The tough policy choices ahead for confronting the climate crisis
Put starkly, my thesis is this: Covid, war, and high inflation have catalyzed yet another “New World Order.”[1] Movements to limit global warming are thus now at a crossroads. Their strategic thinking about how to combat climate change developed in a low-interest rate environment and an open world economy dominated by one superpower. But the changeover to a belligerently multipolar world economy means that trends in financial markets and energy production that previously worked in their favor now run against them. Efforts to contain climate change thus confront stark choices regarding policies toward financial regulation and government spending.
The discussion proceeds in three stages. The first retraces how recognition of the problem of “stranded assets” – fossil fuel deposits that could never be fully exploited if global warming were to be contained – crystallized sentiment within finance and a cross-section of wealthy elites in favor of “green finance.” The next section considers the challenges posed by war and inflation in a multipolar world economy to this development. The concluding segment briefly examines some major implications of choices central banks and national states must make in the new situation.
From stranded assets to green finance
In 2009, a paper in Nature attempted to calculate how much of the world’s oil, gas, and coal reserves would have to stay in the ground to hold rates of climate change to tolerable levels. The numbers were large. Their shattering implications quickly attracted attention: Companies and countries serenely confident that they were sitting on the energy equivalent of goldmines realized they were likely really holding worthless stranded assets. So did owners of many other assets that derived their values in whole or part from existing sources of energy.[2]
In financial circles, vivid memories of how the Great Financial Crisis of 2008 had blindsided markets and mainstream economists triggered rampant fears of a “Carbon Bubble” that could suddenly burst, leading to another “Minsky Moment” (like 2008) threatening financial stability and wealth portfolios (Carney, 2015). In debates over the next few years, coal and nuclear power were drawn into the discussion, often functioning as scarecrows in one or another line of argument.[3]
Mainstream financial theory had completely failed to anticipate the 2008 disaster. But analysts rushed to turn its tools on the newly perceived hazards – whether, for example, markets systematically underpriced climate risks or, alternatively, perhaps undervalued prospects for renewable energy. Studies reached conflicting conclusions. The discord fueled arguments over possible changes in financial regulation and the tasks of central banks.[4]
The fact that international agreements on measures against climate change were actively under negotiation made resolving these arguments more urgent. Quantitative studies of the literature on stranded assets, for example, show a six-fold increase in scholarly publications between 2010 and 2020, with the sharpest rise coinciding with the 2015 Paris Accord that set goals and weak national targets for greenhouse gas emissions by individual countries (Dulong, et al., 2023.
Central bank bond purchasing strategies for buying bonds came under attack for discriminating in favor of carbon-intensive producers. Changes in collateral requirements to favor green financial instruments, mandatory climate stress tests, and scenario planning for firms and esp. banks; even different reserve requirements all found at least a few proponents (Breitenfellner, Pointner, and Schuberth, 2019; De Grauwe, 2019).
Mainstream official thinking readily acknowledged the rudimentary state of information on firm and sectoral climate exposure. In 2015, the Financial Stability Board established the Task Force on Climate Related Disclosures under then Bank of England Chair Mark Carney and Michael Bloomberg to recommend changes in accounting and other practices of firms that they and investors could use as yardsticks for assessing climate risk.
But most economists and regulators clung to hopes that they could somehow stuff the climate change genie back into the bottle of orthodox price theory (Stiglitz, 2019). Central bankers and other financial regulators almost everywhere remained faithful to the traditional separation between fiscal and monetary policy. They recoiled from direct intervention in markets on behalf of specific types of investments.
Statements of fundamental problems were commonly opaque and incomplete, aside from acknowledgments of the need for international agreements.
In the fog of speeches that emphasized the gravity of the problem but treated minor regulatory wrinkles as steps of almost Napoleonic boldness, a key point typically failed to emerge clearly: Effective action against climate change had an ineluctable political dimension. States, for example, absolutely had to make sure that investments in renewable energy could access power grids.
Hands-off attitudes that leave decisions about technologies and systems to “markets” were really implicit bets on prevailing constellations of social, economic, and political forces. Those were radically unstable: The high stakes meant that political money and lobbying would flood policy circles, drowning out calculations about the real social costs and benefits of policy courses.
Which is exactly what happened.
Fossil fuel producers and governments with major reserves mounted sweeping campaigns against reforms. In the US, oil, gas, and coal interests, along with petrochemicals and other heavy polluters, invested enormous amounts of money in US elections, mostly on behalf of Republican candidates. (Ferguson, Jorgensen, and Chen, 2013; 2018; 2021, 2022). Regions with heavy concentrations of fossil fuels also voted more heavily in favor of candidates like Donald Trump, who championed fossil fuels (Ferguson, Page, et al., 2020). As the European Union deliberated about climate targets, Russia attempted to intimidate it (Verleger, 2022).
But support for vigorous (voluntary) action remained strong within big business, esp. in finance and high tech, which were both investing heavily in projects for renewable energy and electric cars. Bloomberg and other major investors from these sectors launched sweeping campaigns against coal and Donald Trump. Insurers continued their highly motivated efforts to understand environmental hazards, though European insurers discussed those more freely than firms based in the US.
Though critics frustrated by the excruciatingly slow pace of progress on limiting emissions mocked the endless “blah, blah, blah,” for a long time sustainability appeared to be the wave of the future. The emergence of a Progressive faction within the Democratic Party that championed a Green New Deal, Trump’s loss in the 2020 election, President Joe Biden’s promises of major action against climate change, and the European Union’s “Green Deal” all moved haltingly ahead, though Republicans in Congress blocked nominees to the Federal Reserve suspected of sympathy for forceful central bank action on climate change.[5]
In concert with private foundations and the UN, Mark Carney launched the Glasgow Alliance for Net Zero in April 2021. In October, Carney and the Alliance announced that almost 500 major financial firms, representing almost 40% of the world’s financial assets, including many of the world’s largest concerns, pledged to support accounting and reporting reforms and eventually, the reductions of emissions to net zero levels. Michael Bloomberg and Mary Schapiro joined Carney in the group’s leadership team.
The war shock
But as energy prices soared in the wake of the Russian invasion of Ukraine, Democratic Senator Joe Manchin and many congressional Republicans joined domestic fossil fuel producers to mount a sweeping campaign to persuade the Biden administration to change direction. They argued that the need to provide substitute energy sources for allies previously dependent on Russian energy made it vital for the US to remain a major exporter of liquid natural gas (LNG) (Ferguson 2022).
The stakes were high: Preserving the US role as a major exporter of LNG implied building a series of major new export platforms. These are big and expensive. Private companies would not build them unless they were confident that they would be profitable for many years into the future and that their governments would support them (Ferguson, 2022; Greenpeace, 2023; Oil Change International, 2023). The policy also courted serious risks from additional releases of methane gas.
The Biden administration rendered a split decision. Or, more precisely, it decided to ride two horses at once in different directions. It persisted in its campaign to green the US economy, but its Inflation Reduction Act included provisions bolstering fossil fuels and securing the U.S. position as a major exporter of LNG for the indefinite future. The recent debt ceiling accord added other clauses confirming the double-track strategy (Ferguson, Jorgensen and Chen, 2023). The administration also adjusted its policies on federal land leasing and other regulatory issues.[6]
The importance of retaining the US role in LNG exports resonated widely within key business sectors as the war sharpened divisions within the world economy. Even before the Russian invasion, doubts that major financial houses would follow through on their pledges to limit lending to fossil fuels were already widespread. The outbreak of hostilities stiffened resistance by financiers to limits on lending to fossil fuel companies. Increasing numbers of asset managers, banks, and private equity funds first wavered, then formally pulled back from such efforts. Shareholders of major oil companies voted overwhelmingly against motions for sustainable finance. After the G7 decided to support continued LNG exports, major global insurers also bailed on Carney’s effort. Shell dramatically recommitted itself to fossil fuel production in the near term, a move of great interest since big European producers have usually been much less forthright about their policies than American firms.
Compelling evidence that vast numbers of green bonds are really faux “greenwashing” is also proliferating, with little response from regulators outside of Europe (Curtis, et al., 2023).
The backsliding is dangerous because a world of many producers can easily degenerate into a “devil take the hindmost” situation in which legacy fossil fuel asset holders compete with one another to monetize their holdings before further global warming becomes so unbearable countries again find the will to act (Barnett, 2019).
Countervailing pressures to this dark scenario do exist. Insurers and asset managers have incentives to leave groups formally committed to net zero because they escape campaigns mounted by Republican legislators in the US to threaten firms aligned with such movements. But their real behavior may change little.
Insurers, in particular, cannot escape dealing with increasingly extreme weather events. These are not merely coastal occurrences caused by, for example, hurricanes. Many involve locally severe incidents of many types formerly viewed as rare. As a result, insurers are becoming extremely wary. They are simply declining to write policies in areas they consider problematic without necessarily signaling this in formal statements.
Since most commercial and many home mortgages require minimum insurance levels, this development heralds broader shifts in systemic risks. Demands for more government support are likely coming, but risk will also transfer within the financial system itself – as, for example, when lenders end up taking over defaulted properties that they can’t properly insure.
Not surprisingly, organized efforts to establish uniform criteria for evaluating green investments are still proceeding and the European Union, at least, is also adopting tighter regulations for marketing green bonds.
Producers trying to pump large quantities of new oil will also have to contend with the dominant position of Saudi Arabia and a few other producers, who could repeat past efforts to crimp producers challenging their position by dropping prices below levels higher cost producers can sustain.
Inflation and the climate implications of high interest rates
The war’s effects on emissions and country timetables for reducing greenhouse gas emission targets are bad enough. But the recent change in central bank policies to curb inflation is a threat of an altogether different order.[7] After initially underestimating inflation, the Fed, the Bank of England, the European Central Bank, and many other central banks are all raising rates. For the first time in years, we are thus out of the ultra-low interest rate world in which new investments could be financed at very low cost.
This situation hits efforts to contain climate change especially hard: Renewable energy investments tend to require large upfront investments before becoming very cheap to run for long periods. (Grubb, et. al., 2022; Ferguson and Storm, 2023). Their costs are thus very sensitive to higher interest rates by comparison with, say, gas-fired power plants (Ferguson and Storm, 2023).
The insurance problems discussed earlier also become more intractable. Building costs have risen sharply thanks to inflation, which means that policyholders are underinsured. But topping up their policies in areas where insurers are withdrawing from the market (or raising premia sharply) becomes all the more difficult.
Compounding these problems is the simple fact that bringing down contemporary inflation by raising rates is extensively quixotic. Much recent inflation is supply-driven (Ferguson and Storm, 2023, among many sources). Raising rates to cure this makes about as much sense as an old-time central bank’s trying to remedy harvest failures through increases in the price of money. Direct action to increase supply and resilience is what’s needed.
It does not help that in the US and probably several other countries, central bank policies of quantitative easing (very low rates for a sustained period) sent markets for securities and housing rocketing upward. The resulting “wealth effect” on spending as countries emerged from the worst of Covid led to a burst of demand from affluent consumers (Ferguson and Storm, 2023) amid constrained supply.
In our new multipolar international economic system, supply shocks (including those from climate change) are likely to be ubiquitous. If central banks refuse to recognize how the wealth effects they create by quantitative easing fuel excess demand in supply-constrained markets, then they will hold rates up much higher for longer.[8] The effects on both climate investment and ordinary people are likely to be severe over time. The beneficiaries will be legacy fossil fuel providers, who benefit from a wide new moat around their holdings.
The problems rising interest rates create for limiting climate change, however, do not stop with monetary policy. Rising rates also lead to deep dilemmas for fiscal policy that inevitably spill over onto climate policy. Once again, the problem is stark: High rates pile massive pressure on governments to limit and consolidate their debts because the costs of servicing them balloon.
In the contemporary world, however, raising taxes on the affluent is very difficult. President Joe Biden’s original program for relief and combatting climate change, for example, included very modest tax rises on corporations and high incomes. Even though many corporate executives professed support for the President’s goals, not a single major business organization in the US supported his tax program (Ferguson, Jorgensen, and Chen, 2023). Similarly, the French government flatly rejected a tax on the wealthy to help fund the transition to a greener economy.
As a result, efforts to find new financing for government expenditures typically turn disproportionately to schemes involving user fees, privatizations, etc. But these expedients add to pressures on ordinary citizens whose real incomes are now being steadily eroded by inflation. The predictable result: The “yellow vest” phenomenon is going international, often with special force in agricultural areas. Besides France, right-wing populist parties in the Netherlands, Germany, the US, and other countries all appear to be drawing strength from campaigns by supporters of green initiatives who have not attended carefully to the short-run transition costs less affluent citizens face.
One astonishing fact in the US epitomizes the danger: the average price of a new automobile in March of 2023 was just over $48,000. While some encouraging signs suggest that prices of electric cars may start coming down, the implications of this fact for sustaining political support for greening the economy are as obvious as they should have been in France in 2018, when the Macron government brought in its proposal for a fuels tax to finance a green transition. Or in Germany, when the current ruling political coalition attempted to rapidly force citizens to convert to heat pumps.
Foundations, think tanks, and social groups in favor of limiting climate change have expended vast sums researching the details of weather, tree rings, ice sheaths, savannahs, the Arctic, temperature variations, and many other phenomena important to understanding climate change. But if they do not quickly focus on how income distribution, political money, and efforts to remedy climate change interact, I am confident that they will confront ever-increasing levels of opposition. That the move to electric cars is likely to bring with it substantially lower levels of employment adds urgency to such efforts.
A Multipolar World Economy
Fiscal pressures on governments will also grow from the rapidly escalating tensions in what is now clearly a multipolar world economy. These show most dramatically in rising military expenditures, not simply for the war in Ukraine, but from accelerating arms races around the globe. The most recent tabulation from the Stockholm International Peace Research Institute, covering only through 2021, for example, shows spending on the military was already running at a record level of over $2 trillion dollars per year before the war started. Total expenditures must certainly have leaped higher since.
It is obvious that the longer the war in Ukraine rages, the greater are likely to be its ripple effects on the world economic order. Already major shifts in alliances have taken place that are likely to lead to some substantial shuffling in global value chains and financial flows. Tensions between the US, China, and other Pacific countries over Taiwan and other issues are also growing, with similar effects on defense expenditures.
But the subject is too vast and complicated to be treated more than summarily here.
The essential points, I think, boil down to these. Firstly, the United States and its allies are not alone in stretching out their timelines for a sustainable economy. China and other developing countries have been doing the same. China has invested heavily in solar and other renewable technologies, and it was among the earliest countries to make efforts to green its economy.[9] But both at home and through its Belt and Road Initiative China has financed large-scale expansion of coal and other fossil fuel-driven power plants and mines.
China and the US also compete actively for the raw materials that are vital for running green economies, as smaller countries, including the Europeans, try to sort out their strategies, too.[10]
The shape of things to come looks troubling: Without major new efforts at mutual reductions in armaments, budgets around the world will bulk up on equipment that tends to be heavily reliant on fossil fuels. In the absence of determined efforts to restart international cooperation, alliance patterns will likely be increasingly important as operative factors in production and distribution. Emerging market debt issues will likely remain painful exercises in case-by-case negotiations, while the vast investments in renewable energy the world needs there get snarled in negotiations.
Exacerbating all these problems is the simple fact that central banks, government officials, and citizens have no real experience with multipolar economies. Today’s world perhaps most resembles the interwar economy of the twenties and thirties. But key works on central banking in that period such as (Brown, 1940) are little known outside of very specialized subfields of economic history. It did not help that national archives released files on financial matters generally earlier than they did on energy questions so that past historical analyses of finance in the period leave a great deal out. One fears the ride this time will be a bumpy one; we can hope it does not end as badly.
Note
This essay derives from a presentation to the Canadian Group of 78 in June 2023. That followed the publication of two papers coauthored with Servaas Storm on inflation which are both referenced in the main text. I am grateful for many valuable clarifications and suggestions to James Kurth, Pia Malaney, Ryan Rafaty, and Mario Seccareccia, along with several other analysts who prefer to remain anonymous. It goes without saying that the views expressed here are my own and not that of any institution with which I am affiliated.
Endnotes
[2] Many studies observe that stranding fossil fuels inexorably implies many more downstream losses: power plants dependent on them; transportation sectors, agriculture, etc. See Daumas, 2023 for a careful review; also Semieniuk, G., et al. 2022. A few sectors also might become more valuable. But this level of detail is unnecessary here.
[3] See the instructive review and discussion in Jaffee, 2020.
[4] See, inter alia, Daumas, 2023; Breitenfellner, et al., 2019.
[5] One point perhaps merits a comment on the political economy of the Green New Deal. Progressive Democrats repeatedly questioned why the Biden administration took at best only very perfunctory action to limit stock buybacks or dividends by firms on the receiving end of subsidies for semiconductors, renewables, etc. See, e.g., the comments of Senator Sanders in 2022. There is no economic logic to this, as William Lazonick and colleagues have repeatedly observed. But an investment approach to political coalitions points to the obvious: the first beneficiaries of green financial subsidies are the firms and their investors that receive them.
[6] The “two horses” approach of the administration is again obvious; compare discussions by environmental advocates and the industry. For a clear-eyed recognition of the new situation by a giant bank that historically has lent heavily to fossil fuels, see, e.g., (Bryan, 2022).
[7] A reader of this essay in draft cautioned that weighing the extra risk from higher rates against, say, regulatory blocks to renewables accessing transmission lines would be hard to quantify. The point is very reasonable.
[8] Note that the recent AI boom in the US is once again driving up the wealth of shareholders, who are, of course, mostly affluent already.
[9] One analyst who heard a version of this paper commented that the People’s Bank of China’s interest in greening the economy antedated discussions of stranded assets. That is true; I think concern with reducing the country’s dependence on imported oil was one reason. On a first visit to China long ago, I recall a former official previously involved in climate change discussions who asked me why the United States was so exercised about the possibility that China might acquire oil storage tanks in the Strait of Malacca. I think that the efforts to find cooperative solutions to such problems have not been explored enough.
On China’s engagement with coal, see, e.g., (Clark, Jindal, Shrimali, Springer, and Rafaty, 2024); forthcoming from BU Global Development Policy Center.
[10] A substantial literature on this exists in various subfields; but see, e.g., the recent study from the (Aspen Institute, 2023).
