06 Mar Holiday from History, Redux
I have long believed and have argued in print that ESG is, more than anything else, a “luxury belief” or, alternatively, a “first-world problem.” By this, I mean that ESG is a phenomenon enabled by the overabundance of capital in the American and European capital markets. Almost exactly two years ago, I put it this way in a piece for Newsweek about the failure of Silicon Valley Bank and its connection to the ESG/DEI complex:
ESG is what one might call a “first-world problem.” It is an indulgence, something that occurs on a mass scale only when times are good and money is plentiful for such extraneous, non-functional business expenditures. ESG’s defenders like to say it is a “risk-management” tool, a mechanism by which investors can evaluate long-term energy and reputational risks. Whatever one thinks of this argument (I wrote a whole book debunking it), in the short term, ESG is nothing more than a distraction, a shiny bauble that keeps corporate executives from doing what they’re supposed to be doing and that, as a result, contributes to the modern-day bezzle.
That last bit – the bit about the “bezzle” – is a reference to the term coined by the economist John Kenneth Galbraith in his great little book, The Great Crash: 1929. Galbraith described the “bezzle” as the “inventory of undiscovered embezzlement.” His assessment of how and why the “bezzle” grows during good times and shrinks during bad times is incredibly important and helps make the case that ESG, in addition to being a luxury belief,” is also a form of corruption. This is a potent argument against ESG, and one that should not be discounted. Nevertheless, for my purposes today, I’d like to keep the focus on the role that those “good times” played in the rise of ESG and that “bad times” have played – and continue to play – in its fall.
In brief, the case here – confirmed by the events of the last several years – is that ESG was a creation of central banks’ easy money policies and of the credulousness those policies fostered among American investors. When interest rates were artificially low and money was easily obtained, almost anyone could do really, really well – both in attracting investors and in generating positive investment returns. ESG was popular because it offered a certain type of investor the opportunity to make money hand-over-fist while, at the same time, allowing him to feel morally superior as well. “I’m getting rich too! It’s just that I’m doing so responsibly.” When central banks had to deal with the reality of inflation, however, investing got a little trickier, and investment strategies that focused on righteous indignation rather than sound business strategies fell behind quickly. ESG returns have trailed the broader markets by a wide margin ever since.
To put it bluntly, ESG was enabled by the “holiday from history” created by central banks in their collective effort to maintain the appearance of economic well-being and equity-market resilience. When the holiday ended, so did most of ESG’s pretensions.
If that term, “holiday from history,” sounds familiar, there’s a reason for that. It is the phrase generally used to describe the unusual fiscal and defense policies that characterized the Clinton Administration and the effects on those policies of the partnership between President Clinton and Speaker of the House Newt Gingrich. As you may recall, during the mid-to-late 1990s, the collective efforts of the Clinton team and the Gingrich-led Congress produced the first (and only) balanced budgets in recent memory. While an impressive accomplishment, the balanced budgets were the direct result of the enormous defense-spending cuts made possible by the collapse of the Soviet Union. Without those cuts, the Clinton-Gingrich budgets would have remained in the red. The cuts and their budgetary impact were the inarguable byproducts of the interlude between the fall of communism and the global rise of Islamist terrorism. This extraordinary “holiday from history” created the extraordinary conditions that enabled some extraordinary fiscal alchemy.
Of course, that holiday – and everything it facilitated – came to a screeching halt on September 11, 2001, when history reasserted its presence.
At the present moment, we are witnessing a similar halt to a holiday from history, albeit one that has been far less screeching. For more than three-quarters of a century, the nations of Western Europe have been on vacation, allowed to spend as freely and as frivolously as they wanted on social programs and other luxuries because of the defense umbrella provided them by the United States. Unlike the Americans, who spend more on defense than any other non-entitlement budget item, Europeans have spent very little on defense, outsourcing their national security to their allies across the Atlantic.
Over the last several years – since Russia invaded Ukraine, at the very least – that vacation has been slowly but surely ending. Last week, when President Trump and Vice President Vance dressed down Ukrainian President Zelensky in the Oval Office, the implications of this return to reality became far more apparent and far more serious for most Europeans. Hence, we’ve seen the rise of reports such as this one from Monday’s Financial Times:
Friday’s blistering spat in the White House produced one winner. On Monday morning, European defence stocks including Germany’s Rheinmetall, France’s Thales and BAE Systems shot through the roof.
Expectations of government spending have pumped up prices. But war’s rebranding — think national security, supporting downtrodden allies and resilience — has been paying dividends for a while. Ethical investors are slowly starting to shed their squeamishness about the sector: the 1,856 European ESG funds with no exposure to the sector at end-2023 had been whittled down to 1,614 a year later.
Indeed, holdings of defence stocks by environmental, social and governance-focused funds had swollen to €8bn by the last quarter of 2024, up from €2.7bn in the first quarter of 2022. That’s partly a factor of the sector’s massive outperformance. Stocks in Europe’s aerospace and defence sector have risen 2.5 times since Russia invaded Ukraine in 2022, multiples of the benchmark gains.
The confluence of circumstances here is edifying. European governments were not the only ones allowed to go on holiday because of the American national security umbrella. European investors tagged along. And like all ESG advocates, while lounging by la plage, the only risk they faced was that of possibly spraining a shoulder or an elbow patting themselves on the back for their righteousness. They were never going to miss a bull market in European defense stocks as long as European defense companies were mere afterthoughts in the global defense establishment. Investing in defense was both unnecessary and uncomfortable. “You want us to be like the Americans and invest in dirty defense companies? Très gauche!”
As the sun rises on a new geopolitical reality, defense companies don’t look so dirty and gauche any longer. Indeed, they look downright “responsible.”
Once again, ESG is shown to be a luxury belief, the byproduct of excess capital that needn’t be invested elsewhere. In this case, of course, the Europeans will simply change the definition of ESG to reflect the new geopolitical reality rather than allow the migration of capital to defense stocks to further sully ESG’s reputation.
C’est la vie, I suppose. Or is it c’est la guerre?
Whatever the case, ESG turns out, once more, to be far less than it was cracked up to be, an ego-inflating distraction during good times but something much more dangerous and sinister in bad times – or normal times, if you will.
