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Pension funds and the Hail Mary Pass of a solution between investment and climate change

Growth is unsustainable in a climate change-threatened economy unless we engineer the magical decoupling of growth from resource throughput.

I recently gave a talk to the Missouri Association of Public Employee Retirement Systems annual meeting. This was the first time I presented my developing thesis of financial overshoot, which arithmetically accompanies ecological overshoot unless we manage to decouple economic growth from material resource throughput in the economy. I call it the ‘Hail Mary Pass’ of all time, an American football term that refers to any very long forward pass made in desperation with only a small chance of success…
The implications are not comforting for investors, especially for pension funds that have plenty of problems already with underfunded pension plans in a climate of financial repression caused by zero interest rates and economic stagnation. First, the necessary context. The Global Footprint Network explains that ecological overshoot occurs when humanity’s demand on nature exceeds the biosphere’s supply or regenerative capacity. Draw-down of natural capital results; the equivalent of an endowment dipping into its principal capital. With ongoing annual deficits and a shrinking residual stock of natural capital, the path to ecological collapse is set unless profound changes occur. The Global Footprint Network calculates that our ecological footprint is now 1.5 times the earth’s natural capacity to regenerate resources and absorb waste. If everyone on the planet used resources like the average American, the global economy would require five planet earths. The global economy has a profound scale problem, as Herman Daly and many others have been telling us for decades. Scaleproblems demand limits, not simply getting prices right. The exponential function embedded in compound interest, the foundation of finance, knows no limits. Last year, I wrote about what I called the $20 Trillion “Big Choice,” based on an excellent report titled “Unburnable Carbon” written by the Carbon Tracker Initiative using climate science from the Potsdam Institute. The punch line was that we have 5 times more carbon embedded in the “proved reserves” (an accounting term meaning booked on the balance sheet) of the world’s largest fossil fuel companies (24%) and State producers (76%) than the climate scientists tell us we can burn without exceeding the already dangerous 2 degree celsius warming threshold, beyond which a climate tipping point is likely to trigger catastrophic consequences. In my essay, I estimated that the eighty percent of this carbon that we therefore needed to leave in the ground was worth at least $20 trillion based on current market valuations. Thus, civilization is facing our $20 trillion big choice: our investments or our planet. Recall the direct financial losses of the subprime crisis in the US were a mere $2.7 trillion, and we know what that did. Bill McKibbon’s recent cover story in Rolling Stone: “Global Warming’s Terrifying New Math,” is a powerful expansion of this thesis, again built on the Carbon Tracker Report, and naming the fossil fuel industry as the enemy in the war on climate change. Unfortunately, if the fossil fuel industry is the enemy, then the enemy must include the fossil fuel rich sovereign States themselves that account for 76% of proved reserves. In describing the piece, McKibben
wrote “it may be the most important writing I’ve done since The End of Nature, way back in 1989” which made him a leading authority on the looming ecological crisis. As terrifying as this math is, we must comprehend that the financial ramifications of it – my $20 trillion “big choice” – is only a piece of a more general problem; one I’m calling “financial overshoot”. Financial overshoot pits our financial resiliency against our ecological resiliency. Like all arms races, there’s no winner here, only hard choices with profound consequences. Had we accepted the need to limit CO2 emissions as the scientists have been telling us for decades, and had we mustered the political will to legislate firm emission limits and an allocation mechanism into place, the investment behind these excess fossil fuel reserves would never have been made, since there would be no path to market for them. Instead we’d be much further along in developing renewable energy, and no doubt, we’d also be much more thrifty in our use of energy in everything from transportation to agriculture. Instead, we overshot our investment by trillions and continue to do so today. The housing bubble was just a pilot project in comparison. Exxon alone plans to spend $37 billion per year on developing additional fossil fuel reserves according to McKibben.
Financial investment overshoot goes hand-in-hand with ecological overshoot and manifests itself in financial assets valued by the market under the assumption that we will proceed head-on into ecological collapse. Givenpolitical cowardice and worse, especially in the United States, the markets are unfortunately right in making that assumption at the moment. But if we fully comprehended the implications of ecological overshoot, we would understand that the perpetual growth of material throughput that goes hand-in-hand with economic growth is also unsustainable unless we engineer the magical decoupling of growth from resource throughput. Energy is a piece of that unsustainable equation but it is by no means the whole of it. The use of water, the destruction of soils, the release of chemicals into the environment, and the loss of biodiversity often from land misuse are also high on the list of unsustainable qualities of the global economic system. If we choose to reverse the ecological overshoot caused by these realities of our economic system, there will inevitably be an associated massive destruction of financial asset value, mitigated to be sure by value creation from innovative new technologies. As a simple example, Puma, a leader in corporate sustainability, calculated in a comprehensive report that their business cost the earth Euro 145 million in 2010 (mostly from carbon emissions and water use), a year in which they reported net income of Euro 202 million. Bold for them to do the analysis and then to make it transparent. Perhaps more problematic, the debt capacity of companies and nations will need to be reassessed in light of lower growth and shrinking fully costed margins, making the current oppressive debt burden of the developed economies
far worse. How much of the financial asset value of the world’s stock and bond markets, private companies, State enterprises, much less the viability of our fiscal national accounts dependant upon economic growth is predicated on an unsustainable economy in ecological overshoot? I don’t know. But I do know it’s likely that the overvaluation is a multiple of the $20 trillion in fossil fuel assets we should leave in the ground and therefore make uneconomic. As one data point, Japan’s economy has been in effective zero growth stagnation for over twenty years. The Japanese stock market now sits at less than a third of its valuation at the peak in 1990, admittedly from an inflated level. Technological optimists will cry foul; we will innovate our way out of this. I say innovation is our only hope to avoid outright catastrophe, so I’m in thetechnological breakthrough camp. I’m also in the consciousness shift camp. But I’m trying to raise awareness and remain realistic about the box we’ve put ourselves in from decades of inaction. As we wrestle to comprehend what the transition to sustainability really means, we had better factor in the seismic shift in financial asset valuations that will undoubtedly accompany the essential reversal of ecological overshoot. Maybe there’s a reason we had Madoff and “Ponzi Scheme” thrust in our faces on an unimaginable scale. The financial collapse showed us what happens when complex systems collapse. There’s no central bank for the planet. The choice is ours: our money or our planet?
John Fullerton, former JPMorgan Managing Director, is President and Founder of The Capital Institute, a non-partisan, trans-disciplinary collaborative space:
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