bondholders do not imperil the financial system. “Financial stability” does not mean that no investor ever loses money.

Moreover, fossil fuels have always been risky. Oil prices turned negative last year, with no broader financial consequences. Coal and its stockholders have already been hammered by climate regulation, with not a hint of financial crisis.  

More broadly, in the history of technological transitions, financial problems have never come from declining industries. The stock-market crash of 2000 was not caused by losses in the typewriter, film, telegraph, and slide-rule industries. It was the slightly-ahead-of-their-time tech companies that went bust. Similarly, the stock-market crash of 1929 was not caused by plummeting demand for horse-drawn carriages. It was the new radio, movie, automobile, and electric appliance industries that collapsed.

If one is worried about the financial risks associated with the energy transition, new astronomically-valued darlings such as Tesla are the danger. The biggest financial danger is a green bubble, fueled as previous booms by government subsidies and central-bank encouragement. Today’s high-fliers are vulnerable to changing political whims and new and better technologies. If regulatory credits dry up or if hydrogen fuel cells displace batteries, Tesla is in trouble. Yet our regulators wish only to encourage investors to pile on.

Climate financial regulation is an answer in search of a question. The point is to impose a specific set of policies that cannot pass via regular democratic lawmaking or regular environmental rulemaking, which requires at least a pretense of cost-benefit analysis.

These policies include defunding fossil fuels before replacements are in place, and subsidizing battery-powered electric cars, trains, windmills, and photovoltaics – but not nuclear, carbon capture, hydrogen, natural gas, geoengineering, or other promising technologies. But, because financial regulators are not allowed to decide where investment should go and what should be starved of funds, “climate risk to the financial system” is dreamed up and repeated until people believe it, in order to shoehorn these climate policies into financial regulators’ limited legal mandates.

Climate change and financial stability are pressing problems. They require coherent, intelligent, scientifically valid policy responses, and promptly. But climate financial regulation will not help the climate, will further politicize central banks, and will destroy their precious independence, while forcing financial companies to devise absurdly fictitious climate-risk assessments will ruin financial regulation. The next crisis will come from some other source. And our climate-obsessed regulators will once again fail utterly to anticipate it – just as a decade’s worth of stress testers never considered the possibility of a pandemic.

Tyler Durden Wed, 07/21/2021 - 16:40

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Economics

Weekly investment update – Emerging markets miss out on equities and bonds surge

At first sight, the direction of financial markets in July might have come as a surprise: global equities posted their sixth consecutive monthly gain despite a steep drop in emerging market equities, while bond markets also recorded strong advances, again

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At first sight, the direction of financial markets in July might have come as a surprise: global equities posted their sixth consecutive monthly gain despite a steep drop in emerging market equities, while bond markets also recorded strong advances, again except for those in emerging markets.

Volatility spiked at times during July. Indeed, it hit its highest since early May and took equities from a historical peak to the lowest level in a month within the space of a week before they set another high towards month-end. Emerging market equities suffered from a persistent sell-off in Chinese stocks over the government’s regulatory clampdown on sectors ranging from ride hailing to gaming.

Economic growth – On an even keel  

While markets worried that the economic recovery had peaked, the latest purchasing managers’ data – seen as a leading indicator of the direction of growth – did not signal a sharp slowdown. China’s PMI for July, typically also a proxy for wider emerging market growth, fell by 0.5 of a percentage point from the previous month, indicating that company activity had slowed down. Remaining at above 50, the indicator also signalled that overall economic expansion overall is continuing.

In the eurozone, business activity rose at its fastest rate in just over 15 years in July. At 59.8 in July, after 58.3 in June, the services sector PMI was at its highest since June 2006 and consistent with a sharp rate of activity growth.

US GDP growth was 6.5% annualised in Q2 after 6.3% in Q1 and fell short of expectations. While inventories and net exports contracted, personal spending on consumption and non-residential private investment grew strongly. GDP was above its pre-Covid peak. Thanks to massive fiscal and monetary stimulus, it is now back on its pre-Covid trend.

Despite this economic progress, the US Federal Reserve has continued to indicate that there is still ‘some ground to cover’ before it will start reducing its pandemic support for the economy. Employment is still some seven million jobs below pre-Covid levels. Risks to the outlook remain, not least as Delta variant Covid cases rise.

Equities: Record-setting

July saw concern over slowing global growth offset by news of strong corporate earnings and still record-low interest rates. Markets were buoyed by optimism over the outlook for the US economy in the second half of 2021, even in the face of a pickup in Covid infections due to the more contagious Delta variant.

Some observers are pointing to the small chance of widespread lockdowns, while others have noted that although caseloads are rising rapidly, hospitalisations and fatalities are not.

US stocks recorded their sixth monthly rise in a row. The S&P 500 rose by more than 2%, while the tech-heavy NASDAQ and the Dow Jones added more than 1%.

There were all-time highs for European stocks as well, allowing them to record a sixth consecutive month of gains. Mid-caps, IT and dividend stocks led the market, while the energy sector lagged.

Asia takes a dip

In contrast, Asian equity indices had a poor month due to rising Covid cases across the region and concerns that a regulatory crackdown on tech businesses in China could slow already decelerating growth. This came on top of spreading Delta cases in the country and a softening land and property market. The developments clouded market sentiment across various regions.

Japanese equities lost more than 2% on concerns about another coronavirus wave and its impact on the economic recovery. Investor worries over global economic growth not only drove down US Treasury yields, but also the US dollar, allowing the yen to strengthen. The break in what had been the yen’s weakening trend also roiled Japanese markets.

Tepid domestic data, concerns about growth in China and volatile oil prices – Japan imports some three quarters of its oil consumption – also weighed on the market.

We believe there are reasons to be somewhat cautious on equities despite the good recent earnings momentum and the continued support from central bank pandemic measures. Recent recoveries followed sell-offs on a modest scale rather than sharp retrenchments and dips have not attracted many more new buyers or more widespread buying. Recent gains look vulnerable to us.

Bonds: The rally rolls on

Yields fell as investors sought shelter in haven assets such as US Treasuries and Bunds, extending the rally by a third month.

In the US market Treasury, 2- and 10-year yields notched their biggest one-month drops in over a year (March 2020), even as the Federal Reserve’s preferred inflation gauge rose sharply in June for the fourth big gain in a row. However, June’s increase was smaller than forecasters had expected.

Investors still appear to be siding with the Fed, accepting its view that higher inflation is due to supply bottlenecks and shortages and that these should ease off as the recovery matures. Ironically, the pressure should also ease as a growth slowdown tamps demand.

Over the month, long-dated debt yields fell to around five-month lows.

What’s up with real yields?

Some investors appear to worry that very low real yields — which measure the returns investors can expect once inflation is taken into account — are warning of a (coming) sharp slowdown in growth as the more contagious Delta variant spreads, turning businesses and consumers cautious again.

Others have argued that market pricing has become too pessimistic, pointing to the US economy’s strong rebound, even if growth has now peaked.

A further explanation could be that continued large-scale bond buying by central banks is still holding down yields across the board – even yields that are adjusted for inflation that has seen high readings in the US, the UK and Europe. An end to this form of support for economies does not appear to be in sight any time soon.

The Fed, which has bought about USD 120 billion of bonds monthly throughout the pandemic to pin down borrowing costs for households and businesses, reiterated after its latest policy meeting that the economy was making ‘progress’, but it remained too early to tighten monetary policy. Any tapering of bond purchases could be delayed by a growth slowdown, which should support markets.

Elsewhere in bond markets, high-yield credit in USD, EUR and GBP had another good month, extending their run of gains by a seventh month. UK inflation-linked bonds were in the lead in the fixed income segment.   

Gold was supported by the continued rise in inflation and the declines in real yields that have made it more attractive as an inflation hedge. Commodities more broadly were the best-performing asset class in July.

BOND MARKETS      
10-year yields   Monthly change 2021
US T-note 1.22 -25 31
JGB 0.02 -4 0
OAT -0.11 -23 23
Bund -0.46 -25 11
EQUITY MARKETS      
Euro Stoxx 50 4089.3 0.6% 15.1%
Stoxx Europe 50 3555.8 1.2% 14.4%
       
Dow Jones 30 34935.5 1.3% 14.1%
Nasdaq 14672.7 1.2% 13.8%
S&P 500 4395.3 2.3% 17.0%
       
Topix 1901.08 -2.2% 5.3%
       
MSCI all countries (*) 724.2 0.6% 12.1%
MSCI Emerging (*) 1277.8 -7.0% -1.0%
(*) in USD      

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Nathalie Benatia. The post Weekly investment update – Emerging markets miss out on equities and bonds surge appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

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Spread & Containment

China Suspends Travel, Ramps Up Testing As Delta Outbreak Hits Wuhan

China Suspends Travel, Ramps Up Testing As Delta Outbreak Hits Wuhan

China’s worst outbreak since COVID first emerged in the city of Wuhan has continued to spread, prompting authorities to intensify their efforts to crush the delta-driven…

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China Suspends Travel, Ramps Up Testing As Delta Outbreak Hits Wuhan

China's worst outbreak since COVID first emerged in the city of Wuhan has continued to spread, prompting authorities to intensify their efforts to crush the delta-driven outbreak. However, as the virus continues to elude their grasp, it's looking increasingly likely that Beijing's "zero tolerance" approach might hamstring economic growth, as analysts from Goldman Sachs warned in a recent note to clients.

More than 2 dozen cities have counted more than 300 cases over the past few weeks as the number of cases has quickly multiplied. China now has 144 medium- and high-risk areas - the most since the initial outbreak in early 2020, according to the National Health Commission.

By Monday, all of China's 31 provincial-level jurisdictions had issued notices by Monday advising people not to travel domestically. Some provincial governments singled out only medium- and high-risk regions, while others asked people to avoid all inter-provincial travel. According to the SCMP, Beijing's "zero-tolerance" approach to fighting COVID, which remains minimal compared with China's vast population, has "scared away" the tourists.

China reported 71 new COVID cases from local transmission on Wednesday, more than half of them in coastal Jiangsu province near the epicenter of Nanjiang, AP reported.

The CCP has decided to expand travel restrictions on Wednesday: ride-hailing services and public transit have been suspended in all medium- to high-risk areas. Immigration authorities have promised to "strictly restrict non-urgent, unnecessary cross-boarder travel" including restricting the issuing of passports for Chinese citizens. To try and stifle the virus before it has an opportunity to take hold, the city ordered millions of residents to undergo mandatory testing, leading to lines forming across the city. The city has also closed 17 bus lines and a handful of subway stations. Cases have been confirmed in 17 provinces and some two dozen cities, including Wuhan, which reported a handful of cases this week, per CNN.

Fears of another crushing lockdown - many Wuhan residents still have PTSD from the 70-day+ lockdown in the city that was used to crush the original outbreak, at a tremendous cost to the city's residents mental and physical health. Videos and photos shared on social media have shown empty shelves and long lines at supermarkets, as residents scramble to stock up on supplies.

"Seeing Wuhan people panic buying at supermarkets makes me feel sad. Only those who have experienced it understand how terrible it is, (we) dread a return to the days of staying at home and not knowing where the next meal is," said one Wuhan resident on Weibo.

The present outbreak began a little over a week ago in Nanjing, a city in Jiangsu province in eastern China, where nine airport cleaners were found to be infected on July 20 during a routine test. Chinese authorities have blamed the cluster on workers from Russia, who arrived at the Nanjing Lukou International Airport on July 10.

"It is believed that the cleaners did not strictly follow anti-epidemic guidelines after cleaning Flight CA910 and contracted the virus as a result. The infection further spread to other colleagues, who are also responsible for cleaning and transporting garbage on both international and domestic flights," reported state news agency Xinhua.

Given the provenance of the latest outbreak, Beijing has committed to ramp up testing of transport workers around the country. Workers at ports and borders considered high risk will be tested for the virus every other day said Li Huaqiang, a senior official with Ministry of Transport.

Earlier this week, another COVID-19 hotspot was identified in the city of Zhangjiajie, near a scenic area famous for sandstone cliffs, caves, forests and waterfalls.

Despite only confirming some 19 cases over the past week, the city ordered residential communities sealed Sunday, preventing people from leaving their homes. In a subsequent order on Tuesday, officials said no residents, and no tourists, would be allowed to leave the city. On Wednesday, the city government's Communist Party disciplinary committee issued a list of local officials who "had a negative impact" on pandemic prevention and control work who would be punished.

Far higher numbers were reported in Yangzhou, a city next to Nanjing, which has recorded 126 cases as of Tuesday. As a result, all cross-city ferry services, water tours were suspended in eastern Yangzhou on Wednesday.

But most alarmingly, the outbreak has already touched Beijing, eve though it's thousands of miles removed from the epicenter in Nanjiang. On Wednesday, 7 cases were confirmed in the capital city, prompting authorities to lock down two residential compounds.

As of this wee, China has doled out more than 1.71 billion vaccine doses to its population of 1.4 billion. Officials say 40% of the population is fully vaccinated, but the outbreak is also raising questions about the efficacy of those vaccines.

Tyler Durden Wed, 08/04/2021 - 18:00

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Government

Broward County Public Schools “Pause” Proposed Mask Mandate After DeSantis Threatens To Cut Funding

Broward County Public Schools "Pause" Proposed Mask Mandate After DeSantis Threatens To Cut Funding

Update: Broward County schools on Aug. 3 again changed course on whether to comply with or defy an executive order by Republican Gov. Ron…

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Broward County Public Schools "Pause" Proposed Mask Mandate After DeSantis Threatens To Cut Funding

Update: Broward County schools on Aug. 3 again changed course on whether to comply with or defy an executive order by Republican Gov. Ron DeSantis which prohibited schools from imposing mask mandates on students.

In a written statement to The Epoch Times, the school board has not changed its policy but “paused it.”

“In light of the governor’s executive order, the district is awaiting further guidance before rendering a decision on the mask mandate for the upcoming school year. At this time, the district’s face covering policy, which requires the use of masks in district schools and facilities, remains in place.”

The School Board plans to discuss next steps at a special meeting on August 10.

Dr. Vickie Cartwright, interim superintendent of Broward County schools is looking into the executive order further.

“The school board is reviewing information and looking for language from our executive rules as a result of the governor’s executive order,” Cartwright said in a video statement.

On July 30, the governor signed an executive order that protects parents’ right to make decisions regarding the masking of their children as a means of protecting them from COVID-19. A month earlier, he signed a bill that protected the parents’ “fundamental right” to make decisions for the upbringing, education, health care, or mental health of their minor children.

“Many Florida schoolchildren have suffered under forced masking policies, and it is prudent to protect the ability of parents to make decisions regarding the wearing of masks by their children,” DeSantis said.

*  *  *

As we detailed earlier, Florida Governor Ron DeSantis has had enough of the Covid hysteria.

Aside from going on record and calling the lockdowns a "huge mistake" back in April of his year, DeSantis has done everything he can to try and turn over the power in his state to its citizens, and away from the government.

The latest example of this comes this week, where DeSantis stood down Florida's second largest school district that was attempting to impose a mask mandate. In response, DeSantis threatened to withhold funding from the district. 

"Broward County Public Schools announced last week that it would require mask use after the CDC issued new guidance recommending universal indoor masking for all teachers, staff, students and visitors to K-12 schools this incoming school year, regardless of vaccination status," Axios reported this week.

DeSantis had issued an executive order last Friday barring schools from requiring masks when school re-opens next month. His order read that "if the State Board of Education determines that a district school board is unwilling or unable to comply with the law, the State Board shall have the authority to, among other things, withhold the transfer of state funds, discretionary grant funds ... and declare the school district ineligible for competitive grants."

And that's exactly what DeSantis threatened to do before Broward County Public Schools backed down, releasing a statement on Monday that said: "Broward County Public Schools intends to comply with the governor's latest executive order."

The statement continued: "Safety remains our highest priority. The district will advocate for all eligible students and staff to receive vaccines and strongly encourage masks to be worn by everyone in schools."

DeSantis also spoke at a press conference this week, stating: “Even among a lot of positive tests, you are seeing much less mortality that you did year-over-year. Would I rather have 5,000 cases among 20-year-olds or 500 cases among seniors? I would rather have the younger.”

“We are not shutting down. We are going to have schools open. We are protecting every Floridian’s job in this state. We are protecting people’s small businesses. These interventions have failed time and time again throughout this pandemic, not just in the United States but abroad.”

As we noted back in April, DeSantis told The Epoch Times that the lockdowns were a “huge mistake,” including in his own state.

“We wanted to mitigate the damage. Now, in hindsight, the 15 days to slow the spread and the 30—it didn’t work,” DeSantis said.

“We shouldn’t have gone down that road.”

Florida’s lockdown order was notably less strict than some of the stay-at-home measures imposed in other states. Recreational activities like walking, biking, golf, and beachgoing were exempted while essential businesses were broadly defined.

“Our economy kept going,” DeSantis said. “It was much different than what you saw in some of those lockdown states.”

DeSantis has also opposed vaccine passports in Florida. 

Tyler Durden Wed, 08/04/2021 - 22:40

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