Could climate change pose an existential threat to the finance sector? We see observable shifts occurring in nature year-on-year, yet we still have only limited knowledge of the full ramifications that climate change could have on the sector that underpins society. Today we’ll be looking at the potential implications of climate change on global finance.
Change is Coming… We Just Don’t Know What it Looks Like
Financial markets have been in flux for millennia. As such, we’ve become quite good at seeing patterns and planning for potential contingencies (except the 2008 financial crisis, of course). This is because we’ve seen, and documented, many similar situations before. But climate change and its potential impact on the world economy is something we have little experience of (the ice age predated the cash economy by about 8,000 years).
The reason for our lack of understanding is that there are simply too many variables in the equation. When considering climate change, one must factor in swathes of volatile data; climate change’s impact (which we can’t accurately map) on labour output, for example, has to be looked at alongside a country’s carbon emission policy (which largely depends on the political party in control at any given time), and don’t forget to add in that market-reactive base interest rate that’s set by a government’s central bank. And that’s barely scratching the surface of the potential ramifications of climate change on finance.
Ignorance Is Not Bliss… What Do We Know?
The import and export of oil still underpins the global economy. So let’s start by looking at the potential effects a transition to cleaner energy might have.
A move away from carbon fuels could destabilise companies large and small around the world, sending shockwaves throughout the global economy. Those businesses that rely on fossil fuels to operate will likely incur significant costs either in increased taxes (a sin tax of sorts) or via infrastructure conversion to a carbon-free alternative energy source. These costs could result in a reduction in profits and a significant number of defaults on loans; it could bankrupt companies, making any stocks held worthless. So how do central banks and governments prepare for such risks? The answer seems to be – negate them before they become irreversible problems. Levies, grants, loans and subsidies to encourage early adoption of zero-carbon energy would offer a sustainable avenue to companies that cannot afford the short-term losses of such a large-scale conversion. Instead of waiting for the seemingly inevitable impacts of climate change on the financial sector, Bank Underground said: “[C]entral banks and regulators [in high-income countries]… could consider supporting a smooth transition of the financial system in a more active way so as to enhance the resilience of the financial system.”
Unfortunately, even if we could satiate the energy demands with alternative sources, the economies of the oil importers (and eventually exporters) would be severely impacted. Energy hungry countries (developing nations, for example) gear their economies towards purchasing oil, but when prices increase too quickly, recessions often follow. And with demand decreasing, the economies of global exporters would struggle soon after. Simply, oil is intrinsically tied to the global economy – the short-term impacts would be significant.
Ecological Economics: Climate Change, Financial Stability and Monetary Policy
But what happens if governments neglect their responsibility to prevent climate change? Next, we look to peer-reviewed academic journal Ecological Economics for some overarching suggestions of how climate change might impact the world’s financial stability. The paper, titled Climate Change, Financial Stability and Monetary Policy, establishes various potential consequences of climate change on the global economy; as an example, we’ll be assuming that climate change will cause a reduction of consumption and investment, alongside a slowing growth of the labour market; it will be a period in which savers are rewarded. These reductions in consumption, investment, and labour output would be the consequences of a rise in pessimism from investors – it would be increasingly difficult to pick a climate-change-proof investment. Likewise, an increasingly tumultuous period could “induce households to save more for precautionary reasons.” In short, no spending and no funding.
Somewhat ironically, sudden economic growth would eventually cause a climate-induced crash due to a rapid rise in CO2 emissions. Higher demand for products would encourage an increase in production for short-term profit, with companies potentially moving their production to the various countries around the world that have laxer environmental legislation. The paper hypothesised that a significant rise in atmospheric temperature would eventually cause a decline in output as demand begins to wane. The “destruction of capital” and slow growth “deteriorates liquidity, which in turn increases their rate of default.” What likely follows is a period of economic recession, which will (again, ironically) decrease investment in green technology and renewable energy. Before this slowdown occurs, or to counter this once it begins, banks and, to a greater extent, governments will likely fill the investment gap by providing credit for green investment (or what the study calls “green bonds”); green investment will likely reduce the risks to the global financial market (or reverse the impacts once it begins).
Green Quantitative Easing – A Potential Solution?
Quantitative easing is the creation of new money to be injected into the economy to encourage investment and lending. Often thought of as a short-term solution, green quantitative easing would, in fact, be directly addressing and preventing a long-term issue. The logic is that the government would inject cash into the economy alongside the creation of a government-owned “green investment bank”. The government would use this newly created money to purchase bonds from the green investment bank that would be used for clean energy investment, the creation of energy-efficient houses, alongside other similar initiatives. The Guardian commented on the topic of green quantitative easing back in 2015, explaining how, unlike traditional quantitative easing, it would not “create new debt” as the government would effectively be backing itself. The money injected into this green investment bank would then be used to invest in green technologies and projects that could potentially yield profits for the government-owned green investment bank, while reducing the country’s environmental impact.
We’ve barely scratched the surface of how climate change meets finance. If you’re passionate about learning more, speak with our course advisors today to find out how our business courses can prepare you for a future where green business is on every company’s agenda.