Hurricane Katrina, one of the most destructive natural disasters
in U.S. history, wreaked damage worth $170 billion.
That's an amount so staggering it dwarfs the annual economic output of most nations.
Flooding alone destroyed 300,000 homes in New Orleans, while 19% of U.S. oil production capacity
was taken offline because of the 2005 hurricane season.
This is just one example of how climate change not only has a
human and environmental toll, but also a huge financial cost.
One that economists say could lead to the world’s next big financial crisis.
Climate change is the biggest challenge we face.
No one nation can solve this problem by itself.
And the worst thing would be if, you know, people care about this issue, we have this goal,
but 10 years from now people are going to see that we are not really going to get the number down
Fighting climate change has hit the mainstream, with many of the world’s most prominent leaders speaking out.
Yet, despite the sense of urgency, one common misconception is that we will need to
trade a healthy economy and jobs for a sustainable planet. Is there any truth in that?
I think now there is an understanding that this has some risks,
they also realize they might face some financial losses if they don’t do anything.
Yannis Dafermos has done extensive research on climate change and financial stability.
He walked me through the two main reasons climate inaction could be a financial time bomb.
There are the physical effects, such as extreme weather events,
and the carbon transition, the impact that moving to a less
carbon dependent economy will have on many industries.
Let’s start by looking at the physical risks.
These disasters are becoming more frequent and more severe.
Kristalina Georgieva is the International Monetary Fund’s managing director.
Property is affected, production capacity of agriculture, of industry is affected, even the very financial institutions
may be affected and what this translates into is a risk for financial stability.
Disasters cost the global economy $146 billion in 2019.
Insurers covered $60 billion of that amount.
In fact, one of the largest insurance companies in the world, Swiss Re,
said that extreme weather events are growing in both number and severity.
This means many industries are bracing for even bigger losses in the future.
But these losses aren’t just lines on a spreadsheet. They impact people like you and me.
Tens of millions of people, for example, have been displaced from their homes due to extreme weather.
So, how could that trigger a financial crisis?
Let’s look at the fallout that could follow extreme flooding as an example.
If the flooding were to happen in a populated area,
property would inevitably be damaged or even completely destroyed.
It is estimated that 50 to 80% of economic losses caused
by natural and man-made catastrophes globally are uninsured.
This means an uninsured homeowner who took out a mortgage to
purchase the property likely won’t be able to pay back their lender.
Factor in this happening to many, many more people
and banks are left without income from mortgage repayments.
As a result, lenders might reduce the number of loans they provide,
or charge more for the service in the form of interest.
Prospective homeowners looking to get a mortgage might not be able to do so,
and businesses may struggle to get loans to expand their operations.
It wouldn’t be long before you have an economy grinding to a halt.
Although it had a different catalyst, the Great Financial Crisis resulted from
banks discovering that investments backed by property had become near-worthless,
and the ensuing credit crunch caused the global economy to shrink.
This is not the only risk facing our financial system.
Managing Director Georgieva filled me in.
The world is clear that we have to move from a high to a low carbon intensity
so we can protect ourselves from rising temperatures
and the very disasters I spoke about, but when that happens,
industries that are in that area of high intensity become less valuable,
asset valuation changes and this shift, if it is abrupt,
can be quite difficult for financial institutions.
More countries are committing to becoming carbon neutral in the coming decades,
meaning they are trying to reduce emissions of CO2 and even capture greenhouse gases from the air.
But this transition to carbon neutrality requires many businesses to change how they operate.
Let's imagine that an oil-producing company has not changed its business model to
focus more on renewable sources of energy. As societies use less gasoline, this firm may lose value.
It simply becomes less attractive to investors. If many companies end up losing value because they
aren't adjusting to a low-carbon society, then this could eventually spark a market sell-off too.
If this happens without too much preparation,
this can cause a kind of a shock to financial markets.
There might be some indirect effects through the interconnection of the financial system,
I mean even those who might have already decided to invest more in green financial products,
if the financial system overall has a problem, they might also see some losses.
We live in an interconnected world and financial markets span the globe.
That’s why a tsunami in Japan or wildfires in California
could have an impact on the retirement plans of a worker in Italy
or on the stocks you bought using platforms like Robinhood and eToro.
One element that could lead investors to
adjust their positions in the market is a carbon tax.
These levies are being discussed in a wide range of countries and
would focus on taxing companies according to their emissions.
By making these firms pay more, governments hope that they will be incentivized to pollute less.
If in the coming years, governments realize that it is necessary
to act quickly in order to reduce emissions, they might therefore decide
to increase carbon taxes very quickly within a short period of time,
and this will be a problem for those companies that
rely too much on gas, oil, coal for their production.
And then those banks that have provided loans to these companies
might not be in a position to remain stable.
So, what can be done to reduce the risks posed by climate change?
The very first and most important thing they need to do is to put in place policies and investments
to shift towards the new climate economy, one that is low carbon and climate resilient,
but they also need to concentrate on the financial system
because it is essential for the functioning of our economies.
In the European Union, governments are working on
several measures as they implement the European Green Deal.
The plan aims to revitalize economic growth in the bloc whilst reducing the consumption of resources,
with a pledge to cut net greenhouse gas emissions to zero by 2050.
In addition, the U.S. has also promised to halve emissions by 2030 compared with 2005 levels.
Japan, Canada and even China have also announced plans to reduce emissions in the coming years.
Central banks, charged with ensuring economic stability,
have also started studying how to tackle climate risks in their policies.
Climate change is the biggest challenge we face
but it is also the greatest opportunity of our lifetimes
because managing climate risks is taxing, but the way we do it
by investing in climate resilience and new technologies,
offers opportunities for green growth and green jobs.
Investing in a low-carbon society may have wider economic benefits too.
An initial 5% of GDP green investment push combined with gradually increasing carbon prices
and attention to those that are affected negatively from the transition,
this can be very beneficial for the world economy,
it can increase growth by 0.7% on an annual basis over the next 15 years.
Hi everyone, thank you so much for watching.
Are you worried about the risks that climate change could pose to your savings and investments?
Let us know in the comments section, and I will see you soon.