California’s history is one of human development in the face of a variable and often hostile environment. The popular press rarely has rarely, over the years, seen California in this light – as a struggle against adverse nature. The sunshine state has come back repeatedly from environmental shocks to grow in benign periods.
This time though, with a clear cycle of drought/wildfire/flood, it looks like the state will be required to adapt to, rather than to recover from, environmental disaster. And it is the climate and not just the legislature, which is causing implicit and explicit taxes to rise in California as well as turning population inflows to outflows.
California’s environment is of intense interest to readers and there is no surer way to get headlines than to predict a California disaster. First of all, such a study predicting disaster will have an automatic audience. California has about 40 million interested persons. In addition, California disaster is an active topic in disaster scenarios. In fact, the massive flooding catastrophe I wrote about late last year is often referred to as “the other big one,” The “big one,” of course being the collapse of the San Andreas fault.
Leaving aside the general hysteria associated with a potential mega flood, the recent study from scientists at UCLA poses important public finance and personal investing issues. First, the potential for mega floods in California is well known. In 1862 California experienced over a month of rainfall which created a 300-mile-long lake in the center of the state. The drought/wildfire/flood cycle in the state is well established in its history.
But it does not mean that a state or city cannot recover from great calamity. The mid-19th century was a time of fearsome epidemics in the center of the country as well as floods in California. Chicago, for example, recovered from typhoid epidemics at that time and California regained its footing after its great flood. The public finance efforts to manage hydraulics met the most egregious of California’s water problems.
And public finance works are afoot to prevent a repeat of the 19th century disaster. Perhaps nothing can prevent flooding under UCLA’s worst-case disaster, but a repeat of severe flooding would not be news to the California water authorities.
International examples of storm resilience are also evident, especially in China. Flooding on an immense scale has plagued the country through history. The legacy of centuries of vast floods is enough for the Chinese to explain the torrents without a strong appeal to global warming. The size and frequency of the Chinese experience should mitigate the worst-case expectations from these worst-case predictions for California.
For investors in California or California base enterprises, the prospect of continuing climate strife is an important risk element. Since floods are presumed to be regionally specific, regional diversification is the first and most obvious choice for investors and businesses. Hedging the unknown, whether it is
drought, fire, or flood is a costly process. Insurance may be available but expensive. Reducing California asset allocations may be a better hedging process.
Much of the risk of immediate calamities in California can be managed with insurance or asset allocations. A more subtle effect, reduced California returns, is more difficult. At this point the state’s environment imposes a growing statewide environmental tax. This Climate tax can be direct, as when the state increases taxes to pay for prevention or cleanup. It can also be indirect, as an addition to systemic state risk. In the long term, the expected value of environmental losses will either be made up with higher taxes or a reduction in public welfare.
The increases in climate tax add to already high tax rates in California, including hedging the “big one.” Hedging the next flood is not different in kind from the costs of other long-term risks in the state. The signs of these higher climate taxes added to the already high-income taxes are becoming apparent as hundreds of thousands of residents’ head out of state. Learning about the higher risk of mega floods merely fuels more outmigration. The UCLA study does not indicate a new risk profile, but it does help clarify the cost and that cost looks high indeed for the Sunshine state.
1. California state diversification is an important element of investor portfolio management.
2. The new studies on California environmental risk are worst case and not simple prediction.
3. Public finance efforts are evolving to mitigate environmental risks in the state but should not be expected to meet worst-case standards.
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