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ZEUS: Climate change pushback rears in central bank circles, threatens markets

By David Callaway, Callaway Climate Insights

SAN FRANCISCO (Callaway Climate Insights) — Higher bond yields shaking markets these days with threats of inflation tied to post-Covid spending are having a dramatic impact on the world’s central banks — thanks to climate change.

Concerns about independence, already heightened in recent years by battles against strong-arm leaders in places like Turkey, Brazil, and even in the U.S. with former President Donald Trump, are now rising up in central bank meetings with the argument that the banks’ mission to create financial stability could be hijacked by governments seeking to fight global warming.

A small but important cadre of global central bankers have spoken out in recent weeks against the banks jumping into the climate finance battle. They argue that taking on environmental and social causes is not only against their remit to fight inflation, but risks breaking their balance sheets at a time when they are essentially holding the world’s markets aloft by flooding them with cash.

This is a mistake. Climate change is fast becoming the major risk to financial stability and indeed could be the reason for the next great economic crisis. To back off now will only place the lenders of last resort in a more precarious position come the next great pandemic or climate emergency.

As the Biden Administration prepares $2 trillion in climate spending plans, and Europe puts the wraps on a €750 billion ($905 billion) recovery fund tied to climate investing, the pushback in these rarefied economic circles is growing. No less than former Bundesbank President Helmut Schlesinger told my former colleague David Marsh last month in an interview that the European Central Bank was beginning to wrestle with the idea.

“There seem only two or three members of the ECB governing council who speak out against these policies,” he said in the interview with Marsh’s bulletin in the Official Monetary and Financial Institutions Forum (OMFIF). “The close linkage between fiscal and monetary policies presents a danger for the independence of the ECB. This danger is intensified if the ECB is following too many targets in the political field, for example, in measures to alleviate climate change, which weaken the focus on its primary goal of stability.”

British economist Howard Davies, a major player in European financial regulation, also noted in a column this week for the World Economic Forum that central bank balance sheets are stacked with fossil fuel investments and utility bonds from a decade of emergency asset buying (quantitative easing) to inject funds into global economies. Unwinding them too fast, if at all, threatens just about every market in the world right now.

Central bankers, led by former Bank of England (and Bank of Canada) Gov. Mark Carney, have taken the lead on demanding that the central banks lead the finance industry in transitioning to adapt to global warming. Janet Yellen, the former Federal Reserve Board head who is now Treasury Secretary under President Joe Biden, is supposedly setting up a climate task force in the Treasury. So far, that hasn’t happened, and Fed watchers are wary Yellen will force any climate measures — such as bank stress tests — on current Fed chief Jerome Powell.

At the heart of the pushback is the concern that rushing into the climate battle threatens the hard-fought independence of the world’s leading central banks, their balance sheets, and their ability to control inflation and to keep monetary policy somewhat separate from government fiscal policy.

These are legitimate worries. It is the Fed and the ECB who stepped up to save global economies a decade ago during the Great Financial Crisis, not governments. Their independence is an essential building block of — and backstop to — modern financial markets.

In many ways, they’ve boxed themselves into a corner, keeping interest rates so low with their asset purchases over the years that they’ve run out of ammunition to raise rates should inflation return, courtesy of climate and Covid recovery spending. This weakness has been exploited by politicians in many countries. Marsh’s column cites concerns that central banks in Japan and India have already effectively turned over their independence to government and that Yellen’s position now in government even threatens the U.S. Fed.

The key issue in this debate is timing though. Quantitative easing is essentially a big, expensive stalling tactic, as we await some Godot-like future when all our economies will be able to stand on their feet again with rising interest rates helping control inflation. Time is what global warming won’t allow.

If investors believe that banks, insurance companies, and global markets are vastly underestimating the financial threat of climate change, then this pushback is simply delaying a solution to what could be the next big global emergency. Bankers and economists love to debate economic policy, but there is no time to waste.

The world’s financial institutions look to central banks to lead. Playing catchup, as they did during the financial crisis and with Covid, will only weaken them further, and may ultimately be an even bigger threat to their independence than the one at hand.

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