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The Federal Reserve Is Catastrophically Wrong About Climate Change
Does climate change really not pose a risk? Let's look at the numbers.
At a recent event, Federal Reserve Governor Christopher Waller said that climate change does not pose a serious risk to financial systems, and the large banks don’t need to worry about it. To be clear, he does believe that climate change is real, just that it isn’t a risk, at least when it comes to the banking industry. But this notion seems to fly in the face of what climate scientists have said for years and what common sense seems to say about the knock-on effects of the looming climate disaster. So, is Mr Waller misguided? And is the Federal Reserve, and in turn, the American economy, on course to be woefully underprepared for climate change?
To quote Mr Waller exactly, he said, “Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States” and then went on to say “Risks are risks. There is no need for us to focus on one set of risks in a way that crowds out our focus on others.” In other words, Mr Waller doesn’t see climate change affecting the economy or the banking system, and so the Federal Reserve, who “monitors financial system risks and engages at home and abroad to help ensure the system supports a healthy economy for U.S. households, communities, and businesses” doesn’t need to give it any special attention. While it is true that the Federal Reserve has a lot of other risk factors to mitigate presently, such as ensuring inflation doesn’t go bananas, this seems terribly short-sighted.
But rather than speculate whether Mr Waller has the right stance here, let’s look at the numbers and see if he is right.
US Farming will by far be the most affected by climate change. The stable weather patterns and vast stores of water in underground aquifers to see farms through bad years have helped US agriculture over the past century. But any slight change in climate can spell disaster. Just a few degrees of climate change can collapse these weather patterns, leading to prolonged megadroughts that last years, biblical floods that can wash away entire farms, heatwaves that decimate crops and livestock alike, and far, far more frequent and fatal hurricanes and storms. This makes the farming sector extremely sensitive to climate change. What’s more, those underground aquifers and drying up, meaning that many US farms will soon lose their ability to weather some of these catastrophic events, meaning the sector is only going to get more sensitive to climate change.
This is why US farms are already feeling the climate squeeze. In 2019, floods linked to climate change cause vast numbers of fields and livestock to be washed away and drowned in Nebraska and Iowa. Nebraska alone lost $440 million worth of cattle during this event. In 2022, The US experienced its first megadrought, causing many farms to cripple under water shortages. In fact, in 2022 alone, extreme weather, fuelled by climate change, cost the U.S. $165 billion in damages! And annual losses are set to only soar from here.
Why is this a problem? Well, agriculture and its associated businesses make up 5.4% of US GDP. This might not sound like a lot, but it is actually a sizeable chunk of the US economy.
But US agriculture is also up to its eyes in debt. The total debt of the farming sector is forecast to reach $535.1 billion this year! This is because many US farmers rely on short-term loans after harvesting to pay for the next round of seed, fertilisers, livestock and machinery with a view to repaying upon the next harvest. Farmers also have debt on their land, buildings and machinery, similar to a mortgage, and recently these loans have been getting higher levels of leverage. This means that the percentage of debt to asset value is increasing.
This increased leverage, combined with the horrific recent weather and interesting financial climate, means that all this debt is already stressed. Wall Street banks are already looking to bail out of the farming market as they see costs increase and profit decreases, making the industry a risky one to lend to. This situation might not be directly caused by climate change, but it indicates that the relationship between the financial system and the farming sector is already under a vast amount of stress. And don’t forget, it is the Federal Reserve’s job to ensure this debt is safe, and not a risk to the economy.
But, there is another way the economy is tied to farming, through shares. Sector equity funds invest in stocks of companies in a particular industry or economic sector. The farming sector’s equity, or in other words, how much of its value is tied up in these funds, is expected to increase by 5.0% in 2023, which is worth $3.5 trillion! Many companies, from banks to big tech firms, use funds like this to safely invest surplus cash, and some even use debt to buy more. So if the value of farms were to plummet, it could drag a lot of these funds, and their shareholders, down.
Okay, so US farms are going to struggle with climate change, and the US economy and financial systems (i.e. banking debt) is strongly linked to them. So, the next question is, what is the scale of the damage here?
Well, studies are predicting that in seven years, because of climate change, the US crop output will reduce by 25%. And it will only get far worse from there on, as in the 2040s, climate change will get far stronger. It’s hard to predict farming output last 2030, but we know that between 2050 and 2099, there is an 80% chance of an extended megadrought, far worse than what we just experienced, thanks to climate change. And those aquifers that help US farms through droughts will be unable to support irrigation by 2070, and their use will need to be severely limited by 2050 to preserve them.
In short, over the next two decades, farming’s output, economic production and value are set to decrease. Past 2050, entire countrywide crop failures are possible, and the US may have to resort to importing vast amounts of food to feed its population.
What does this mean for the economy? Well, the 2008 financial crash caused the US GDP to shrink by 4.3%. So, you might think that this means that if US farming was completely wiped out by climate change (which is highly unlikely), it will only cause a financial crash of the same size as its GDP share is only slightly higher at 5.4%. Well, no, because of how interlinked the US is with its farming industry. If the farming industry shrank by 25%, as some studies suggest it will, then many farmers default on their loans, their businesses (and, in turn, their shores in sector equity funds) dramatically decrease in value, and the price of food in the US skyrockets (as around 90% of food and beverages in the US is grown domestically). This will cause dramatic knock-on effects within financial systems and the wider economy. As such, if US farming output consistently decreases over the next two decades, it could cause the US significant financial woes.
But there is another way the US economy and banking system is sensitive to climate change. Property.
You see, by 2050, 650,000 US properties are set to be lost to sea level rise directly caused by global warming. The current average US property mortgage debt is $460,000, and this figure has been consistently rising since the 90s. So by 2050, the banking system could lose around $300 billion in mortgage loans as houses they lent against are reclaimed by the sea, which is a massive blow.
But these coastal ports are also going to require vast government investment to either adapt to sea level rise or to relocate families and crucial industries (such as fishing and shipping). One study estimated that this would cost the US government $11 billion per year! Where are they going to get that amount of money? Well, they are going to have to borrow it, meaning it is the Federal Reserve’s job to ensure this lending is both accessible and safe (i.e. not threaten the US economy).
I could go on and on. We haven’t even talked about how the US government will soon have to spend literally hundreds of billions of dollars per year fixing damages caused by climate change-induced natural disasters. Or how overall economic output will shrink due to more regular heatwaves, snow storms and floods. Or how migration caused by climate change could floor many huge industries, as they have to abandon no-longer viable infrastructure.
So by now, I hope you can see what these figures are telling us. There is a good chance that climate change will impact key US industries, like farming, to a level that is high enough to cause major problems with the US financial systems.
Now, you could say that Mr Waller meant that climate change has no current risk to the US financial system and that these risks will only start to bite in the next decade or so, and that the Federal Reserve and the banking system have far more pressing issues to solve right now. Such as sorting out the financial mess left by the Covid-19 pandemic. Firstly, I highly doubt that is what Mr Waller meant, given his political stance. But even if there were what he said, it would still be categorically wrong.
You see, the US is inching closer to its debt ceiling, the maximum it can borrow. Soon it will either have to default on loans, dramatically cut back governmental spending, or increase the debt ceiling. All of which have massively negative economic implications. This complicates things in terms of Federal spending, as to meet our climate targets, government sending has to increase. Estimates reckon that the cost to turn the planet net-zero is about $275 trillion, and as the US is responsible for around 15% of the world’s annual carbon emissions, it will likely have to spend $41 trillion between now and 2050. Or, to put it another way, around $1.5 trillion per year! A lot of this cost will be shouldered privately, but a sizeable amount will be governmental. Combine this with governmental support for aiding sea level rises and natural disasters, which has already exceeded $165 billion per year, and is set to drastically increase, and you can see just how much extra money the US government is going to have to find from somewhere. And that somewhere is loans, which they can’t get if they are close to the debt ceiling or have defaulted on their loans.
In short, the Federal Reserve needs to find a way to ensure US debt is low enough so that it can spend the money on fighting climate change whilst weathering possible climate change-induced recessions. It takes time to roll out solutions like this, meaning that climate change isn’t a future problem for the Federal Reserve. It is a very current one.
So for Christopher Waller to say that climate change doesn’t pose a significant risk to the US economy or banking is a catastrophic oversight. He has the luxury of knowing that he will be out of office when these disastrous consequences kick in. So, those awkward interviews of “why did you let this happen?!” won’t be directed at him. But, if he, and the Federal Reserve don’t start preparing for the monumental spending it will take to keep the US afloat through the coming decades, he will be remembered as having helped sow the seeds of a national cataclysm.