How Climate Change Could Trigger the Next Global Financial Crisis

Aug 1, 2019 by

Federal Reserve Chairman Jerome Powell testifies on Capitol Hill on July 11, 2019.
Jerome Powell, the chairman of the Federal Reserve, has promised to finish his term even if President Donald Trump demands his resignation.LEAH MILLIS / REUTERS

A few years ago, Mark Carney, a former Goldman Sachs director who now leads the Bank of England, sounded a warning. Global warming, he said, could send the world economy spiraling into another 2008-like crisis. He called for central banks to act aggressively and immediately to reduce the risk of climate-related catastrophe, taking the warming planet as seriously as they would a cooling economy.

Adam Tooze, a history professor at Columbia University, knows quite a bit about central banks—and the Great Recession. Last year he published Crashed, an award-winning account of the 2008 collapse and its aftermath. In that book, he argues that the U.S. Federal Reserve was the pivotal American institution in stopping a second Great Depression. Its actions were “historically unprecedented, spectacular in scale,” he writes, and widely understood by experts to be the “decisive innovation of the crisis.”

Now, in an article this month in Foreign Policy, Tooze asserts that the Fed needs to battle climate change in the same way. “If the world is to cope with climate change, policymakers will need to pull every lever at their disposal,” he writes. “Faced with this threat, to indulge in the idea that central banks, as key agencies of the state, can limit themselves to worrying about financial stability … is its own form of denial.”

Jerome Powell, the Fed chairman, would not call himself a climate-change denier. Indeed, he is probably the most powerful person in the American government who affirms climate science. Yet he has taken a subdued approach to mitigating climate change. In April, in a letter to Senator Brian Schatz, Powell wrote that “addressing climate change is a responsibility that Congress has entrusted to other agencies.” The Federal Reserve, he added, is using its tools to “prepare financial institutions for severe weather.” In England, by contrast, Carney has convened 33 central banks to investigate how to “green the financial system.” According to Axios, every powerful central bank is working with him—except for Banco do Brasil and the Fed.

I talked with Tooze last week about whether climate change could really cause another global crash, how to think about climate policy in history, and what the Fed could do to decarbonize the economy. Our conversation has been edited for length and clarity.

Robinson Meyer: In your Foreign Policy piece, you draw an analogy between the financial crisis of 2008 and what’s happening now with climate change. You describe a crisis in a near-term future, one where climate change has taken hold but where much of the economy is still tied up in oil.

I will say: I’m a little skeptical. I’m not sure you could get the kind of sudden financial stop through climate change that you got in 2007 and 2008. What’s the right way to think about that analogy?

Adam Tooze: That skepticism is perfectly warranted. I’d say that in some sense, I’m here writing with my historian’s hat on, and all I’m really observing is that Mark Carney, the governor of the Bank of England, in 2015, in a speech which has subsequently received massive coverage—and he is a man, after all, absolutely ofthe global financial establishment—coined the idea of a climate Minsky moment. [Editor’s noteA Minsky moment is when an asset’s price suddenly collapses after a long period of growth.]

So the point, to me, is not so much the realism of that prospect, of the fact that we could have some kind of subprimelike scenario. For me, the significant thing is that the argument is actually going on inside the establishment, in the network of financial regulators and central-bank thinkers.

Are we likely to see a financial Minksy moment? I think that is a reasonable question mark. We would need [fossil-fuel assets] to be on the balance sheet of actors who were under huge pressure in a fire-sale situation and who couldn’t deal with a sudden revaluation. We would need an entire network of causation to be there, which is what produced the unique crisis of 2007 to 2008.

Meyer: What would cause that kind of sudden revaluation? Would there need to be a policy shock, such as the United States suddenly imposing a climate policy?

Tooze: That would be one way in which this could be sudden. So imagine that we stay on our current path, and we’re headed toward 3 or 4 degrees’ [Celsius] temperature change. And then imagine some of the nonlinearities kick in, which the climate scientists tell us about, and we face a Fukushima-style event.

What happens next? You then get nervous democratic politicians—and not necessarily those who are known for their populism, but just nervous democratic politicians—suddenly deciding that we have to stop doing one or another part of our carbon-based economy. It has to stop, and it has to stop immediately. And then you get big shocks. Then you get sudden revaluations.

That, I think, is the sort of scenario that the Bank of England people are working with. In other words, the success of the delaying tactics of the carbon lobby create a situation in which we’re then faced with the possibility of a sudden regulatory shock, something that really inflicts major losses.

Meyer: You quote this astonishing statistic: “One-third of equity and fixed income assets issued in global financial markets can be classified as belonging to the natural resource and extraction sectors, as well as carbon-intensive power utilities, chemicals, construction, and industrial goods firms.”

Who is in that group? Are those the oil majors such as Exxon, or does that encompass every construction firm?

Tooze: It isn’t just the oil and gas majors, because they wouldn’t get you to 30 percent. Exxon isn’t big enough to get you to that kind of percentage. It’s Exxon, and [the major automakers] Daimler and BMW, and the entire carbon-exposed complex.

In Germany right now, there’s a very serious conversation about whether BMW and Daimler are too big to fail. Americans don’t have that sense of a manufacturing industry anymore—except, of course, we did end up bailing out GM in 2008. But Germany is far, far more exposed. A huge slice of their economy is basically all about internal combustion engines, and so that number includes all of those stocks, for sure.

Meyer: And just to get back to the financial-crisis point, if there were some kind of immediate crunch, and all those stocks tanked …

Tooze: Yes. If we saw a huge shock to, say, European equity [exchange-traded funds], which were heavily in German automotive, that’s the sort of trigger that we might be looking at.

Mark Carney, the governor of the Bank of England, believes that climate change threatens the global financial system. He spoke with Jerome Powell during a summit in France in July. (Pascal Rossignol / Reuters)

Meyer: In your view, what do you see as the goal of climate policy? Is it only to reduce carbon emissions? Do you see any benefits to the economic transition that we scientifically have to make, beyond mitigating climate change?

Tooze: I mean, that’s been the green-modernization agenda of climate politics, certainly in Europe, since the 1980s, right? This is not simply a zero-sum game; this is a structural transformation that has many very attractive properties. There’s loads of excellent jobs that could be created in this kind of transition.

There’s no reason why, even by conventional GDP-type metrics, it need even be associated with the kind of feel-bad factor of slow GDP growth. Then [you could] also link it to a revival of social democracy for the United States. From a progressive political point of view, that’s obviously extremely attractive.

Whether that will, in fact, ease the formation of majorities in Congress is another question. Because, after all, it does somehow have to get through the Senate, you know.

Meyer: Yes, well, welcome to the life of a climate-change reporter. You get to talk about lots of ideas and policies, but then it’s all about what will survive the Senate.

Tooze: Exactly. I mean, ever since the 1990s that’s been the logjam on any serious American commitment. So …

Meyer: I think part of what I’m asking is: When you look at a third of securities tied up in the carbon economy and the evidence for decoupling GDP growth from carbon emissions maybe not being as strong as we’d like, do you think the change that needs to happen is realistic?

Tooze: Realistic? No. I mean, depends what you mean by realism. The scale of the challenge requires a boldness of action for which there is no precedent. That’s the only good purpose that the war analogies serve, in my mind. I think in many ways the war-emergency analogy is terribly unhelpful because [climate change] is not that kind of challenge at all really, but at least that gives you some measure of the scale and urgency of what’s necessary.

Meyer: In your piece, you write: “Those in the United States who call for a Green New Deal or a Green Marshall Plan are, if anything, understating the scale of what is needed.” Do you think climate action needs to be larger than, say, the U.S. mobilization for World War II?

Tooze: Well, less large in absolute terms. Because even the U.S. was spending almost 40 percent of GDP on World War II. And if you’re the Soviet Union, you’re spending 55 to 60 percent in 1940. We don’t need to do anything like that. It needs to be much bigger than the New Deal, which in fiscal-policy terms was really quite trivial.

Crucially, what makes it totally unlike the war is that there’s no happy end. There’s no moment where you win and then everything goes back to the way it was before, but just better. That’s a misunderstanding. This isn’t crash dieting; this is a permanent change in lifestyle, and we need to love that and we need to live it and we need to own it and we need to reconcile ourselves to the fact that this is for us and for all subsequent generations of humans.

And further more—and much more fundamentally than any of those things—this isn’t really about America. I mean, America can be an obstacle and get in the way, but none of the really hard choices needs to be made by America, and all the really hard choices need to be made by people like China and India and Pakistan and Bangladesh and Indonesia. Our choices are all trivially easy, because for all the assets that we’re going to lose, we need to create $5 trillion worth of new ones.

Meyer: What’s the closest analogy to what needs to happen? Is there a single historical analogy that we could think of—of a broad transition with no happy victory parades at the end?

Tooze: I don’t think I’m uncomfortable with saying that this is unprecedented, so I’m not sure that looking for analogies is all that helpful, to be honest. I don’t write lessons-from-history-type pieces, because I really buy the hockey stick. [Editor’s note: The “hockey stick” graph shows that economic growth over the past 300 years has been unprecedented compared with human history before it.] In other words, we have never had to fundamentally rethink the energy basis of our way of life. I mean, we never have.

Meyer: Industrialization has only happened once.

Tooze: Exactly. And furthermore, it has turned out to be exponential—a hockey-stick-style process. So no, it’s not obvious to me that [analogies are] a terribly helpful way of thinking about it.

It strikes me, perhaps, as an indication of the poverty of our democratic imagination right now that we go backwards so much. One of the striking things about the American left is its nostalgia. There’s always some moment that you can handily pick up, a lesson you can learn from the New Deal. Or if not the New Deal, then the Progressive era. Or if not from the Progressive era, then the Homestead Strike. Like there’s some heritage of struggle that you want to draw on. And that backwards move is—even among the smartest, smartest people on the American left—is a compulsion, almost. It seems to me, in some sense, a mirror image of the strange practice of originalist interpretation of the Constitution. The sheer fact of the continuity of the American political argument, back to the founding, sucks people into this line of thinking.

You don’t have that very much in Germany. There isn’t anyone in Germany saying, “Which bit of mid-20th-century history is this most like?,” mercifully. The one analogy that has popped up in Germany is reunification, which I actually think is quite a good one, because that’s still an ongoing problem. So in the American case, it would be civil rights and Reconstruction, which isn’t a particularly optimistic comparison to draw. It’s an ongoing problem, it’s a deep historic problem, it only happened once, we still haven’t fixed it, and we’re not at peace.

Meyer: There’s a kind of shallow view of climate change: that it is something we need to avert or stop. And that’s somewhat true. But there’s also a deeper view: that climate change is the situation within which all other politics will happen for the next several generations, at least. That like Reconstruction or the civil-rights movement, it needs to be something that people take on like a moral commitment, in the same way they take on genocide prevention as a moral commitment.

Tooze: I’m not sure quite why you go to moral commitment here. I can see the attraction of that. But I would take a more functionalist line. Like, morals aside, mass incarceration, the destruction of the lives of millions of African American men—it is clearly a moral issue. But that isn’t, to me, the thing which should give it urgency. The crisis that African American men suffer in the United States is extraordinarily acute and oppresses them every single day of their lives, from cradle to grave. Anyway, this is the point where I think this analogy becomes problematic.

I do like your point that this is a forever problem—at least for all conceivable futures—like working through that problem of racism and the legacies of slavery is a forever problem in the United States.

Meyer: And there’s a degree to which it also increases the functional load on everything else.

Tooze: Yes. Because problems that we thought we’d fixed, like the Green Revolution and the feeding of the world population, for instance—totally not obvious that those fixes cope with the next 20 years of what’s ahead of us. The food problem that was such an oppressive issue globally in the 1970s may resurge in an absolutely dramatic way.

Meyer: Given all that, if Jerome Powell decided that he wanted to intervene on the side of climate action, what could he do? What could the Fed do?

Tooze: What I think the Fed should announce is that it enthusiastically supports the idea of a bipartisan infrastructure push focused on the American electrical network, first and foremost, so that we can actually hook up the renewable-generating capacity—which is now eminently, you know, realistic in economic terms. Setting a backstop to a a fiscal-side-led investment push is the obvious thing.

Meyer: So basically it should say: If the government were to issue a bunch of new debt to fund green investment and no one was buying it, then the Fed would?

Tooze: And there isn’t the slightest evidence [it wouldn’t sell], because the U.S. Treasury is issuing unprecedented quantities of debt right here and right now. But the Fed would view [the issue of new debt tied to infrastructure] as in no way alarming. It is indeed a highly appropriate response to an environment of extremely low interest rates, and [former Treasury Secretary] Larry Summers & Co. would argue that it might help, as it were, to suck us out of the state of secular stagnation that we’re in.

Then you could get into the technicalities of thinking how the Fed addresses issues of finance and green bonds. That would be another avenue to go down—for the Fed to take a role in helping develop a classification of green bonds, of green financing, with a view also to rolling out comprehensive demands for disclosure on the part of American firms, for climate risks to be fully declared on balance sheets, and for due recognition to be given to firms that are in the business of proactively preparing themselves for decarbonization.

Meyer: One idea that you mention in particular is that if there were some kind of green bond, it would count in some greater way against the amount of capital that banks are required to hold.

Tooze: Yes, exactly. Where it would really matter is that the Fed could work to modify Dodd-Frank regulation in such a way as to be supportive of that kind of lending, and the Fed could proactively work through the Basel process [which governs international bank rules] to make changes at the global level. You could, for instance, declare that the Fed views with disfavor the role of several large American banks in continuing to fund coal investment. Some of the carbon-tracking NGOs have done very good work showing and exposing the way in which some of the largest, the most reputable American banks are still in the business of lending to Big Coal. Banking regulation could be tweaked in a way that would produce a tilt against that.

Meyer: Has the Fed ever done something like this before? Where it’s said, “We need to move the economy in this direction, so we’re going to treat certain asset classes favorably?”

Tooze: Yeah, this idea of neutrality comes up: Isn’t the Fed supposed to be neutral?It’s an attractive idea, and goes along with the idea of Fed independence—except it’s completely ahistorical. I mean, the classic role of the Fed is to support government-issued debt. Insofar as the Green New Deal is a government-issued business, the Fed has just an absolutely historical warrant for supporting fiscal action.

It hasn’t historically done that—and there’ve been moments where the Fed acted as a goad, notably in the early stages of the Clinton administration. But with regards to the broader economy, the entire federal-government apparatus essentially stood behind the spread of home ownership in the United States and the promotion of suburbanization through the credit system. And kind of what we need is a Fannie Mae and Freddie Mac for the energy transition.

Meyer: But without the crisis at the end of Fannie Mae and Freddie Mac, I guess.

Tooze: Of course. Fannie Mae and Freddie Mac became vehicles for truly toxic modes of leverage and intermediation. But if the question is, Is there historical warrant for the financial agencies of government in the United States biasing the property structure in the economy in a certain way?, the answer is emphatically yes—all the way down to the grotesque role of the New Deal financial apparatus in enshrining the racial segregation of the American urban space, with massive effects from the 1930s onward.

The idea of neutrality should not even be allowed in the room in this argument. It’s a question of where we want to be biased. If you look at QE, especially in the U.K. and the EU, it was effectively fossil-biased. [Editor’s noteQuantitative easing, or QE, is when central banks buy stocks and bonds to boost the economy.] The assets that were bought as part of the asset-purchasing program had heavy carbon contact.

That’s not surprising: The bonds of the European energy majors have very high ratings, and so they tend to be part of the process of asset purchases. So in the same way as QE is believed to have an effect on inequality through the way in which it drives asset-market prices, it also underwrites the existing biases of the financial system toward fossil fuels. So monetary policy is not neutral with regards to the environment. There’s no safe space here. The only question is whether you’re going to lead in the right way.

Meyer: Last question. With any of this, is there a role for interested Americans to play if they are not particularly tied to the financial- or monetary-policy elite?

Tooze: Support your congressperson in doing exactly what AOC did in the hearings with Powell a couple of weeks ago. [Editor’s Note: Representative Alexandria Ocasio-Cortez asked Powell whether inflation and unemployment are still closely connected, as the Fed has long argued.] Applaud, follow with interest, raise questions. That’s exactly what needs to be happening. The politicization of monetary policy is a fact. I mean, I write these pieces because I personally think this is eminently suitable for political conversation. If we don’t raise these questions, the de facto politics is, more often than not, conservative and status quo–oriented. So this, like any other area, is one where citizens—whether they’re educated and informed or not—need to wise up, get involved, and follow the arguments and develop positions. So applaud your congresspeople when they do exactly what AOC was doing in that situation. In many ways, I thought it was one of the most hopeful scenes I’ve seen in that kind of hearing in a long time.

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ROBINSON MEYER is a staff writer at The Atlantic, where he covers climate change and technology.

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