Eccles Building in Washington, where
the Federal Reserve is headquartered. The US central bank has admitted that
climate change poses a financial risk. Image: futureatlas.com, CC BY 2.0
Eco-Bussiness
By Morten Strange
Monday 27 February 2017
The unfettered growth of our
economies has come at the environment’s expense for far too long. But now that
the US central bank has recognised climate change as an economic risk, it’s
time to change course, writes financial analyst Morten Strange.
We live in amazing times. On Valentine’s Day this
year, chairperson for the Federal Reserve (the US central bank) Janet Yellen
admitted that climate change plays a role in the economy and has implications
for monetary policy.
Testifying before the US Senate Banking Committee,
Yellen was initially evasive on whether climate change was a risk factor for
the economy but eventually said: “The various international fora (sic)…are
looking into the economic aspects of climate change. For example, that (climate
change) could affect financial stability and the exposures of financial
organisations; and I think that is appropriate.
“We recognise that risk events with severe weather and
climate changes could have effects on the financial system.”
This is the first time in 50 years of following international
economic and social affairs that I have heard a major financial decision-maker
even consider the environment!
We know that the environment has for decades provided
limits to how much the aggregate economy can grow. We know that our way of
calculating GDP is flawed. We count the depletion of natural capital as income,
and we see the “uneconomic” growth of crime, accidents, wars, population growth
and pollution as GDP increases, when in fact there is no improvement in social
welfare from this type of expansion.
The recent financial crisis of 2008-2009 was the earth
crying out that it has had enough, but we didn’t listen. With easy monetary
policies we allowed consumers to consume and companies to expand beyond what
market forces and prudent financial policies would allow. We have too much
steel in China; too much oil in the US.
Much of this extractive production ends up in storage
facilities or is dumped on the market at low prices; eventually it ends up
dumped all together in landfills and as atmospheric pollution.
This mechanism works because of quantitative easing
and the Federal Reserve’s large-scale asset purchases, which has pushed up the
price of junk-bonds from mining and fracking companies to inflated levels. The
financial expansion and the environmental damage, including climate change
consequences, go hand in hand. We are basically wrecking the earth on borrowed
funds and borrowed time.
Now that an environmental issue - climate change - has
grabbed the attention of the mainstream economic academic community for the
first time ever , this acceptance has to be translated into policy.
To reduce environmental damage and associated climate
change, we need a monetary policy that supports prudent financial management.
We need to get back to the old concept from pre-1980s economics where capital
was deferred spending, not an ever-expanding supply of cheap electronic money.
We all have a role to play in reducing the risk of
environmental collapse. Individuals can control their spending and use their
powers as political consumers; companies can respond to those new consumer
habits and allocate investments accordingly.
Since they now officially accept the risk, central
banks - like the one Janet Yellen is in charge of - can raise interest rates
quickly to cool down the extractive and capital-heavy parts of the economy,
reduce the broader money supply and ensure that banks and other financial
institutions are well-financed to meet increased risk from inevitable insurance
losses as well as so-called ‘stranded assets’, i.e. carbon-intensive projects
that are being made redundant by disruptions from the new carbon-light future
economy.
Three immediate sets of policies from the Fed would
facilitate this and be welcome from a climate change point of view:
1. Revert back to the so-called Taylor Rule for
setting interest rates. Very simply, this would target interest rates to be
inflation rate plus 2 per cent.
2. Reduce the Fed’s balance sheet by not re-investing
its holding of treasuries and mortgage-backed securities at maturity. This
would contract the money supply and reduce the price of other bonds, including
corporate bonds from polluting industries.
3. Raise the reserve - as well as the
capital-requirements substantially for commercial banks to avoid excessive
risk-taking and discourage the debt culture that is harming the environment.
Ideally banks should only lend out money they have, and not use financial
gearing at all.
Morten Strange is a former petroleum
engineer and a former naturalist. He is currently an independent financial
analyst based in Singapore.
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