Reserve Currency Status
Brainard’s speech didn’t address recent concerns regarding the reserve currency status concerns of the US dollar or China’s current lead in the CBDC race, which could advance its national interests. The reserve currency status is among others determined by the resilience of a country’s payment system, depth and trust in the well-functioning of the capital markets and exchanges, appeal to and innovation acumen of its tech industry and financial market infrastructure, international thought leadership, lead into climate change solutions and the global military might and power base, which reinforces adoption of a currency. (Customers pay for oil in the currency of the nation which offers regime protection at the oil fields. Asians and Europeans move every month out of their home currency in favor of the US Dollar to pay for their imported oil bill). Global adoption can also be ensured if censorship or control concerns, linked to the use of the CBDC, can be substantially mitigated.
Referring to innovation acumen and climate change solutions, could the central bank digital currency project incorporate scientific data observations regarding climate change triggering terrestrial and atmospheric trends? Could TRACE, a consortium tracking greenhouse gas emissions 24/7 by satellite, foster a balance between monetary policy and a thriving planet and be made part of this initiative? Could monetary policy be framed incorporating observations from those data trends, with support from climate scientists? Could digital currency be directed at ZIP code levels, impacted by climate change calamities? From a supervisory perspective, could solvency weightings for banks’ asset exposure be dynamically set as a function of the data observations and the remaining finite carbon budget? Could bank stress testing scenarios under CCAR (Comprehensive Capital Assessment and Review), undertaken to assess the banks’ adequacy of solvency levels, be articulated as an extended continuum of such climate change observations?
Innovative monetary design ingenuity linked to climate change solutions can only solidify the continued appeal in the US dollar as the global reserve currency.
The Current Five-Headed Crisis
The current crisis is five-headed in nature, characterized by a
- public health crisis, a
- financial crisis, a
- social justice crisis, a
- climate change crisis and a
- trust crisis in institutions and international trade.
Could a central bank digital crypto currency address each of the crisis challenges? How could financial inclusion offer a dent into the social injustice paradigm? How could distributed, decentralized and crypto-graphed data sharing enhance trust in institutions? How could the Central Bank consensus protocol be made more energy efficient than the private crypto-currency protocols? How could smart contract design introduce a central bank digital currency-based reward economy?
Instead of offering mere helicopter money, could compensation be offered in exchange for contributions to the regenerative (climate change) and caring economy (childcare and parental care at home)? How could blockchain supported supply chain data trace the global export and import flows in relationship to FX trades and exchange rates? How could market intervention and/or sustainable change to circular economic paradigms be steered on the back of those data?
Need For A New Anchor Currency
The debasing of currencies by the most important central banks ($6 Trillion of QE in the US alone), the arising currency tensions in the emerging markets (e.g. Lebanon, Turkey, South-Africa,….) and the COVID-19 default impact on total debt outstanding of $258 trillion per Q1 2020 will only accelerate the need and call for debt rescheduling and ensuing FX rate mechanism interventions. If gold is no longer an option, could a central bank issued stablecoin, finite in supply, become a store of value or new anchor currency to manage the restructurings and market support activities?
Brainard’s speech makes reference to a new initiative with the Bank of International Settlement’s Innovation Hub. This initiative could provide a useful avenue to design such Central Bank stablecoin.
The collateral base of the stablecoin could consist of a reserve of natural capital assets, consisting of
- 50% of land and forests,
- 35% In renewable energy initiatives, and
- 10% in the top 100 most compliant ESG companies and
- 5% in biotech research.
The collateral base would be managed dynamically, but would also benefit from monetary policy and prudential supervisory decisions aimed at regenerating the natural capital base on earth and replenishing its finite carbon reserve. The supply could be managed, within a range, as a function of the TRACE observations.
On the occasion of Bretton Woods II, the new Central Bank Stablecoin could be introduced and offered, akin to the gold standard, as a fixed rate against all other fiat currencies, including the US dollar.
Milton Friedman once observed, only a crisis – actual or perceived – produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. Then, ideas once dismissed as unrealistic or impossible might just become inevitable.
After the 2007-09 financial crisis, the imbalances and risks pervading the global economy were exacerbated by policy mistakes. So, rather than address the structural problems that the financial collapse and ensuing recession revealed, governments mostly kicked the can down the road, creating major downside risks that made another crisis inevitable. And now that it has arrived, the risks are growing even more acute. Unfortunately, even if the Greater Recession leads to a lacklustre U-shaped recovery this year, an L-shaped “Greater Depression” will follow later in this decade, owing to 10 ominous and risky trends.
The first trend concerns deficits and their corollary risks: debts and defaults. The policy response to the Covid-19 crisis entails a massive increase in fiscal deficits – on the order of 10% of GDP or more – at a time when public debt levels in many countries were already high, if not unsustainable.
Worse, the loss of income for many households and firms means that private-sector debt levels will become unsustainable, too, potentially leading to mass defaults and bankruptcies. Together with soaring levels of public debt, this all but ensures a more anaemic recovery than the one that followed the Great Recession a decade ago.
A second factor is the demographic timebomb in advanced economies. The Covid-19 crisis shows that much more public spending must be allocated to health systems, and that universal healthcare and other relevant public goods are necessities, not luxuries. Yet, because most developed countries have ageing societies, funding such outlays in the future will make the implicit debts from today’s unfunded healthcare and social security systems even larger.
A third issue is the growing risk of deflation. In addition to causing a deep recession, the crisis is also creating a massive slack in goods (unused machines and capacity) and labour markets (mass unemployment), as well as driving a price collapse in commodities such as oil and industrial metals. That makes debt deflation likely, increasing the risk of insolvency.
A fourth (related) factor will be currency debasement. As central banks try to fight deflation and head off the risk of surging interest rates (following from the massive debt build-up), monetary policies will become even more unconventional and far-reaching. In the short run, governments will need to run monetised fiscal deficits to avoid depression and deflation. Yet, over time, the permanent negative supply shocks from accelerated de-globalisation and renewed protectionism will make stagflation all but inevitable.
A fifth issue is the broader digital disruption of the economy. With millions of people losing their jobs or working and earning less, the income and wealth gaps of the 21st-century economy will widen further. To guard against future supply-chain shocks, companies in advanced economies will re-shore production from low-cost regions to higher-cost domestic markets. But rather than helping workers at home, this trend will accelerate the pace of automation, putting downward pressure on wages and further fanning the flames of populism, nationalism, and xenophobia.
This points to the sixth major factor: deglobalisation. The pandemic is accelerating trends toward balkanisation and fragmentation that were already well underway. The US and China will decouple faster, and most countries will respond by adopting still more protectionist policies to shield domestic firms and workers from global disruptions. The post-pandemic world will be marked by tighter restrictions on the movement of goods, services, capital, labour, technology, data, and information. This is already happening in the pharmaceutical, medical-equipment, and food sectors, where governments are imposing export restrictions and other protectionist measures in response to the crisis.
The backlash against democracy will reinforce this trend. Populist leaders often benefit from economic weakness, mass unemployment, and rising inequality. Under conditions of heightened economic insecurity, there will be a strong impulse to scapegoat foreigners for the crisis. Blue-collar workers and broad cohorts of the middle class will become more susceptible to populist rhetoric, particularly proposals to restrict migration and trade.
This points to an eighth factor: the geostrategic standoff between the US and China. With the Trump administration making every effort to blame China for the pandemic, Chinese President Xi Jinping’s regime will double down on its claim that the US is conspiring to prevent China’s peaceful rise. The Sino-American decoupling in trade, technology, investment, data, and monetary arrangements will intensify.
Worse, this diplomatic breakup will set the stage for a new cold war between the US and its rivals – not just China, but also Russia, Iran, and North Korea. With a US presidential election approaching, there is every reason to expect an upsurge in clandestine cyber warfare, potentially leading even to conventional military clashes. And because technology is the key weapon in the fight for control of the industries of the future and in combating pandemics, the US private tech sector will become increasingly integrated into the national-security-industrial complex.
A final risk that cannot be ignored is environmental disruption, which, as the Covid-19 crisis has shown, can wreak far more economic havoc than a financial crisis. Recurring epidemics (HIV since the 1980s, Sars in 2003, H1N1 in 2009, Mers in 2011, Ebola in 2014-16) are, like climate change, essentially manmade disasters, born of poor health and sanitary standards, the abuse of natural systems, and the growing interconnectivity of a globalised world. Pandemics and the many morbid symptoms of climate change will become more frequent, severe, and costly in the years ahead.
These 10 risks, already looming large before Covid-19 struck, now threaten to fuel a perfect storm that sweeps the entire global economy into a decade of despair. By the 2030s, technology and more competent political leadership may be able to reduce, resolve, or minimise many of these problems, giving rise to a more inclusive, cooperative, and stable international order. But any happy ending assumes that we find a way to survive the coming Greater Depression.
• Nouriel Roubini is professor of economics at New York University’s Stern School of Business. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.
In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.
At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.
Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.
A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcast) does expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.
Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.
Intelligencer recently spoke with Roubini about our impending doom.
You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?
Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.
Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.
Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?
Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months.
So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. You think they are going to spend?
You’re going to start having food riots soon enough. Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves, because they’re worried people are going to steal the Chanel bags. The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.
Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?
First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.
Since then, Trump got elected. Now, we have a full-scale
- trade war,
- technology war,
- financial war,
- monetary war,
- pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.
And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.
Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?
When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.
I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers.Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment.
But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).
But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7.
The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.
There’s a conflict between workers and capital. For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.
Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win.
Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression?
The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. Otherwise, the trends of the market are going to imply more income and wealth inequality. There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.
In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government.
In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?
First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.
What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.
Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster.
In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?
For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.
In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.
You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?
I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now.
So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.
The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.
And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans.
- First, we had HIV. Then we had
- SARS. Then
- MERS, then
- swine flu, then
- Zika, then
- Ebola, now
- this one.
And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming.
Climate change is the major environmental challenge facing nations today, and it is increasingly viewed as one of the central issues in international relations. Yet governments have used a flawed architecture in their attempts to forge treaties to counter it. The key agreements, the 1997 Kyoto Protocol and the 2015 Paris climate accord, have relied on voluntary arrangements, which induce free-riding that undermines any agreement.
States need to reconceptualize climate agreements and replace the current flawed model with an alternative that has a different incentive structure—what I would call the “Climate Club.” Nations can overcome the syndrome of free-riding in international climate agreements if they adopt the club model and include penalties for nations that do not participate. Otherwise, the global effort to curb climate change is sure to fail.
In December 2019, the 25th Conference of the Parties (COP25) of the UN Framework Convention on Climate Change (UNFCCC) met in Madrid, Spain. As most independent observers concluded, there was a total disconnect between the need for sharp emission reductions and the outcomes of the deliberations. COP25 followed COP24, which followed COP23, which followed COP22, all the way back to COP1—a series of multilateral negotiations that produced the failed Kyoto Protocol and the wobbly Paris accord. At the end of this long string of conferences, the world in 2020 is no further along than it was after COP1, in 1995: there is no binding international agreement on climate change.
When an athletic team loses 25 games in a row, it is time for a new coach. After a long string of failed climate meetings, similarly, the old design for climate agreements should be scrapped in favor of a new one that can fix its mistakes.
THE PRISONER’S DILEMMA OF CLIMATE CHANGE
Concepts from game theory elucidate different kinds of international conflicts and the potential for international agreements. A first and easy class of agreements are those that are universally beneficial and have strong incentives for parties to participate. Examples include coordination agreements, such as the 1912 accord to coordinate the world measurements of time and, more recently, the agreement to use “aviation English” for civil aviation, which coordinates communications to prevent collisions during air travel. A second class of agreements, of medium difficulty, rely on reciprocity, a central example being treaties on international trade.
A third class of international agreements confront hard problems—those involving global public goods. These are goods whose impacts are indivisibly spread around the entire globe. Public goods do not represent a new phenomenon. But they are becoming more critical in today’s world because of rapid technological change and the astounding decline in transportation and communication costs. The quick spread of COVID-19 is a grim reminder of how global forces respect no boundaries and of the perils of ignoring global problems until they threaten to overwhelm countries that refuse to prepare and cooperate.
Agreements on global public goods are hard because individual countries have an incentive to defect, producing noncooperative, beggar-thy-neighbor outcomes. In doing so, they are pursuing their national interests rather than cooperating on plans that are globally beneficial—and beneficial to the individual countries that participate. Many of the thorniest global issues—interstate armed conflict, nuclear proliferation, the law of the sea, and, increasingly, cyberwarfare—have the structure of a prisoner’s dilemma. The prisoner’s dilemma occurs in a strategic situation in which the actors have incentives to make themselves better off at the expense of other parties. The result is that all parties are worse off. (The studies of Columbia’s Scott Barrett on international environmental agreements lay out the theory and history in an exemplary way.)
International climate treaties, which attempt to address hard problems, fall into the third class, and they have largely failed to meet their objectives. There are many reasons for this failure. Since they are directed at a hard problem, international climate agreements start with an incentive structure that has proved intrinsically difficult to make work. They have also been undermined by myopic or venal leaders who have no interest in long-term global issues and refuse to take the problem seriously. Further obstacles are the scale, difficulty, and cost of slowing climate change.
But in addition to facing the intrinsic difficulty of solving the hard problem of climate change, international climate agreements have been based on a flawed model of how they should be structured. The central flaw has been to overlook the incentive structure. Because countries do not realistically appreciate that the challenge of global warming presents a prisoner’s dilemma, they have negotiated agreements that are voluntary and promote free-riding—and are thus sure to fail.
MORE KNOWLEDGE, NO PROGRESS
The risks of climate change were recognized in the UNFCCC, which was ratiﬁed in 1994. The UNFCCC declared that the “ultimate objective” of climate policy is “to achieve . . . stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.”
The ﬁrst step in implementing the UNFCCC was taken in the Kyoto Protocol in 1997. Kyoto’s most important innovation was an international cap-and-trade system for emissions. Each country’s greenhouse gas emissions were limited under the protocol (the cap). But countries could buy or sell their emission rights to other countries depending on their circumstances (the trade). The idea was that the system would create a market in emissions, which would give countries, companies, and governments strong incentives to reduce their emissions at the lowest possible cost.
The Kyoto Protocol died a quiet death, mourned by few.
The Kyoto Protocol was an ambitious attempt to construct an international architecture to harmonize the policies of different countries. Because it was voluntary, however, the United States and Canada withdrew without consequences, and no new countries signed on. As a result, there was a sharp reduction in its coverage of emissions. It died a quiet death, mourned by few, on December 31, 2012—a club that no country cared to join.
The Kyoto Protocol was followed by the Paris accord of 2015. This agreement was aimed at “holding the increase in the global average temperature to well below 2°C above pre-industrial levels.” The Paris agreement requires all countries to make their best efforts through “nationally determined contributions.” For example, China announced that it would reduce its carbon intensity (that is, its carbon dioxide emissions per unit of GDP), and other countries announced absolute reductions in emissions. The United States, under the Trump administration, declared that it would withdraw from the agreement.
Even before the United States withdrew, it was clear that the national targets in the Paris accord were inconsistent with the two-degree temperature target. The accord has two major structural defects:
- it is uncoordinated, and
- it is voluntary.
It is uncoordinated in the sense that its policies, if undertaken, would not limit climate change to the target of two degrees. And it is voluntary because there are no penalties if countries withdraw or fail to meet their commitments.
Studies of past trends, as well as the likely ineffectiveness of the commitments in the Paris accord, point to a grim reality. Global emissions would need to decline by about three percent annually in the coming years for the world to limit warming to the two-degree target. Actual emissions have grown by about two percent annually over the last two decades. Modeling studies indicate that even if the Paris commitments are met, the global temperature will almost certainly exceed the two-degree target later in the twenty-first century.
The bottom line is that climate policy has not progressed over the last three decades. The dangers of global warming are much better understood, but nations have not adopted effective policies to slow the coming peril.
Why are agreements on global public goods so elusive? After all, nations have succeeded in forging effective policies for national public goods, such as clean air, public health, and water quality. Why have landmark agreements such as the Kyoto Protocol and the Paris accord failed to make a dent in emission trends?
The reason is free-riding, spurred by the tendency for countries to pursue their national interests. Free-riding occurs when a party receives the benefits of a public good without contributing to the costs. In the case of international climate change policy, countries have an incentive to rely on the emission reductions of others without making costly domestic reductions themselves.
Focusing on national welfare is appropriate when impacts do not spill over national borders. In such cases, countries are well governed if they put their citizens’ well-being first rather than promoting narrow interests such as through protectionist tariffs or lax environmental regulations. However, when tackling global problems, nationalist or noncooperative policies that focus solely on the home country at the expense of other countries—beggar-thy-neighbor policies—are counterproductive.
Free-riding lies at the heart of the failure to deal with climate change.
Many global issues induce cooperation by their very nature. Like players on athletic teams, countries can accomplish more when acting together than when going their separate ways. The most prominent examples of positive-sum cooperation are the treaties and alliances that have led to a sharp decline in battle deaths in recent years. Another important case is the emergence of low-tariff regimes in most countries. By reducing barriers to trade, all nations have seen an improvement in their living standards.
However, alongside the successes lie a string of failures on the global stage. Nations have failed to stop nuclear proliferation, overfishing in the oceans, littering in space, and transnational cybercrime. Many of these failures reflect the syndrome of free-riding. When there are international efforts to resolve a global problem, some nations inevitably contribute very little. For example, NATO is committed to defending its members against attacks. The parties to the alliance agreed to share the costs. In practice, however, the burden sharing is not equal: the United States accounted for 70 percent of the total defense spending by NATO members in 2018. Many other NATO members spend only a tiny fraction of their GDPs on defense, Luxembourg being the extreme case, at just 0.5 percent. Countries that do not fully participate in a multiparty agreement on public goods get a free ride on the costly investments of other countries.
Free-riding is a major hurdle to addressing global externalities, and it lies at the heart of the failure to deal with climate change. Consider a voluntary agreement, such as the Kyoto Protocol or the Paris accord. No single country has an incentive to cut its emissions sharply. Suppose that when Country A spends $100 on abatement, global damages decline by $200 but Country A might get only $20 worth of the benefits: its national cost-benefit analysis would lead it not to undertake the abatement. Hence, nations have a strong incentive not to participate in such agreements. If they do participate, there is a further incentive to understate their emissions or to miss ambitious objectives. The outcome is a noncooperative free-riding equilibrium, in which few countries undertake strong climate change policies—a situation that closely resembles the current international policy environment.
When it comes to climate change policies today, nations speak loudly but carry no stick at all.
In light of the failure of past agreements, it is easy to conclude that international cooperation on climate change is doomed to fail. This is the wrong conclusion. Past climate treaties have failed because of poor architecture. The key to an effective climate treaty is to change the architecture, from a voluntary agreement to one with strong incentives to participate.
Successful international agreements function as a kind of club of nations. Although most people belong to clubs, they seldom consider their structure. A club is a voluntary group deriving mutual benefits from sharing the costs of producing a shared good or service. The gains from a successful club are sufficiently large that members will pay dues and adhere to club rules to get the benefits of membership.
The principal conditions for a successful club include that there is a public-good-type resource that can be shared (whether the benefits from a military alliance or the enjoyment of low-cost goods from around the world); that the cooperative arrangement, including the costs or dues, is beneficial for each of the members; that nonmembers can be excluded or penalized at relatively low cost to members; and that the membership is stable in the sense that no one wants to leave.
Successful international agreements function as a kind of club of nations.
Nations can overcome the syndrome of free-riding in international climate agreements if they adopt the club model rather than the Kyoto-Paris model. How could the Climate Club work? There are two key features of the Climate Club that would distinguish it from previous efforts. The first is that participating countries would agree to undertake harmonized emission reductions designed to meet a climate objective (such as a two-degree temperature limit). The second and critical difference is that nations that do not participate or do not meet their obligations would incur penalties.
Start with the rules for membership. Early climate treaties involved quantitative restrictions, such as emission limits. A more fruitful rule, in line with modern environmental thinking, would focus on a carbon price, a price attached to emissions of carbon dioxide and other greenhouse gases. More precisely, countries would agree on an international target carbon price, which would be the focal provision of the agreement. For example, countries might agree that each will implement policies that produce a minimum domestic carbon price of $50 per metric ton of carbon dioxide. That target price might apply to 2020 and rise over time at, say, three percent per year in real terms. (The World Bank estimates that the global average carbon price today is about $2 per ton of carbon dioxide.)
Why would carbon prices be a better coordinating device than the quantity of emissions? One important reason is that an efficient path for limiting warming would involve equating the incremental (marginal) costs of reductions in all countries and all sectors. This would be accomplished by having equal carbon prices everywhere. A second and equally powerful reason involves bargaining strategy, a point emphasized in the writings of the economist Martin Weitzman. When countries bargain about the target price, this simplifies the negotiations, making them about a single number: dollars per ton. When the bargaining is about each country’s emission limit, this is a hopeless matter, because countries want low limits for others and high limits for themselves. A bargain about emission limits is likely to end up with no limits at all.
A treaty focusing on an international target carbon price would not mandate a particular national policy. Countries could use carbon taxes (which would easily solve the problem of setting the price) or a cap-and-trade mechanism (such as is used by the European Union). Either can achieve the minimum price, but different countries might find one or the other approach more suited to its institutions.
The second and critical feature of the Climate Club would be a penalty for nonparticipants. This is what gives the club mechanism its structure of incentives and what distinguishes it from all current approaches to countering climate change: nonparticipants are penalized. Some form of sanction on nonparticipants is required to induce countries to participate in and abide by agreements with local costs but diffuse benefits. Without penalties, the agreement will dissolve into ineffectiveness, as have the Kyoto and Paris schemes.
Although many different penalties might be considered, the simplest and most effective would be tariffs on imports from nonparticipants into club member states. With penalty tariffs on nonparticipants, the Climate Club would create a situation in which countries acting in their self-interest would choose to enter the club and undertake ambitious emission reductions because of the structure of the payoffs.
One brand of penalty could be a countervailing duty on the carbon content of imports. However, this approach would be both complicated and ineffective as an incentive to join a club. The main problem is that much carbon dioxide is emitted in the production of nontraded goods, such as electricity. Additionally, calculating accurately the indirect carbon content of imports is exceedingly complicated.
A second and more promising approach would be a uniform tariff on all imports from nonclub countries into the club. Take as an example a penalty tariff of five percent. If nonparticipant Country A exported $100 billion worth of goods into the club countries, it would be penalized with $5 billion of tariffs. The advantage of uniform tariffs over countervailing duties is simply simplicity. The point is not to fine-tune the tariffs to a nonparticipant country’s production structure but to provide powerful incentives for countries to be part of the Climate Club.
SANCTIONING THE NONPARTICIPANTS
There is a small academic literature analyzing the effectiveness of clubs and comparing them to agreements without sanctions. The results suggest that a well-designed climate club requiring strong carbon abatement and imposing trade sanctions on nonparticipants would provide well-aligned incentives for countries to join.
I will illustrate the point using the results of a study I presented in my 2015 Presidential Address to the American Economic Association and summarized in my Nobel Prize lecture. (The former provided a full explanation of the model, the results, the qualifications, and the sensitivity analyses; the latter was a nontechnical discussion of just the key results.) The study divided the world into 15 major regions. Each region has its own abatement costs and damages from climate change. Because of the global nature of climate change, however, the abatement costs are local, whereas virtually all the benefits of a region’s emission reductions spill over to other regions. Even for the largest players (the United States and China), at least 85 percent of the benefits of their emission reductions accrue abroad.
Voluntary international climate agreements will accomplish little.
The modeling of the study tested alternative uniform tariff rates, from zero to ten percent, and different international target carbon prices, from $12.50 per ton to $100 per ton. It then asked if there were stable coalitions of countries that wanted to join and remain in the club. One case is a regime with a carbon price of $25 per ton and a penalty tariff of three percent. With this regime, it is in the national interest of every region to participate, and it is in the interest of no region to defect and free-ride. The coalition of all regions is stable because the losses from the tariff (for nonparticipants) are larger than the costs of abatement (for participants).
The Kyoto Protocol and the Paris accord can be thought of as regimes with zero penalty tariffs. Both history and modeling have shown that these induce minimal abatement. Put differently, the analysis predicts—alas, in a way that history has confirmed—that voluntary international climate agreements will accomplish little; they will definitely not meet the ambitious objectives of the Paris accord.
Such detailed modeling results should not be taken literally. Modeling offers insights rather than single-digit accuracy. The basic lesson is that current approaches are based on a flawed concept of how to manage the global commons. The voluntary approach needs to be replaced by a club structure in which there are penalties for nonparticipation—in effect, environmental taxes on those who are violating the global commons.
TOWARD EFFECTIVE POLICIES
The international community is a long way from adopting a Climate Club or a similar arrangement to slow the ominous march of climate change. The obstacles include ignorance, the distortions of democracy by anti-environmental interests, free-riding among those looking to the interests of their country, and shortsightedness among those who discount the interests of the future. Additionally, nations have continued with the losing strategy (zero wins, 25 losses) pursued by the UNFCCC’s Conference of the Parties structure. Global warming is a trillion-dollar problem requiring a trillion-dollar solution, and that demands a far more robust incentive structure.
There are many steps necessary to slow global warming effectively. One central part of a productive strategy is to ensure that actions are global and not just national or local. The best hope for effective coordination is a Climate Club—a coalition of nations that commit to strong steps to reduce emissions and mechanisms to penalize countries that do not participate. Although this is a radical proposal that breaks with the approach of past climate negotiations, no other blueprint on the public agenda holds the promise of strong and coordinated international action.
Whether you agree with it or not, the sentiment around ESG has dramatically shifted and talk of an impending ‘Carbon Correction’ is going to create havoc in the markets. Company valuations are about to be judged by different metrics which will create huge opportunities for investors. With insights from politicians, financiers,0 environmental consultants and tech experts, this investigative documentary will get you ahead of the curve so you can understand what’s coming.
right morning everyone morning oh yeah
that’s what keys look it’s great
I’m Jamie McDonald and I was a fund
manager in London in New York for 10
years in that time
ESG investing was certainly something we
talked about but it wasn’t something
that really mattered and it didn’t
matter because it couldn’t be valued and
therefore it didn’t really affect Morken
sentiment but now now I’ve got a feeling
that’s gonna change wore off to Davos
the World Economic Forum melting pot of
business politics and finance and we’re
going to get underneath the skin of the
key question this year which is what is
the future of capitalism and how can we
sustain our economic system for future
so I’m here I’ve made it to Davos and
through the tunnels on through the
numerous security checks and I’ve got
one to hear on to the high street now
I’m really getting a sense of the kind
of chaotic atmosphere that’s going on
there’s people in ski suits and business
suits there’s expensive cars as cable
cars it’s sort of mayhem really I know
already I’m gonna have to grab people in
between their meetings as they come out
of interviews very much on the fly
Marcus hey how are you I’m really good
thank you so much for taking our with
I’m going around Davos and I’m speaking
to people about this shift that’s
happening in terms of environment and
investing yes and it’s taught that 2020
might be a tipping point now I really do
value your opinion on this is that
something you agree with you know I
started to feel this was happening in
couple of years ago I think 2019 was the
transition here millions of people start
to understand that the environment was
much more than something given to us you
we have to actually have a return on
this and I think business understanding
this if you’re invest in sustainability
you’re improving the quality of business
sophistication of consumer more more
consumer they want to know where the
things are coming from
I think 2020 is really at the beginning
of maybe the 21st century finally this
is the echo chamber that will push it
and propel us to the future
I’m now heading across town for meeting
with David Craig he’s the CEO of
affinity they are a data company right
at the heart of this issue on ESG
because they’re at the forefront of
helping companies and governments both
monitor the issue and measure it so
really interesting it feels like 2020 is
going to be the year for green investing
but why now why 2020 the reason that
it’s cool is that people are realizing
the price of the harm that we’re doing
to the environment be it carbon
emissions or carbon equivalents or
illegal logging that price isn’t
factored in it’s gonna mean a reprice of
many assets and funds and debt and
liabilities and when you talk in those
terms when central bank’s say they’re
going to ask companies to look at this
you know that actually a substantial
shift is coming so this shift is going
to lead to a reshaping of the world of
yes finance is going to be reshaped I
think there’s no doubt in our mind that
this is going to happen and people have
talked about this for many years but now
I think everything’s coming together to
say the shift is coming the question
people are asking is not if it’s coming
it’s how quickly is this a cliff event
or is a a gradual shift over several
years David what is going to be the role
of data within all of this and how can
we use that data well the data is
incredibly important because if you want
to understand the the environmental
footprint the emissions for example or
the water usage of the investments in
making you need data you need to
understand and what those are and you
need to compare between companies to
make those investment decisions even
quoted as saying that financial markets
need to prepare themselves for this
impending carbon correction what do you
mean by the companies and funds and
banks are going to revalue instruments
based on the true forward-looking likely
price of carbon and that they would move
that estimate so that they had
incorporate an overall revaluation of
those assets and the overall impact
could be significant a but of course it
won’t be uniform it would be different
from high carbon intense
and carbon equivalent emissions
industries too low so that was daily
prayed from repetitive and what I took
away from that was the debate previously
may have been is climate change
happening or not but that’s not the
debate anymore because companies and
governments are making that shift debate
now from vestiges this shift is
happening how am I going to be able to
profit from that and clearly at the
center of this is data because it’s data
that makes people accountable and I
think it’s data that’s gonna be the
catalyst for the shift
one thing I’ve noticed is that the shops
and stores are then if you can see
they’ve been taken over by some of the
larger corporates around the world and
they’ve turned them into their
headquarters for the next few days why
it presumably they talk about their
agenda for the next twelve months now
Shannon I know you’ve just come out of a
private web session here at Davos as
much as you can can you tell us who is
what you talked about and what your
conclusions were this session which was
banking on sustainability so it’s the
financial services industry banks
there were CEOs of some pretty important
banks in the room nope I cannot but
we’re all passionate about the subject
of obviously the topic which is the
climate crisis and the financial
services role in the climate crisis and
it was fascinating because I think that
there were two really key threads or or
themes of this which was to
differentiate between climate risk and
climate transition climate risk is
evaluating how much risk you are exposed
to with the carbon that you have in your
portfolios and are you financing the
climate risk and what was interesting is
the voices around this for and we’re all
in favor of a carbon tax and really
really you know to the point of we’re
ready for it and we would like this tax
to be proportional to the damage it’s
doing to the climate now what about
those companies that are using carbon
now I mean they can’t just switch
overnight there’s got to be some sort of
transition phase did they talk about
that yeah absolutely so that was the
second part of the topic which was the
climate transition and there was this
notion of it’s not a binary thing
between what they started calling green
assets and brown assets right so green
obviously being carbon you know limited
or neutral and brown assets being those
dirty ones that are quite carbon heavy
so we can’t just divest from the brown
ones is the the notion but that the
financial services industry and banks in
general really need to invest and
finance the transition so keep investing
in let’s call the brown assets but do so
with conditions in place that makes it
apparent that the funding is going
towards the transition to renewable
energy sources well Shannon thank you so
much you’ve literally give us insight
into what’s going on behind closed doors
so thank you for your time absolutely no
exactly my sink another slap you only
like the name planet’ the name is my
living together on the bow and at the
company so when we arrived this morning
it was certainly a few protesters around
I’m talking like tens of protesters why
are we marching up and down the street
you can tell there’s a sense of protest
but here we are you know six or seven
hours into the day and now we’re talking
hundreds of protesters all singing
chanting behind me
we’re very lucky indeed to have grabbed
here former Prime Minister Helen Clark
who’s literally dashing in between
meetings in interviews so we’ve got this
opportunity to ask her a few questions
which if you don’t mind I’m just going
to dive straight into so when it seems
like this financial shift is happening
in markets and more credit being given
to those companies who are behaving
should we say more responsibly do you
think that’s going to come from
shareholders or do you think it’s going
to come from governments and policy
makers no I think it’s going to come
from the public I think it’s going to
come from the consumer if you’re a
company who’s not taking ESG and the
data around ESG seriously are those
going to be companies who fall behind
I think they’ll suffer financially as
consumers increasingly make their
choices wanting to know what the whole
value chain was how was this made what
were the ethics behind it was that
sustainably produced was the labor
exploited people asking these questions
and they’re asking these questions more
and more as we go to more and more and
the companies that don’t measure up are
going to suffer financially in my
so it’s very clear that this shift in
financial markets is happening and
that’s going to produce winners and
losers so we want to know is who are
going to be the winners and losers and
when are we going to see that divergence
starting to happen at Davos for many
years the whole conversation about ESG
has been sort of present but this year
there’s a real palpable shift from a
rhetoric to an urgent call for action
there is a real top-down push from
responsible governments and then there
is a huge groundswell and a surge of
emphasis particularly from the
Millennials and I think the companies
that win are going to be the companies
that have real strong proof points that
they’re not just focused on a financial
bottom line they’re actually focused on
sustainable performance that is good for
shareholders but it’s good for employees
it’s good for customers and it’s good
for the planet I think the the
corporations that do that convincingly
and with integrity they will attract
more customers they’ll attract a
stronger talent base because Millennials
all want to work for companies that have
a real commitment to sustainability and
those companies through changes that are
taking place sweeping changes that are
taking place in financial services are
going to have much greater access to
capital and much greater access to
financial services they’ll be the
winners and conversely the companies
that fail to make that leap you know
they’ll lose on every one of those
dimensions do you think investors going
forward are going to get much more
they’re going to require a lot more
transparency into the ESG comply ability
of the companies they invested in the
funds that they invest in and will there
be a shift of money away from general
funds more towards these greener funds
yeah absolutely financial services firms
are really looking for the data proof
points of companies and the data proof
points of their funds investors are
seeking them out most corporations today
going on let’s say a roadshow listing to
go public the number one question that
they are asked is what is the ESG score
investors are going to be putting
pressure on corporations to make sure
that they understand the ESG scores of
the companies that are in their supply
chain as well so the knock-on effect of
this is going to be extremely pervasive
companies that have very very very
advanced and proactive practices around
diversity and inclusion are actually the
highest performing financial companies
out of the 7,000 companies in our
database that was really interesting as
there was alluding to its those
companies that are paying attention to
issues around ESG that are outperforming
so ESG is now at the forefront of
investors decisions because it’s
becoming a deciding factor
who knows that win and those that lose
there are some people out there some
cynical people who don’t believe in
climate change what would you say to
those kind of investors we don’t even
necessarily have to have the
conversation about whether you believe
in climate change or not let’s have the
conversation about what are you
concerned about in terms of risks and
opportunities for your portfolio we’re
seeing increasing evidence that weather
patterns waters or h3 Georgia’s energy
shortages material shortages that all
these things are increasingly realities
when you have a consuming growing
population and a finite planet so if you
isn’t a business person or investor care
at all about any of those inputs of
costs or risks to your business then you
need to care about this whole other
suite this whole suite of issues many of
those things happen to be involved in or
affected by sort of the mega issue of
climate change I mean think about it
another way if I said to you would you
like me to invest your money in a way
that ignores a number of factors that
could affect your business whether
that’s weather or water or pollution or
do you want me to take into account
those things that could be risks
opportunity to your business I don’t
know many investors who say please
ignore all those macro megatrend effects
now you’re talking about the change
happening and I want to talk about the
pace of that chat because in 2020
I’m walking around Davos and I feel like
a lot of people are talking more about
this topic do you feel that 2020 is a
real tipping point for the
I think now that it sort of bubbled up
to the level where you’re hearing pretty
much every CEO here at Davao is talking
about how do we do this how do we
integrate this into our sustainability
strategy that it’s really we’re at this
tipping point well I think there’s been
a psychological and sociological shift
to understanding that there’s been more
and more data supporting that you can
actually do both and in fact good
business good asset management run you
know running a company well all involves
thinking about the environment and how
your business affects that when all
these things come together I think we’re
really just gonna see you know a real
sea change so the shifter seems to be
coming from so many different angles
it’s coming and all the stars are
aligning so investors stop thinking
whether climate change is real or not
right a fact is the future for those
companies who are not being here XI
compliant it’s going to be more
difficult exactly I mean look look at
the reality of all these factors that
are coming together and again I don’t
know any investor who will ignore
regulatory issues you know ignore
governmental changes ignore commodities
prices you know ignore new markets that
are emerging and you know other works
that are becoming more risky
this has got a message saying that from
quick about two minutes with Jimmy Wales
so I’m off to try and grab him Jimmy
thank you so much for taking the time so
we’ve got really one fundamental
question want to ask which is is 2020 a
tipping point for the world of ESG I do
think so I think there been a lot of
important developments I think the sense
of urgency around climate change is
stronger than ever I think companies are
now beginning to realize that their
customers are demanding it their
employees are demanding it and that
there’s actually opportunities in it I
think there is a moment here where
caring about some of these issues is no
longer just like a do-gooder thing but
it’s actually profitable and if that’s
true then we’re gonna make some progress
and how do you think this area is going
to affect the valuation of companies
well you know obviously consumers care
about these issues more than ever before
governments care about these issues when
they’re before this means there’s
pressure on companies ultimately I think
companies need to answer to their
shareholders but I think shareholders
are beginning to realize that these
things actually do have an positive
impact on the bottom line doing the
right things consumers as their tastes
change then it’s gonna have a negative
impact on companies that don’t wake up
and actually get ahead of the trend and
have an image with consumers like yeah
you actually care now follow up
questions that is investors have
previously to some extent ignored ESG as
a topic because it hasn’t typically made
you money to be a green investor should
we say but now would you say that
investors have to wake up and pay
attention to ESG because those are the
companies that are going to basically
outshine I mean yeah if you’re an
investor is it’s just like every single
sort of fundamental shift in society if
you’re ahead of that trend and you
recognize that trend there are
opportunities to make money and so being
a green investor that’s simply trying to
sort of do good might not have had
superior returns but if you’re entering
into an era where we’re fundamentally
transforming the infrastructure society
hey you better be ahead of that and
there’s going to be returns to be
I’m getting towards the end of the day
here in Davos and of course been quite a
to be honest I’ve met with politicians
finance ears tech experts data experts
ESG experts obviously and I’ve had so
many conversations that what I want to
do now is just go away and have a real
think about everything I’ve talked about
today and then in the car come up with
some conclusions and finally work out is
2020 the year when we see this real
shift and ESG is at the forefront of
as I look back on my time at Davos
it’s clear to me that whatever your
views on ESG investing and I was
definitely a cynic we’re now at a
tipping point seismic changes are coming
and that’s going to create massive
opportunities for investors the huge
increase in ESG data led by companies
like ref init ‘iv is the catalyst
because it means that after years of
false promises in greenwash companies
are suddenly going to be accountable and
this will surely be reflected in their
valuations David Craig called this the
carbon correction and he says the
adjustments could reach trillions of
dollars this will trigger extraordinary
shifts in prices the trick for investors
is to get on the front foot in terms of
risk management while taking advantage
of the new profit opportunities that
will be created by this shaker
hold onto your hats
The BlackRock CEO auditions to be the next Treasury Secretary.
BlackRock CEO Larry Fink is among the world’s most powerful investment managers, but it seems he longs for more influence. To wit, he has assumed a role as self-styled conscience of the business world in telling CEOs how to run their companies.
“We believe that sustainability should be our new standard for investing,” he wrote to clients in his annual letter this week. He added that “all investors—and particularly the millions of our clients who are saving for long-term goals like retirement—must seriously consider sustainability in their investments.”Mr. Fink gets attention because BlackRock is the world’s largest asset manager, with some $7.43 trillion in client assets. He is now threatening to vote against corporate directors and management if they don’t do what he says, and he is especially exercised about climate change. He is demanding that companies disclose climate risks, and wants to see their plans to operate under scenarios in which warming is limited to fewer than two degrees Celsius this century.
Corporations in which BlackRock invests will also have to comply with the rules from a “Sustainability Accounting Standards Board” on issues such as labor practices and workforce diversity. “Disclosure should be a means to achieving a more sustainable and inclusive capitalism,” Mr. Fink writes.
Like his friends at the Business Roundtable, Mr. Fink is big on “stakeholder” capitalism. “Each company’s prospects for growth are inextricable from its ability to operate sustainably and serve its full set of stakeholders,” he says. If he means serving employees, customers, suppliers and communities, he is merely saying what any successful company already does. But our guess is that by stakeholders Mr. Fink really means regulators and politicians.
The giveaway is that Mr. Fink says BlackRock will divest its actively managed funds from corporations that generate 25% or more of their revenues from coal production. “We don’t yet know which predictions about the climate will be most accurate,” Mr. Fink acknowledges, but “even if only a fraction of the projected impacts is realized, this is a much more structural, long-term crisis.”
He might be right, but then estimates of future temperature increases are based on climate models that have overstated warming to date. Mr. Fink wants to make corporations plan for unknown temperature increases as well as climate regulations that are even less certain.
Coal is an easy target since its share of American power is declining. But the International Energy Agency projects that oil and coal demand will stay flat through 2040 and natural gas consumption will increase 40% even if all countries keep the promises they made in the 2015 nonbinding Paris climate accord. The U.S. is predicted to account for 85% of the increase in global oil production over the next decade thanks to shale drilling.
All of which means that fossil fuels still have a long shelf life, especially in developing countries. There are 170 gigawatts of coal-plant capacity under construction across the world, which is more than what currently exists in Europe. So what happens if Mr. Fink’s political and climate predictions prove wrong? His clients will pay the price.
BlackRock is a fiduciary and as such is legally obligated to act in its clients’ best interest. This is ostensibly why BlackRock has voted against more than 80% of the climate resolutions on proxy ballots by activist shareholders. But suddenly Mr. Fink is prioritizing the interests of liberal politicians and pressure groups.
We can’t help but wonder if Mr. Fink, after a profitable life in business, is auditioning to be Treasury Secretary in, say, the Warren Presidency. His “stakeholder” notions sound similar to her plans to put American corporations further under the government’s thumb.
CEOs who take Mr. Fink seriously might note that his political and moral importuning isn’t satisfying progressives. “BlackRock will continue to be the world’s largest investor in coal, oil and gas,” the Sierra Club said in response to Mr. Fink’s letter.
Businesses will never be able to appease the climate absolutists. The best way they can prepare for climate risks and serve their stakeholders is to succeed as a business and create the wealth and broad prosperity that will make the world better able to adapt to whatever happens. That’s real “sustainablility.”
Climate crises, like financial crises, will be damaging, unpredictable and almost impossible to avoid
Last year Australia’s central bank hoped that several interest-rate cuts would mark a turning point for its slowing economy. That was before the worst bushfires in Australia’s history hit tourism, consumer confidence and growth forecasts for this year. There is now a good chance the bank will cut interest rates again soon.
Welcome to a world in which climate change’s economic impact is no longer distant and imperceptible.
- Puerto Rico never fully recovered from Hurricane Maria in 2017.
- Extreme drought in California and poorly maintained utility power lines led to severe wildfires in 2018, the utility’s bankruptcy and blackouts last year.
Climate change can’t be directly blamed for any single extreme weather event, including Hurricane Maria, California’s wildfires or Australia’s bushfires. But it makes such events more likely. “They are starting to be more than tail events, they’re starting to affect economic outcomes,” Robert Kaplan, president of the Federal Reserve Bank of Dallas, told an economic conference earlier this month.
Climate crises in the next 30 years may resemble financial crises in recent decades:
- potentially quite destructive,
- largely unpredictable and, given the powerful underlying causes,
Climate has muscled to the top of business worries.
Every year, the World Economic Forum asks business, political, academic and nongovernmental leaders to rank the most probable and consequential risks, from cyberattacks to fiscal crises. This year, ahead of its annual meeting next week in Davos, Switzerland, climate-related risks took the five top spots in terms of probability, the first time a single issue had done so in the survey’s 14-year history.The New NormalAs global temperatures rise, extreme temperatures and environmental disasters become more common.Summer temperatures for local regions in the northern hemisphereSTANDARD DEVIATION FROM 115-YEAR AVERAGETHOUSANDS OF OCCURRENCES1961-19802011-2015-4-3-2-10123450102030405060World-wide extreme weather eventsSources: McKinsey Global Institute (temperature distribution), JPMorgan (extreme weather events).events1980’85’90’952000’05’10’150100200300400500600700800900
Of course, economies have always been vulnerable to natural disasters. Before the modern industrial era, crop failures were a leading cause of recession. The monsoon season remains a key economic variable in India, and the Tohoku earthquake and tsunami in 2011 tipped Japan into recession.
And while estimates of climate’s economic impact are suffused with uncertainty, they don’t suggest any major economy will be pushed into recession, much less depression.
Studies reviewed by David Mackie of JPMorgan Chase suggest climate change could reduce global gross domestic product by 1% to 7% by 2100, assuming “business as usual” (i.e., absent policies to mitigate emissions of carbon dioxide). Given that the impact is spread out over 80 years, in which per capita incomes probably rise 300% to 400%, even larger climate change impacts would appear small, he said.
Aggregate changes in GDP, though, can be misleading. As global temperatures climb, the probability of extreme temperatures and events and the associated economic consequences should rise more.
This relationship is driven home in a study released Thursday by the McKinsey Global Institute. It estimated that “unusually hot summers” affected 15% of the Northern Hemisphere’s land surface in 2015, up from 0.2% before 1980.
McKinsey estimated that climate change made the European heat wave that in 2019 killed 1,500 in France 10 times more likely and the forest fires that devastated northern Alberta in 2016 up to six times more likely.
Looking ahead, assuming business as usual, McKinsey projected the probability of a 10% drop in wheat, corn, soybean and rice yields in any given year will rise from 6% now to 18% in 2050. Such a change wouldn’t cause food shortages but could cause prices to spike. The probability that a catastrophic cyclone disrupts semiconductor manufacturing in the western Pacific will double or quadruple by 2040. Such an event “could potentially lead to months of lost production for the directly affected companies,” McKinsey said. The probability of rain heavy enough to halt the mining in southeastern China of rare-earth elements, vital to many electronic devices, will rise from 2.5% now to 6% by 2050.
Such an exercise comes with plenty of caveats. The projections make no allowance for adaptation, though no doubt some outdoor activity will move indoors, some businesses will relocate from flood plains, and insurance will cushion the cost for many.
But adaptation goes only so far. Humans can’t survive prolonged high heat and humidity beyond certain thresholds. Those thresholds are rarely met now, but will be reached regularly in some regions by 2050.
Adaptation and insurance may be deemed too costly. “Underinsurance may grow worse as more extreme events unfold, because fewer people carry insurance for them,” McKinsey predicted.
Some on Wall Street are starting to treat climate change the way they regard financial crises. “Climate change is almost invariably the top issue that clients around the world raise with BlackRock,” Chairman and CEO Laurence Fink told chief executives this week in explaining why climate would be a key criterion in how BlackRock Inc. invests its $7 trillion of client money. For businesses, mandates—private or government-driven—pose a risk distinct from climate change itself. Car companies are now spending heavily to market electric vehicles with no assurance they will be profitable.
Some central bankers are also talking about climate risk the way they talk about financial crises. Christine Lagarde, the newly installed European Central Bank president, told European parliamentarians last fall, “At a minimum…[the ECB’s] macroeconomic models must incorporate the risk of climate change.”
SHARE YOUR THOUGHTS
How do you adjust an economy for climate change? Join the conversation below.
Yet worrying about it isn’t the same as doing something about it. Unlike financial crises, neither Wall Street nor central bankers have the tools to alter the forces making climate crises more likely: rising carbon dioxide emissions and economic development in vulnerable regions. Only political leaders can—and it isn’t clear they will.
The Madrid climate summit in December “is the most recent example of countries failing to cooperate to create a global emissions trading regime,” Mr. Mackie said. “Most likely, business as usual will be the path that policy makers follow in the years ahead…[which] increases the likelihood that the costs of dealing with climate change will go up as action is delayed.”