Avoiding the Carbon Crash: reform the financial system now

February 10, 2014

NOTE: Images in this archived article have been removed.

Image RemovedThe global financial system displays the same bounded resilience that many complex systems in nature display. Within certain limits the system maintains its integrity but when those limits are broken positive feedback loops can rapidly move the system to a very different state. We refer to such events in the financial markets as “crashes”. Given that the financial system is central to the allocation of capital and liquidity, such crashes rapidly impact the “real” economy. This was the case in the 1930′s, and a repeat was only averted in 2009 through unprecedented measures taken by central banks and governments.

The move to a low carbon economy will devalue large amounts of financial and other assets, either directly through the “stranding” of fossil fuel reserves, and more indirectly as economic infrastructure and business models become non-viable. The Carbon Tracker organization has identified trillions of dollars of fossil fuel assets that must remain unused if the amount of greenhouse gases in the atmosphere is to be kept below levels that could trigger dangerous climate change1. In addition to these are the huge investments in such things as airports, and businesses dependent on fleets of individual car driving citizens, which may also be severely devalued.

An 80% reduction in carbon emission by 2050, within the industrialized countries, would be required to stay within the “safe” 450ppm carbon dioxide level2, requiring significant yearly reductions in those emissions. Such large reductions have previously only been associated with economic contraction, examples being the collapse of the Soviet Union and the financial crisis of 2008-9. At a 3% annual growth rate the world economy would double in size by only 2038, requiring a reduction of over 90% in the carbon intensity of a unit of gross domestic product (GDP) to meet the required 2050 targets. Thus, a realistic position is that economic stagnation or contraction will be required for society to meet the required emission reductions. If a limit of 350ppm of carbon dioxide is used, as McKibbon and others have proposed3, the problem becomes even greater.

The financial system acts as a time machine, telescoping our perception of the future into the value of financial assets today through such things as price/earnings ratios linked to future growth rates, and the ability of corporations and governments to pay debt interest and principal. Thus, the realization of “stranded” and devalued assets, together with a future of economic stagnation or contraction, would cause significant downward reductions in financial asset prices.

The resulting financial crash would significantly disable the workings of the general economy, including the very supply chains and organizations required to build out the low carbon economy. The building of a wind turbine relies upon a highly complex web of suppliers, trade finance, and business relationships. If such a crash bankrupts some of those suppliers, makes the financing of international trade much more difficult and inhibits the levels of trust required for such complex organizational webs to function, how long would it take to get to a point where turbine production could be restarted? Thus, the production of the new renewables infrastructure may be greatly inhibited leading to significantly reduced levels of energy supply from renewable sources.

Given these highly negative impacts, any plan for significant emission reductions must include significant changes within the financial system to remove it as a major impediment. Such changes will involve decisions on “pain sharing” as a significant part of current wealth is based on a chimera of fossil-fuel dependent assets and future growth that will not come to pass. Extremely high levels of debt, which are dependent upon future growth for repayment, will need to be removed through debt forgiveness. The impact of much lower equity prices will have to be managed and financing to important sectors, such as renewables production, maintained. Levels of wealth will fall substantially as the future reality is accepted; the only question is how that impact will be shared. Will it be predominantly on the super-rich who have profited so much from the growth of the past years or will it be the pensioners and the poor?


1. Carrington, Damian (2013), Carbon bubble will plunge the world into another financial crisis – report, The Guardian. Accessed at http://www.theguardian.com/environment/2013/apr/19/carbon-bubble-financial-crash-crisis

2. Hassol, Susan (2011), Presidential Climate Action Report, U.S. Government. Accessed at http://www.climatecommunication.org/wp-content/uploads/2011/08/presidentialaction.pdf

3. 350.org website. Accessed at http://350.org/


Photo credit: Wikipedia

Roger Boyd

I have a BSc in Information Systems from Kingstom University U.K., an MBA in Finance from Stern School of Business at New York University, USA, and a MA in Integrated Studies from Athabasca University, Canada. I have worked within the financial industry for the past 25 years, and am also a research member of the B.C. Alberta Social Economy Research Alliance (BALTA) looking at the linkages between issues of sustainability and models of ownership and finance. Most recently I have completed a book, to be published shortly by Springer, titled “Energy and the Financial System”.

Tags: degrowth, emission reductions, financial system