Streetwise Professor

I’ve written often about the economic nightmare that are renewables, specifically wind and solar power. They are terribly inefficient because they are intermittent, and they are diffuse. The intermittency requires maintaining substantial backup capacity. Their diffuse nature means that they are incredibly land intensive. I should also add that renewable energy sources are not miraculously located where loads are. Indeed, they are often located far, far away from load, and therefore necessitate substantial investment in transmission.

How inefficient? This recent University of Chicago study documents that the difference in cost between renewable and conventional generation dwarfs any possible benefit from CO2 reduction. To reprise the old joke: governments that subsidize renewables want to reduce CO2 emissions in the worst way, and they have.

Heretofore the Germans have been the world’s leader in renewable idiocy, with their Energiewende debacle, which has raised power costs to among the world’s highest, and not led to decreases in CO2 emissions (due mainly to the intermittency problem mentioned above). Well played! So how are the Germans going to deal with this? Perhaps by making electricity MORE expensive, by adding a CO2 tax on top of the CO2 cap and trade scheme.

I would say that will be hard to top Germany’s leading position in the ranks of renewables retards, but the Swedes are giving it a gallant try. So get this. The Swedes are replacing cheap zero carbon power (from four nuclear plants) located near load centers like Stockholm with expensive zero carbon power produced my windmills in the frozen back of buggery in the far north of Sweden. One big problem, they are woefully short of transmission capacity from back of buggery to the places where Swedes actually live and work.

This will make power more expensive, and is already constraining economic activity in Sweden. Moreover, it is raising the risk of blackouts.

So the Swedes may be replacing reliable carbon free electricity with electricity free electricity. That will be fun in the winters, eh?

Realistic people who believe that it is necessary to reduce carbon emissions understand that nuclear power is the efficient way to do so, and will become even more efficient with the development of new reactor technologies. It would be far more economical to invest in improvements in nukes than vast wind and solar projects.

But the Swedes appear to still be in the thrall of post-Three Mile Island hysteria (note that the decision to close the plants was made in 1980, a year after TMI) just as the Germans responded to post-Fukushima hysteria by deciding to close all their nukes.

That is, the energy policies of supposedly sophisticated societies are being driven by bugbears and bogeymen–a morbid obsession with CO2, and a view of nuclear power shaped by a nearly 40 year old Jane Fonda movie. This is leading them to force people to rely energy sources that are monstrously inefficient, making said people poorer. (Not to mention that a monomaniacal focus on CO2 leads them to overlook the total environmental impact of wind and solar, which is not a pretty picture.)

The Swedes are also leaders in a modern-day Children’s Crusade (that worked out great the first time, right?) to impose their climate bogeymen on the rest of the world. A rather unfortunate Swedish teenager is going around lecturing the world on the need for drastic action on CO2 now. This is an emotionally manipulative use of children as a substitute for actual argument and analysis and facts. Cynically, it exploits the reluctance of people to criticize children (even though they know nothing, or next to it), especially ones (in the words of the immortal Hank Hill) that ain’t right.

And behold what policies the Swedes want to visit on the rest of us. What they do in Sweden is their business, but they should keep their noses out of everyone else’s.

Makes me more glad than ever that my ancestors bugged out for Minnesota 140 odd years ago. But recent research suggests that they are to blame for Sweden’s current idiocies! I’ve long hypothesized that more independent souls are far more likely to emigrate, leaving the conformists behind. And recent research focusing on Scandinavia provides support for this hypothesis:

The researchers suggest the migration flows, which were small relative to the native population of America but equivalent to about 25 per cent of the total population of Scandinavia, changed the character of Norwegian and Swedish society by removing the most ambitious and independently-minded people.

So Scandinavia’s loss was America’s gain. And if their energy policies are any indication, they are still paying the price today.

Trump just departed from Ellington Joint Reserve Base here in Houston, ending a quick trip to Texas which included a rally in Houston. The focus of Trump’s visit was the US energy sector (In Texas? Go figure!). As part of that, he announced and signed an executive order limiting the power of states to block or obstruct the construction of interstate oil and gas pipelines.

Overall, I’m not a fan of executive orders, as they tend to be used to override or circumvent normal Constitutional procedures and purposes. There is a strong argument, however, that this order is an exception.

The very genesis of the Constitution traces to commercial disputes between states under the Articles of Confederation. Contention between Virginia and Maryland over navigation of the Potomac and the Chesapeake resulted in the calling of the Annapolis Convention (formally The Meeting of Commissioners to Remedy Defects of the Federal Government) in 1786. Although the Convention itself was something of a damp squid, it did result in the calling of the Philadelphia Convention of 1787, which wrote the Constitution that continues to be the law of the land to this day, 232 years later.

Of course, one part of that document is the Commerce Clause (Article I, Section 8, Clause 3) which grants to the Federal government the power to regulate commerce between the states. This was not an accident, comrades. Preventing protectionism by the states against each other was one of the main reasons for creating a more powerful central government.

State governments always have the temptation and incentive to favor their own constituents at the expense of people in other states. Letting that impulse operate freely would result in a Balkanized country with myriad wasteful restrictions, taxes, tolls, and regulations that would sap wealth. (Consider pre-Revolutionary France, with its oppressive system of local tolls on the movement of goods.) Anticipating that, the Founders expressly sought to limit the protectionist powers of states.

In Gibbons v. Ogden (1824) the Marshall court forcefully exerted the Commerce Clause. Things have likely gone too far since: for example, the Commerce Clause’s delegation of authority over navigable waters to the US government has been pushed to the extreme by using it to impose Federal environmental regulation on an intermittent wet spot on your back 40.

But what Trump is ordering is clearly within the four corners of the Clause as originally conceived. Oil and gas are produced in some states, and consumed in others. Interstate movement is necessary to connect producers and consumers. Further, for myriad motives many states have attempted to obstruct that movement. That is not, and has not been since the formation of the Republic, their prerogative.

The case can be made that the Commerce Clause has proved a Trojan Horse that has facilitated an expansion of Federal power beyond that what the Founders envisioned. But what Trump is ordering is squarely within the intent of the Clause, as drafted and intended.

The dramatic growth in US energy production is being hampered by infrastructure constraints. For many, that is a feature, not a bug: the hostility towards fossil fuel energy in particular by many in the US, especially on the left, makes such infrastructure a schwerpunkt for environmentalists. Knock out the transit links between producers and consumers, and energy will be neither produced nor consumed. They often find it easier to focus their efforts on state and local governments because (a) they are often more biddable, and (b) since you only need to prevail in one or two to delay or derail altogether a pipeline moving across many, the odds of success are higher. (If there are N jurisdictions crossed by a pipeline, and the probability of getting a jurisdiction to block it is P, the probability that it will go through is (1-P)^N, which decreases with N.)

Yes, local communities do have concerns. The question is what is the appropriate remedy for them. A properly applied Takings Clause (with payment of true value for taken property) is one: it prevents subsidization through expropriation. Insofar as environmental issues are concerned, the question is whether ex ante restrictions (i.e., imposing high standards to permit construction) are better than ex post penalties for damage imposed (which provide an incentive for infrastructure operators to take precautions against damage).

Since infrastructure operators are well-capitalized, and unlikely to be judgment proof, and since there are armies of class action attorneys waiting in the wings salivating at the opportunity to sue for damages, ex post penalties are likely to be more efficient than ex ante restrictions, especially ex ante restrictions imposed by state and local governments who internalize the benefits they obtain for their constituents, but who do not internalize the costs that they impose on producers upstream or consumers downstream.

And this is not to say that the Federal government is inevitably predisposed to efficient outcomes. Look no further than the previous administration, which largely embraced the environmentalist hostility to domestic energy development, and which as a consequence used its powers to thwart some important infrastructure developments (e.g., Keystone, which would have proven especially valuable in light of the loss of heavy crude production in Venezuela and to a lesser degree Mexico). So Federal power can be exercised for good or ill when it comes to energy infrastructure. Trump’s order is an example of it being exercised for the good of energy consumers and producers.

In my derivatives classes, here and abroad, I always start out by saying that another phrase for “derivative” is contingent claim. Derivatives have payoffs that are contingent on something. For most contracts–a garden variety futures or option, for example–the contingency is a price. The payoff on WTI futures is contingent on the price of WTI at contract expiration. Other contracts have contingencies related to events. A weather derivative, for instance, which pays off based on heating or cooling degree days, or snowfall, or some other weather variable. Or a contract that has a payoff contingent on an official government statistic, like natural gas or crude inventories.

Credit default swaps–CDS–are a hybrid. They have payoffs that are contingent on both an event (e.g., bankruptcy) and a price (the price of defaulted debt). Both contingencies have proved very problematic in practice, which is one reason why CDS have long been in such disrepute.

The price contingency has proved problematic in part for the same reason that CDS exist. If there were liquid, transparent markets for corporate debt, who would need CDS?: just short the debt if you want to short the credit (and hedge out the non-credit related interest rate risk). CDS were a way to trade credit without trading the (illiquid) underlying debt. But that means that determining the price of defaulted debt, and hence the payoff to a CDS, is not trivial.

To determine a price, market participants resorted to auctions. But the auctions were potentially prone to manipulation, a problem exacerbated by the illiquidity of bonds and the fact that many of them were locked up in portfolios: deliverable supply is therefore likely to be limited, exacerbating the manipulation problem.

ISDA, the industry organization that largely governs OTC derivatives, introduced some reforms to the auction process to mitigate these problems. But I emphasize “mitigate” is not the same as “solve.”

The event issue has been a bane of the CDS markets since their birth. For instance, the collapse of Russian bond prices and the devaluation of the Ruble in 1998 didn’t trigger CDS payments, because the technical default terms weren’t met. More recently, the big issue has been engineering technical defaults (e.g., “failure to pay events”) to trigger payoffs on CDS, even though the name is not in financial distress and is able to service its debt.

ISDA has again stepped in, and implemented some changes:

Specifically, International Swaps and Derivatives Association is proposing that failing to make a bond payment wouldn’t trigger a CDS payout if the reason for default wasn’t tied to some kind of financial stress. The plan earned initial backing from titans including Goldman Sachs Group Inc., JPMorgan Chase & Co., Apollo Global Management and Ares Management Corp.

“There must be a causal link between the non-payment and the deterioration in the creditworthiness or financial condition of the reference entity,” ISDA said in its document.

Well that sure clears things up, doesn’t it?

ISDA has been criticized because it has addressed just one problem, and left other potential ways of manipulating events unaddressed. But this just points out an inherent challenge in CDS. In the case Cargill v. Hardin, the 7th Circuit stated that “the techniques of manipulation are limited only by the ingenuity of man.” And that goes triple for CDS. Ingenious traders with ingenious lawyers will find new techniques to manipulate CDS, because of the inherently imprecise and varied nature of “credit events.”

CDS should be a cautionary tale for something else that has been the subject of much fascination–so called “smart contracts.” The CDS experience shows that many contracts are inherently incomplete. That is, it is impossible in advance to specify all the relevant contingencies, or do so with sufficient specificity and precision to make the contracts self-executing and free from ambiguity and interpretation.

Take the “must be a causal link between the non-payment and the deterioration in the creditworthiness or financial condition of the reference entity” language. Every one of those words is subject to interpretation, and most of the interpretations will be highly contingent on the specific factual circumstances, which are likely unique to every reference entity and every potential default.

This is not a process that can be automated, on a blockchain, or anywhere else. Such contracts require a governance structure and governance mechanisms that can interpret the contractual terms in light of the factual circumstances. Sometimes those can be provided by private parties, such as ISDA. But as ISDA shows with CDS, and as financial exchanges (e.g., the Chicago Board of Trade) have shown over the years in simpler contracts such as futures, those private governance systems can be fragile, and themselves subject to manipulation, pressure, and rent seeking. (Re exchanges, see my 1994 JLE paper on exchange self-regulation of manipulation, and my 1993 JLS paper on the successes and failures of commodity exchanges.)

Sometimes the courts govern how contracts are interpreted and implemented. But that’s an expensive process, and itself subject to Type I and Type II errors.

Meaning that it can be desirable to create contracts that have payoffs that are contingent on rather complex events–as a way of allocating the risk of such events more efficiently–but such contracts inherently involve higher transactions costs.

This is not to say that this is a justification for banning them, or sharply circumscribing their use. The parties to the contracts internalize many of the transactions costs (though arguably not all, given that there are collective action issues that I discussed 10 years ago). To the extent that they internalize the costs, the higher costs limit utility and constrain adoption.

But the basic point remains. Specifying precisely and interpreting accurately the contingencies in some contingent claims contracts is more expensive than in others. There are many types of contracts that offer potential benefits in terms of improved allocation of risk, but which cannot be automated. Trying to make such contracts smart is actually pretty dumb.

In 2014, I wrote a whitepaper (sponsored by Trafigura) on impending changes to the liquefied natural gas (LNG) market. The subtitle (“racing towards an inflection point”) captured the main thesis: the LNG market was on the verge of a transformation. The piece made several points.

First, the traditional linkage in long term LNG contracts to the price of oil (Brent in particular) was an atavism–a “barbarous relic” (echoing Keynes’ characterization of the gold standard) as I phrased it more provocatively in some talks I gave on the subject. The connection between oil values and gas values had become attenuated, and often broken altogether, due in large part to the virtual disappearance of oil as a fuel for electricity generation, and the rise in natural gas in generation. Oil linked contracts were sending the wrong price signals. Bad price signals lead to inefficient allocations of resources.

Second, the increasing diversity in LNG production and consumption was mitigating the temporal specificities that impeded the development of spot markets. The sector was evolving to the stage in which participants could rely on markets to provide security of demand and supply. Buyers were not locked into a small number of sellers, and vice versa.

Third, a virtuous liquidity cycle would provide a further impetus to development of shorter term trading. Liquidity begets liquidity, and reinforces the willingness of market participants to rely on markets for security of demand and supply, which in turn frees up more volumes for shorter term trading, which enhances liquidity, and so forth.

Fourth, development of more liquid spot markets will make market participants willing to enter into contracts indexed to prices from those markets, in lieu of oil-linkages.

Fifth, the development of spot markets and gas-on-gas pricing will encourage the development of paper hedging markets, and vice versa.

Sixth, the emergence of the US as a supplier would also accelerate these trends. There was already a well-developed and transparent market for natural gas in the US, and a broad and deep hedging market. With US gas able to swing between Asia and Europe and South America depending on supply and demand conditions in these various regions, it was likely to be the marginal source of supply around the world and would hence set price around the world. Moreover, the potential for geographic arbitrages creates short term trading opportunities.

When pressed about timing, I was reluctant to make a firm forecast because it is always hard to predict when positive feedback mechanisms will take off. But my best guess was in the five year range.

Those predictions, including the time horizon, are turning out pretty well. There have been a spate of articles recently about the evolution of LNG as a traded commodity, with trading firms like Vitol, Trafigura, and Gunvor, and majors with a trading emphasis like Shell and Total, taking the lead. Here’s a recent example from the FT, and here’s one from Bloomberg. Industry group GIIGNL reports that spot volumes rose from 27 percent of total volumes in 2017 to 32 percent in 2018.

There are also developments on the contractual front. Last year Trafigura signed a 15 year offtake deal with US exporter Cheniere linked to Henry Hub. In December, Vitol signed a deal with newcomer Tellurian linked to Henry Hub, and last week Tellurian inked heads of agreement with Total for volumes linked to the Platts JKM (Japan-Korea-Marker).* Shell even entered into a deal linked with coal. There was one oil-linked deal signed recently (between NextDecade and Shell), but to give an idea of how things have changed, this met with puzzlement in the industry:

The pricing mechanism that raised eyebrows this week in Shanghai was NextDecade’s Brent-linked deal with Shell. NextDecade CEO Matt Schatzman said he wanted to sell against Brent because his Rio Grande LNG venture will rely on gas that’s a byproduct of oil drilling in the Permian Basin, where output will likely increase along with oil prices.

Total CEO Patrick Pouyanne said he didn’t understand that logic.
“Continuing to price gas linked to oil is somewhat the old world,” Pouyanne said on Wednesday. “I was most surprised to see new contracts linked to Brent, especially from the U.S. Someone will have to explain this to me.”

I agree! In fact, the NextDecade logic is daft. High oil prices that stimulate oil production will lead to lower gas prices due to the linkage that Schatzman outlines. If you have doubts about that, look at the price of natural gas in the Permian right now–it has been negative, often by $6.00/mmbtu or more. This joint-production aspect will tend to make oil and gas prices less correlated, or even negatively correlated.

But it’s hard to believe how much the conventional wisdom has changed in 5 years. The whitepaper was released in time for the LNG Asia Summit in Singapore, and I gave a keynote speech at the event to coincide with its release. The speech was in front of the shark tank at the Singapore Aquarium, and from the reception I got I was worried that I might get the same treatment from the audience as Hans Blix did from Kim Jung Il in Team America.

To say the least, the overwhelming sentiment was that oil links were here to stay, and that any major changes to the industry were decades, rather than a handful of years, away. Fortunately, the sharks went hungry and I’m around to say I told you so 😉

I surmise that the main reason that the conventional wisdom was that the old contracting and pricing mechanisms would be sticky was an insufficient appreciation for the nature of liquidity, and how this could induce tipping to a new market organization and new contract and trading norms. These were ideas that I brought from my work in the industrial organization of financial trading markets (“market macrostructure” as I called it), and they were no doubt alien to most people in the LNG industry. Just as ideas about spot trading of oil were alien to most people in the oil industry when Marc Rich and others introduced it in the 1970s.

Given the self-reinforcing nature of these developments, I believe that the trend will continue, and likely accelerate. Other factors will feed this process. I’ve written in the past about how some traditional contract terms, notably destination clauses, are falling by the wayside due to regulatory pressure in Japan and elsewhere. The number of sources and sinks is increasing, which makes the market thicker and mitigates further temporal specificities. The achievement of scale and greater trading opportunities will encourage investment in infrastructure, notably storage, that facilitates trading. Right now most LNG trading involves only one of the transformations I’ve written about (transformation in space): investment in storage infrastructure will facilitate another (transformation in time).

It’s been kind of cool (no pun intended, given that LNG is supercooled) to watch this happen in real time. It is particularly interesting to me, as an industrial organization economist, given that many issues that I’ve studied over the years (transactions cost economics, the economics of commodity trading, the nature and dynamics of market liquidity) are all present. I’m sure that the next several years will provide more material for what has already proved to be a fascinating case study in the evolution of contracting and markets.

*Full disclosure: My elder daughter works for Tellurian, and formerly worked for Cheniere. I have profited from many conversations with her over the last several years. One of my former PhD students is now at Cheniere.

A coda to yesterday’s post. The EIA announced that in 2018 60 percent of new US electricity generating capacity was fueled by natural gas. This outstripped wind by a factor of almost 3, and solar by a factor of almost 5.

But those ratios understate matters, given that capacity factors for natural gas are about double those for renewables. Thus, in terms of actual real generation, natural gas added about four times as much effective capacity in 2018 as renewables. Not to mention that combined cycle plants are available pretty much on demand, rain or shine, day or night. Unlike the wind and the sun.

This despite the continued subsidization of renewables.

So tell me again how renewables will permit the fossil fuel-free electrification of the economy. I like fairy tales.

Reuters reports that Deutsche Bank and Commerzbank have begun merger talks. The German government has been pushing for such a merger. In part, Berlin is hot for a combination because it wants to create a “national banking champion”:

And as Mr Scholz and Mr Kukies’ clandestine London meetings show, the idea is now gaining traction in Berlin. Policymakers and corporate bosses see a stable national banking champion as the backbone of their export-led industrial policy, vital if the country is to weather the next downturn that many economists warn looms large.

This is hilarious and infuriating on so many levels.

First. Hmmm. “National champion” sounds kinda, uhm, I dunno, nationalist, doesn’t it? And Frau Merkel keeps telling us only bad people are nationalists, and nationalists are bad people.

Again–German hypocrisy knows no bounds.

Second, by what financial alchemy does merging two horribly underperforming banks create anything of championship caliber, unless you mean a national champion clusterf*ck? Both banks are priced at a huge discount to book–for good reason. Both have returns on equity that are at the bottom of league tables. Merging two manure piles will not improve the smell.

Further, Deutsche Bank in particular is already a bloated monstrosity. Successive CEOs have failed to rationalize it. Every merger faces huge integration challenges, which would only complicate the task of rationalizing and downsizing DB.

Moreover, Deutsche Bank is already a huge systemic risk, given its size and dodgy balance sheet. Mashing it together with Commerzbank will only increase its systemic importance, and its complexity, and hence its systemic risk.

And this is yet more hypocrisy: the Germans are always lecturing everyone (especially the Italians and Greeks) about financial imprudence, and the risks that they impose on Germany. Speak for yourself, Fritz. DB is the poster child for financial imprudence. So why not make it bigger? What could possibly go wrong?

Maybe sanity will prevail, and the merger will not go through. But the very fact that it is being thought of, and indeed pushed by the German government, tells you everything you need to know about how hypocritical, and how clueless, the German government is.

My daughter alerted me to this interview of Rhiana Gunn-Wright, “one of the architects of the Green New Deal.” It’s annoying–I swear I would have gone completely mental had she said “right?” one more time–but educational. Not because you will learn anything about the way the world works, but you will learn the way the minds of the Green New Dealers work.

The interview is hosted by ex-Obamaite Jason Bordoff, now of Columbia University’s Center on Global Energy Policy. Given Bordoff’s current gig, he was obviously interested in the GND’s implications for energy. After all, the supposed raison d’etre of the GND is that our current energy system, dependent on fossil fuels as it is, is causing us to hurtle towards catastrophic warming.

But whenever Bordoff asked a question about energy, or climate policy, Gunn-Wright couldn’t even feign interest. Her responses were in the vein of “whatever”, and then she launched into impassioned monologues about what really interested her–a laundry list of progressive dreams from health care to child care to labor policy.

What’s clear from Gunn-Wright’s performance is that “climate change” is merely a Trojan Horse for a hard-core leftist agenda. The plan is to use climate alarmism to stampede voters into electing hard-left politicians who, once ensconced in power, will implement what good (I use that term ironically) socialists have been drooling to implement for decades–since before the original New Deal.

Meaning that if you think the GND as presented by the likes of AOC and Sen. Ed Malarky–excuse me, Markey–would be ruinously expensive–you ain’t seen nothing yet!

Speaking of AOC, thinking of her reminded me of Mark Twain: “First, suppose you are an idiot; now suppose you are a member of Congress. But I repeat myself.” I think even Twain would be gobsmacked by the stupidity of Ocasio-Cortez. It’s beyond disturbing that such a moron promoting such a malign program is taken seriously, and has indeed bamboozled virtually every Democratic presidential candidate into endorsing her program.

But maybe that’s the good news. I think that it is highly likely that as enthusiastically as the coastal elites have embraced GND, it will prove toxic at the ballot box. Trump’s full-throated attacks on socialism certainly indicate that he believes so. And he has an innate sense for these things, as the very fact that he is president demonstrates.

One last thing. If you think I was scathing about the GND, I had nothing on Richard Epstein. He about jumps out of your computer in this podcast from a few weeks back. Worth a listen–especially as an antidote to the leftist bromides of Rhiana Gunn-Wright. Right?

In the folk tale about B’rer Rabbit and the Tar Baby, the trapped trickster bunny is at the mercy of B’rer Fox. The Fox debates ways to dispose of the Rabbit–hanging, drowning, burning–and the Rabbit pleads to do any of those things–just don’t throw him into the briar patch. Falling for the reverse psychology, B’rer Fox hurls B’rer Rabbit into the supposedly dreaded briars, after which B’rer Rabbit says: “Born and bred in the briar patch. Born and bred!”

Yesterday mining behemoth Glencore announced that it would cap coal output at 150 million tons per year, claiming that the cap was an acknowledgement of the threat of global warming. Various activists claimed vindication and victory.

Might I offer a more cynical explanation? Getting thrown into the output limitation briar patch is exactly what B’rer Glasenberg wants. A firm exercises market power by limiting output to raise price: global warming gives Glencore an elite-blessed excuse to limit output, i.e., exercise market power. It will be especially beneficial for Glencore if other coal producers are stampeded into cutting output too.

Indeed, you know how this will play out. The activists will now descend on the other producers, holding up Glencore as a shining progressive example. Some, perhaps most, and maybe even all, will capitulate, further increasing prices.

And Glencore/B’rer Glasenberg will laugh all the way to the bank.

As an aside, this is an interesting illustration of the theory of the second best. In a world without any distortions, an exercise of market power is a bad thing–it reduces welfare. But in a world with other distortions, an exercise of market power can enhance efficiency.

If due to an externality, coal output in a competitive industry is too large, the exercise of market power mitigates the effect of the externality.

I was considering not commenting on the Green New Deal, given the largely negative–and often incredulous and scathing–response that its release evoked. Including from mainstream Democratic politicians, notably Nancy Pelosi. But most of the cast of thousands currently seeking the Democratic presidential nomination have embraced it to some degree or another, and the criticism has spurred a counterattack from many media precincts. The plan will therefore not be consigned immediately to oblivion, so I will weigh in.

In a nutshell (emphasis on the “nut”), the proposal aims at making the US “carbon neutral” in a mere decade by eliminating the internal combustion engine, retrofitting every existing building in the US, largely eliminating air travel and replacing it with high speed rail, and reducing, er, flatulence from cows by sharply reducing our consumption of meat. No biggie, right?

I find it somewhat ironic that hard on the heels of the announcement of the basics of the GND, the hard left governor of California, Gavin Newsome, said it was necessary to “get real” and recognize that the state’s high speed rail project was a disaster, and to eliminate most of the route.

But “getting real” is not on the GND agenda.

If implemented, the GND would effectively destroy a vast amount of the existing US capital stock, or require its replacement with less productive capital. This will make Americans poorer, in terms of consumption of goods and services.

The proponents of the GND commit the fundamental economic fallacy of arguing that this destruction of productive resources will bolster the economy because of all the jobs that will be created to build a fossil-fuel free power system, electric autos, massive rail systems, etc. The reality (sorry, but I can’t help dealing in reality) is that jobs are a cost, as is the decline in consumption required to make massive investments in new capital to replace existing capital.

The point of producing–including through the use of labor which entails the cost of foregone leisure–is to consume. The GND will unambiguously reduce consumption of goods and services, and make us poorer. GND is crypto-Keynesianism at its worst.

Then there is the detail of paying for this. Here advocates of GND invoke MMT–Magical Monetary Theory. Sorry, MMT actually stands for “Modern Monetary Theory” but my description is far more accurate. MMT is free lunch economics writ large, mistakes accounting identities for economic substance, and commits errors that would be embarrassing for someone in their first session of Econ 101 at one of your more backward community colleges.

The Magical Monetary Theorists argue that an endeavor as massive as the GND can be paid for by printing money.

Really. Don’t believe me? Consider this (rather conclusory) tweet by a major MMT advocate, Stephanie Kelton:

Q: Can we afford a #
GreenNewDeal? A: Yes. The federal government can afford to buy whatever is for sale in its own currency.

What follows (as is usually the case with MMT arguments) is a verbal discussion of a game of financial Three Card Monte.

Read that again: ” The federal government can afford to buy whatever is for sale in its own currency.” But at what price, dear? At what price? Venezuela has been operating on this principle, and is on pace to achieve record inflation of more than a million percent per year.

All of which obscures the economic essence. Investment today requires people to reduce consumption of goods and services. They only do so in anticipation of consuming more in the future–the “more” is the interest/return on capital from the investment. In private capital markets, the interest rate/return on capital adjusts so that the additional consumption people demand to fund investment is just paid for by the additional production flowing from the assets invested in.

In GND, as noted above, the massive investment will not result in a greater flow of goods and services in the future that will make people willingly reduce their consumption today. Indeed, future consumption in goods and services will decline. The private rate of return will be negative.

And indeed, GND implicitly acknowledges this. Its entire rationale is to reduce carbon emissions, under the theory that these are a “bad.” That is, the payoff from the massive investment (the sacrifice of private consumption) is a lower level of bad carbon emissions.

But to the extent that the reduction of this particular bad is a good, it is a public good. Everyone benefits from a decline in this putative pollutant, regardless of their contribution in paying for the reduction. Meaning that it cannot be financed voluntarily via private capital market transactions, but must be compelled, and paid for through massive taxation.

Printing money only changes the form and/or the timing of the taxation. Inflation is a tax. Moreover, if you borrow/print to pay for investment today, the investment cost not covered by the inflation tax must be paid for by higher taxes in the future. Like the old oil filter commercial: you can pay me now, or you can pay me later. But you must pay.

This is not hard. But reality is not magical.

Furthermore, given that it will be the most massive government program in history, it will entail all of the rent seeking and waste inherent in such programs.

I should also note that it will entail massive redistribution, most notably from rural, exurban, and suburban areas to urban ones as it will dramatically raise the costs of transportation and mobility which are borne disproportionately by those living outside cities. If a few Euro cents/liter fuel tax in France sparked massive protest in non-metropolitan France, just think of what would be in store in the far more sprawling US in response to taxes orders of magnitude larger than those imposed by Manny Macron.

These costs could be justified if the cost of carbon is sufficiently high, in which case the social rate of return could be substantially higher than the private rate of return, and the cost of capital. But even if one believes the most alarmist estimates of the cost of carbon, the adoption of GND by the US would have a modest–and arguably trivial–impact on emissions and temperatures, given the level and growth of emissions elsewhere, especially in China and India. Thus, the social rate of return is almost certainly far below the cost of capital.

The advocates of GND argue that the US needs a grandiose mission. The analogies that they draw are to NASA’s moon landings, or–get this–World War II and the defeat of the Nazis.

But neither Apollo nor even WWII envisioned the radical transformation of society–which is an explicit goal of GND. Apollo was a focused, and by comparison with GND, a relatively moderate expenditure financed in the ordinary course of government business and intended primarily as a campaign in the Cold War, undertaken at a time when the Johnson administration waged another Cold War campaign–Vietnam–with the specific objective of minimizing disruption to US society and the economy. World War II definitely altered every aspect of American life, but these disruptions were also viewed as temporary sacrifices necessary to win the war, to be reversed at its conclusion. Which happened in the event: the US demobilized rapidly, and most wartime expedients (e.g., rationing, the massive employment of women in manufacturing) were scrapped precipitously at its conclusion. As happened in WWI as well: Harding’s 1920 campaign slogan was “return to normalcy” after the extraordinary measures adopted during the war. But GND proposes to be the new normalcy, deliberately destroying the old normalcy.

The original New Deal as implemented was also not intended to be as transformative as its latter day green version (though the more Bolshi elements of the Roosevelt administration did harbor such ambitions).

What are the politics here? This is being pushed by the urban progressive left, epitomized by Alexandria Ocasio-Cortez, D-Brooklyn. (Sorry, Tatyana!) The ubiquitous AOC is the face and voice of the movement, though frankly I doubt it would get the same attention if her face looked like, say, Debbie Wasserman-Schultz, and I wonder whether her Munchkin voice will eventually grate on even her fellow travelers, not to mention the rest of us.

But the main political effect here is to cause deep fissures in the Democratic party. Mainstream elements are in a state of near panic, which they are attempting to conceal, with little success.

And this will redound to the benefit of Donald Trump. Opposition insanity is the greatest gift an incumbent can receive. And methinks this is a gift that will keep on giving, through November 2020.

Bloomberg reports that New York state’s plan to eliminate its few remaining coal power plants has caused power prices for delivery in 2020, 2021, and 2022 to increase. Eyeballing the chart, the impact of the proposed regulation is on the order of $7/MWh, or about 25 percent of the 2019 price.

Coal represents a dwindling fraction of New York’s generation. The EIA reports 0 electricity from coal in October, 2018. As of 2014, the last full year for which I could find data on the EIA website, coal accounted for 4.6 million MWh, out of a total of 137 MWh of generation.

The efficiency impact of this depends on (a) the estimated social cost of carbon, (b) the kind of generation that will replace the shuttered coal plants, and (c) the non-energy costs that this replacement generation creates.

If you believe that the cost of carbon is $40/ton, if coal is replaced by zero emissions generation, the move is efficiency enhancing. A coal plant with a heat rate of a little more than 10 implies a carbon cost per MWh of $40. This is well above the price increase of around $7.

If coal is replaced by natural gas, with a carbon cost of about $20/MWh, the call is closer, but still comfortably in favor of eliminating coal.

Lower social costs of carbon of course affect the math. The other thing to keep in mind, though, is that the price is for energy only. Changing the generation mix also affects the need for ancillary services to maintain grid stability. In particular, substituting diffuse and intermittent renewables for coal increases the non-energy costs of supplying electricity. These costs can be appreciable, though again it’s difficult to see them being so large as to overcome the approximate $160 million in carbon cost savings from eliminating coal, based on a $40/MWh CO2 cost, ~4 MWh of coal fired generation, and replacement of coal by zero carbon emissions generation sources.

What’s truly startling about the numbers, though, is the redistributive impact. Price is driven by marginal cost, and the price impact suggests that the cost of the marginal megawatt hour from coal replacement generation is about $7/MWh above that of the eliminated coal units. Note: that $7/MWh price increase benefits every single MWh generated by inframarginal units (e.g., combined cycle NG). Coal represents (as noted before) ~3 pct of NY generation, but the remaining 97 percent will see a big increase in margins.

This is a crude calculation, but roughly speaking the regulation will result in a transfer of about $1 billion/year from consumers to owners of generation (~140 million MWh x $7/MWh). The vast bulk of this $1 billion will be a quasi rent for inframarginal generating assets. (About $28 million–4 mm MWh/year x $7/MWh–will cover the cost of the more expensive generation that replaces coal plants.)

As is often the case with regulation, the wealth transfers swamp the efficiency effects (which total at most $130 million=~4 MM MWh x $33/MWh in social cost savings). (Since coal generation has probably dropped from the 4 million in 2014, and the price impact reflects the elimination of the remaining coal generation, the total efficiency effects now are probably substantially smaller than $130 million.)

Thus, although this regulation is sold as one benefitting the environment, I strongly suspect that the political coalition that has given it birth is strongly supported by incumbent generation operators selling into the New York market. That is, it smacks of the typical special interest regulation that benefits a small concentrated group at the expense of a large diffuse one (i.e., the consumers in New York), all dressed up in pretty green (environmental green camouflaging Benjamins green, as it were).

Yes, in this instance perhaps–depending on one’s assumptions about the cost of carbon and the incremental uplift costs created by the regulation–this bargain has produced an efficient outcome. But the redistributive nature of this regulation, and those like it, creates a great risk that such regulations will be introduced even when they are inefficient.

Those harmed include ordinary New Yorkers lighting their homes, and commercial and especially manufacturing firms (and their employees) who pay higher power costs. (Employees will pay in lost employment and lower wages, due to a decline in derived demand for labor driven by higher costs of other inputs.) In France, a seemingly small imposition on a similar group sparked widespread social unrest. It hasn’t happened in the US yet (or in places like Germany, where consumers and employers are paying steeply higher electricity costs due to anti-carbon regulations), but US states should be aware that such policies could trigger resistance here as well–especially if and when the hoi polloi realize that the biggest winner from these policies is not the environment, but companies that are pretty unpopular to begin with.