Could climate change drive a resurgence in inflation?

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The battle against climate change is far from over. Indeed, it is only at the point of preliminary skirmishes. It remains hard to predict when the fully-fledged, merciless war will begin. The well-being of future generations may be at stake and even, some say, the survival of the human race. History shows that all-out wars trigger a notable resurgence in inflation. This is what occurred during the two world wars: in France, inflation exceeded 250% between 1915 and 1920 and 1400% between 1940 and 1949; in the US, inflation surpassed 80% between 1916 and 1920 and 40% between 1943 and 1941. The battle against climate change could lead to a  similar increase!

In times of war, central banks have shown a singular and surprising ability to create money to allow governments to fund military spending (among other things). Tax increases to fund vastly higher war spending would cause the people to revolt. Monetisation through the central bank is a far more subtle (and hypocritical) way for the state to fund its expansion. Citizens are not directly exposed to it: the resulting inflation creeps surreptitiously into the economic landscape after the event, without the link between cause and effect being clear to the layman.

Can the US (the largest emitter of greenhouse gases) continue to live at the current, fossil-fuel-driven pace?

With its vehicle culture, easy airplane travel, humming air conditioners, copious meat-based food culture, sprawling suburbs and oversized houses can the US continue at this pace? These are just a few features of the high-energy American lifestyle!

According to the Intergovernmental Panel on Climate Change (IPCC) climatologists, to prevent average temperatures from rising by more than two degrees compared to the pre-industrial era, the fight against climate change must be comprehensive. It’s time to act, given that IPCC climatologists say that at today’s pace, the two-degree increase will not be seen in 100 years, as some would like us to believe, but rather in 25 years – that is not all that long from now. Comprehensive action means that many dimensions of modern human society will have to be rethought. Exceptions cannot be permitted, or every pressure group and clique would have to be granted the exemptions they are asking for. Lifestyles will have to be revised.

Government budgets are required to radically shift priorities, including large-scale investment.

As a corollary, deficits and public debt will subsequently surge, just as the two world wars forced governments to drastically change their ways of operating and commit huge financial resources. There is no point in expecting citizen/consumers to happily agree to reduce consumption and to have taxes raised so that such investment can be made. So, political decision-makers face the terrible trio of spending/public deficits, debt, inflation as the unavoidable way to conduct this unprecedented fight.

Investment will likely be mainly in the form of subsidies accompanying coercive measures to reduce greenhouse gas emissions, including banning the heaviest-polluting cars, forcing homeowners to insulate their homes, discouraging car traffic, restricting air traffic, ordering the manufacture of resilient and durable products, equipping homes with micro-windmills, restructuring public spaces, imposing a CO2 tax, and more generally, discounting future costs in today’s prices.

Investment will likely also have to include public or private credits for scientific advances in fields such as enhancing the energy yield of engines, generators, batteries, photovoltaic cells and electrical connectors, capturing and storing CO2, storing energy, environmental buildings, recycling metals in public dumps and harnessing energy from marine currents.

During the Second World War, large-scale Keynesian investment was the source of extraordinary innovation and growth, surpassing the New Deal measures taken to end the Great Depression. Equally, it can be reasonably assumed that investment during the climate change fight will help to pull the economy out of the current bout of sluggishness.

When will this fight take shape?

Certainly once extreme climate events have been recognised as a tangible and real threat. This is not yet the case. Certainly once parties with an interest in yesterday’s development model, including the burning of fossil fuels, are displaced by parties that see this model as a threat to their own interests. Certainly once today’s economic renters, who currently fear a resurgence in inflation, have less political clout than economic agents who can profit from the growth of the environmental industries of tomorrow. Certainly – and this was the recent warning from the governor of the Bank of England – once the interests represented by the financial establishments are jeopardised by the worsening of climate change. [divider] [/divider]

All these trends are being watched closely by the managers of BNP Paribas Investment Partners’ environmental funds.

Alexandre Jeanblanc

Investment Specialist, SRI

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