How unsound money opposes sustainable development principles, and how it guarantees ESG strategies to fail despite its merits.
In the previous chapter “Green-shaming no more”, I pointed out the flaws of fiat currency incentives with a metaphor involving bananas and wine. Often, pushing systems to (absurd) extremes allows us to better grasp their outcomes.
It’s basic engineering. We saw that incomes received for work can essentially be allocated in 3 buckets:
- Essential spending (food, housing, etc)
- Discretionary spending
- Savings/investments
The banana/wine metaphor has shown us how #3, savings/investment, is perceived as a way to increase wealth, but in practice it is merely an attempt to extend the expiry date — those that wish to teleport wealth across time. I explored and explained how #2, discretionary expenses (example: a weekend in Spain) and #3 savings/investments, are mostly responsible for the resources depletion and excessive footprints on the environment.
Money printing keeps the system “afloat” and drastically reduces bankruptcies and micro failures in the economy. Along that process, money debasement inflates asset prices, making investments a compelling and natural choice for cash savings — largely de-risked. As long as the trust is not broken, and that ponzi pyramid grows, it creates a perpetual rush forward that results in unquantifiable resources and energy footprint. I will leverage sound money and first principles thinking to shed light on this issue.
Investing from first principles thinking in a sound money system
The importance of sound money is that it enables two very distincts options for each individuals:
- Transport wealth across time and risk free.
- Grow wealth by investing with the least amount of interference.
Both options are probably a foreign concept in 2022 to most. Between the US and Europe, inflation is now between 10% and 20%. Transporting wealth across time is not possible without risk, and investing has been reduced to listening to FED policy.
People are likely to invest in innovative projects that generate yield through greater efficiency. It resonates well with people, more than disruptions. Innovation is deflationary, and that’s where yield comes from: Do the same (or more) with less. A perfect incentive, so to speak, for limiting environmental impacts. The incentive is to chase inefficiencies in the system, and reward those who fix it.
Since sound money offers negligeable and predictable debasement or inflation rates, investors can assess project characteristics with the least amount of interference. Sound money is a pure signal to investors. Accurate calculations enable rational capital allocation. And remember, investors also have the optionality to do nothing, until better opportunities appear. Sound money incentivizes a low time preference. The rational decision not to waste resources and energy at all is the biggest environmental gain.
What happens when the signal gets corrupted?
In a fiat currency world, debasement and inflation are somewhat correlated. It mostly depends on how the additional money supply gets distributed. Calculation methodologies are subjective, and often change. If you are curious, I invite you to read the mind-bending number of inflation methodology changes over the past 50 years or so.
Change in methodology is problematic of course, but not as much as their impossible forecast: that’s mission impossible, even for the “experts”.
Manipulation of money by central banks and fiscal response influence the debasement and inflation rates, which are hidden taxes that suck the profitability out of your investments or savings, to bail out companies and investments that should have failed in a free and open market.
In a manipulated fiat system where both methodology and rate changes constantly, investors are not capable of such nuanced arbitrages. If forecasts are unpredictable, then let’s at least look back in the mirror.
Under a compounded debasement rate of nearly 7%, you are not offered the privilege to wait and do nothing. You must act or you will lose half of your purchasing power every decade.
You are forced to chase yield greater than the debasement rates, to move earth and consume energy, be damned if you do not beat the debasement rate, it will still be better than doing nothing! Be damn if it’s a gross capital misallocation that consumes enormous amounts of resources and energy. After all, that’s the necessary cost to protect wealth across time, as much as you can.
Fiat currencies are inflationary. It means that there is a constant need for more units of accounts in the system to keep the system afloat, or it collapses in the event of credit crunch. If innovation creates yield through greater efficiency, then it’s an opposing force to the fiat system. Central banks will need to offset the innovation effect via debasement. And debasement, as we saw earlier, is a terrible incentive for limiting environmental impacts: it’s an accelerant!
Following the release of the first chapter, I received quite a few comments noting that Green/ESG investments have been overlooked, and too quickly discarded. Fair enough. In this second chapter, I first felt a moral obligation to respond to these critics. Then I will explore why fiat-based currencies oppose sustainable development principles through the lens of time preference, and innovation.
The everything ESG
About a decade ago I was working in the Cleantech & Sustainability division of a “big-four”. Beyond my personal motivations of doing something good for the environment, this period gave me the opportunity to get first-hand experience with ESG investments (Environmental, Social and Governance): from framework, advisory, audit, and reporting.
It was in the early 2010’s. I believe my former colleagues wanted to make a positive impact as much as I did. From new joiners to partners. Long story short: ESG investments describes investment funds with an ESG strategy, to cherry pick companies that are disclosing their most important ESG issues. Measuring them and having a credible plan in place to reduce their environmental impacts. After all, this seems like a reasonable value proposition.
Of course, there are multiple standards which frame what ESG is in more detail than the definition I just gave: SFDR, GRI, SASB, SAM CSA, TCFD, ISO, etc to name a few. Nowadays, most pension funds and institutional investors have ESG embedded in their mandates. Investments are reviewed carefully against ESG checklists. It has become mainstream in finance. But what does it really look like in practice?
Below you’ll find some information about the 2nd biggest “ESG equity funds” in the world : the “iShares ESG Aware”. You might be surprised to find Apple, Exxon, and JPMto name a few. Not exactly the companies that jump to the tip of my tongue for making a positive impact on the world . And by the way, who gets to decide what’s positive and what’s not? For who? What ages? What time frame? What parts of the world?
Source: iShares
But let’s stay focused. I’ll save you the burden of going through what these companies actually do under their ESG policies — and whether they’re a net positive or negative. Their achievements are public information, if you’re curious.
The takeaway is that, any activity/company can be tagged with “ESG” as long as they have a dedicated team doing the paperwork, and passing the necessary audits. And so companies around the world embrace the fashion, and the result is as expected:
Deloitte projects that over half of funds will be ESG-mandated. Almost $100 trillion. Which begs the question: Does ESG still even mean anything? What we know from the first chapter is that it certainly doesn’t produce tangible results worldwide. CO2 emissions are at an all-time-high, and the trend relentlessly continues.
The issue is not so much to know what ESG does, but if it really stands a chance to do what it intends to do on a fiat-currency based system.
The incentive is the yield, not the label pinned on it
Let’s simplify the picture. Bring it closer to the ground for the average “Joe”. In reference to the first chapter “Green-shaming no more”, we will build on the metaphor and assume that the official medium of exchange is “bananas” (fiat-currencies). Bananas as Money increase the feeling of urgency created by unsound money — money with a short shelf-life.
It’s the end of the month and you have a massive pile of bananas, far more than you can eat. Knowing that your banana pile is already starting to ripen and will soon begin to rot (high inflation) you wish to invest the bananas you won’t be able to eat, but you care very much about the planet. So you look up investments with ESG stamps, and you select Raspberries Inc., a truly outstanding ESG friendly investment. The company is in the news for being one of the most ‘green’ companies of the past few years. You invest all your excess bananas in Raspberries Inc. in exchange for a few shares of the company.
After a few weeks, Raspberry Inc. has been doing extremely well and has sold all their raspberries grown in the month, and at good margins. The P&L delivers a large positive bottom line. To summarize, the company is now “full of ESG compliant-bananas”, which allow the shareholders (you) to be paid a banana-based dividend. Raspberry Inc. now has a lot of bananas on their books too, even after paying out dividends.
The trend continues. You, other shareholders and the board of Raspberry Inc., end up with even more bananas at the end of the following month. Other shareholders and the board of Raspberry Inc. must also do something about their bananas. Every board in the world has a fiduciary duty: it cannot let their bananas rot — they must be re-invested as fast as possible in capex to avoid the loss of benefits from the hard work of employees. And so even if you pick the best-in-class-top-notch ESG investment possible, you are still left with the constant problem of inflationary money.
To be clear, this essay is not a criticism of ESG as such, but the incentive structure underneath the ESG mandate makes it doomed to failure. Money chases yields and as long as the money base continues to expand at an accelerated rate it creates a favorable environment for all sorts of investments, even the most questionable ones. I am however more critical as to how ESG is often leveraged by sales and marketing divisions to boost the development of the company among customers-believers. Tesla is a prime example. The company may generate positive outcomes by ESG standards for some aspects (centralization of PM particles which is easier to abate), but it is debatable for other aspects (mining operations and battery recycling). Tesla has gathered a very solid base of customers, attracted by the ludicrous performances of their cars, but also as a way to claim modernity and consciousness about environmental impacts. After years of investments and challenges, the company became profitable. Tesla generated $11.5B in net operating cash flow in 2021, and deals with the same problems as the Raspberry Inc. The board has an obligation to put the hard work of their employees to good use and avoid the lurking specter of inflation and money debasement.
It’s the basic nature of things. Investments and businesses’ raison d’être is to generate yields/profits for their investors and shareholders. Without sufficient returns, business dies and investments fail. But if you are investing in an ESG friendly vehicule in spite of yields, then you make a conscious decision to lower your rate of return for higher virtue standards. It’s respectable, but then it’s not investing or doing business anymore, it is a political action.
Sustainable development and time preference
Under the sustainable development lens, fiat currencies are performing very poorly. Bad mediums of exchange also reduce the optionality to delay or withhold a decision. Sometimes in life, good opportunities can be rare, or they can bear too many risks. The rational decision would be to wait for better momentums.
And that’s not all. Fiat-currencies also oppose long-term thinking. Think about it: one of the first “project finance” fundamentals you may learn is how to discount future cash flows. It is a way to account for inflation in each investment decision. The inflation rate that financiers incorporate in their financial plans are usually official CPI prints.
Almost any significant investment decision around the world is executed after passing the discounted cash flow test. People discount the Future (capital F), developed a high-time preference because they consiously or unconsciously think the Future is worth less than the present. Excel spreadsheets set the tone for the Human Race, telling us that those years in which you will see your kids grow up (or have them in the first place) don’t count as much as today. The further in the Future, the heavier the discount.
And that is kind of a big deal for sustainable development. Sustainable development has been defined in many ways, but the most frequently quoted definition is from Our Common Future from 1987, also known as the “Brundtland Report”:
“Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.
Fiat currency-based systems happen to be in total opposition with the goals of sustainable development. If the goal is to indeed foster and promote a sustainable development, then the incentive structure should favor low-time preference.
Sustainable development requires a high degree of decentralized innovations
Sustainable development requires drastic changes in our lives, and high innovation. It’s also heavily dependent on specific geographies. What works locally, may not work globally. Innovation often brings to mind technology solutions, shiny objects, and life improvements. But innovation is also how to do the same thing, with less — also known as the “local and frugal innovation”. What is clear is that fiat currency’s incentives do not work toward that goal. Let me explain.
Ethical issues are caused by repeated financial bail-outs, money printing, rounds of stimulus, market distortion, and money manipulation/debasement. Those actions increase inflation pressures and make issues outlined above much worse. Inflation forces us to see the world through the lens of high time preference, even for those aware of the destructive nature of debasement. Even more so for those operating in this system unaware of how damaging it is. Ie, the least educated on the topic of economics.
Since the Covid19 outbreak in March 2020, it has become more visible to many that the money can be manipulated at will by a select few. Who gets to be saved and who does not? Who wins, and who loses? And why be responsible and reasonable, when you know that, no matter what, you’ll be rescued from bankruptcy? This constant noise distorts the signal. With signal manipulation, corruption wins; rationality loses. The market is forbidden to balance itself, with terrible but necessary bankruptcies. Products and services not in demand should disappear. By putting noise in the signal (Money), politicians keep zombie companies alive, misallocate capital, and influence the free market in proportions that it is difficult to comprehend.
Over the past 2 decades, the free market has slowly been captured by central authorities. Central planners are good at central planning: they create huge market distortions, in the hope that entrepreneurs will fill the void and respond to their will instead of letting the free market propose innovations and settle which innovation wins. To a level of absurdity never seen before: Money printing (debasement) to tame inflation and fight climate change!
In August 2022, US President Joe Biden signed the Inflation Reduction Act of 2022, ushering in a new decade of $370 billion in climate and energy spending.
In opposition, a society that fosters innovation through economic freedom and on sound money principles will deliver more innovation outputs than a centralized society. More importantly, those innovations will be fit for the environment they emerge from. And in that context, “Maybe 100,000 brains is better than one”, especially in a low-time preference system: where the future matters more in the decision-making process.
The millions of minds able to freely operate in a monetary-system with cleaner signals will always be more innovative for sustainable development than a few dozen central planners. With free and incorruptible signals, innovation will thrive for a long time-frame, out of a series of micro-failures. The best of 100,000 experiments will make their way to the world because of market demand, not because somebody said a thing should be the innovation. That’s what the free market does. In that way, sustainable development can only be achieved through a high degree of decentralized innovations capabilities, and with the right time-preference.
An aside, it is interesting to note that innovation is deflationary. That is what engineers do: they engineer energy efficiency and deploy disruptive technologies. They drastically cut costs by reinventing how we do things, and optimize existing processes. Deflationary forces are good for sustainable development, but opposing inflation needs to avoid a credit collapse. The more innovation, the more the money printer needs to rumble to avoid a credit collapse. I encourage you to read The Price of Tomorrow, where Jeff Booth covers these forces in fascinating details.
It will be either sound money, or guaranteed Climate Change and Energy Waste
In Chapters 1 and 2 I demonstrated how inflationary money such as fiat-currency is likely the worst incentive structure to protect and respect the environment we live in, our climate, and how it opposes rational long-term thinking.
Despite its merits, ESG policies are merely a bandaid on a broken system, a mix of politics, coercion, and virtue signaling that intend to overcome the shortfalls of fiat currencies. Fix the money, fix the world: the world needs to replace inflationary money for sound money if we want to be better equipped/incentivised to:
- Better protect/respect the environment (capital allocation and low-time preference)
- Drive local innovation
- Foster economic freedom
I do not think sound money will fix everything. But it gives us all a much greater shot for a sustainable development path than staying on a fiat currency standard. In particular, via better capital allocation, lower time preference, and local innovation.
Today, there are mainly two credible sound money alternatives, or bearer assets: Gold and Bitcoin. To be clear, the objective of this essay is not to make the case for Bitcoin over Gold. Nor is the goal to explore whether Bitcoin is superior Money technology. Many books have been written on the matter and whether you agree or not with the conclusion is up to you, and the number of hours you study. Let the market figure it out.
Bitcoin belong to the sound money club, and thats makes it already a much better incentive structure to tackle waste, ineffiencies, Climate Change and capital misallocation, than fiat currencies.
But Bitcoin is not just sound money, it is energy money with new attributes that never existed before 2009. Despite what virtue signallers may think or write in news outlets, I will explain in the last chapter, why these unique energy features make Bitcoin the best ESG investment vehicle and tech ever invented, on steroids.
This text was edited with the support of @DelioPera.
