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Climate finance beyond carbon finance
Michel Aglietta (CEPII), Jean-Charles Hourcade (CIRED/CNRS), Carlo Jaeger
(GCF), Baptiste-Perrissin Fabert (CIRED)
Working paper not to be quoted
Abstract
The Cancun Conference decided the establishment of a Climate Green Fund (CGF) to help
developing countries in aligning their development policies with the long run UNFCCC
objectives. This paper starts clarifying the links between two motives of this establishment:
the first, technical in nature, is the necessity to redirect the infrastructure instruments in
these countries (energy, transportation, building, material transformation industry) to avoid
their lock-in in carbon intensive pathways in the likely absence of a significant world carbon
price in the forthcoming decade ; the second, political in nature, is the interpretation of the
CGF as a practical translation of the notion of the common and differentiated responsibility,
since the funds are expected to come from Annex 1 countries.
In a first section this paper shows why this perspective might generate some distrusts given
the orders of magnitude of funds to be levied in Annex 1 countries in an adverse context of a
financial crisis and major constraints on public budgets. Its second section explores basic
principles around which it is possible to minimize these risks by upgrading of climate finance
in the broader context of the evolution of the financial and monetary systems. After exploring
how such a liaison would make climate policies a possible contribution to reducing some of
imbalances of the current world economic globalization by reorienting world savings
reducing investment uncertainty, it sketches how this perspective might be palatable for the
OECD, the major emerging economies and the exporters of fossil fuels.
Introduction
The Cancun agreement establishes a Global Climate Fund (GCF) as an operating entity of the
Financial Mechanism of the Convention. Whatever the content of arrangements to be précised later,
its scaling up is critical for breaking the distrust circle which pervades climate negotiations since the
Kyoto’s unfinished business (Jacoby, 2007) and for materializing the Common But Differentiated
Responsibility principle (CBDR) of the UNFCCC.
This paper begins with delineating the risks of reinforcing this distrust circle in an adverse context of
public budgets deficits in the donor countries. It first shows the magnitude of the funding needs
beyond the GCF and why, because climate finance cannot stay a marginal department of global
finance, its scaling up cannot be disconnected from the reforms of the financial and monetary
systems. It then proposes the basic principle of a monetary based device to redirect world savings
towards low carbon investments and lower the risk level of these investments. It ends in explaining
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why this device paves the way to a palatable deal for all world regions by making climate policies a
fulcrum to reduce imbalances of the current pattern of world economic globalization.
1.
Climate finance at risks of disappointments and misunderstanding
1.1. Problems of order of magnitude
The credibility of climate negotiations might be undermined by the gap between the US$ 100 billion a
year by 2020 to which 2020 Annex 1 countries committed to at Copenhagen (2009) and the $15 billion
per year envisaged by the EU member states in a first step. Would the same share of the GDP
(0.082%) be envisaged by all Annex I countries, transfers would amount to $31 billion. Although
representing only about one third of the commitments, they would increase by one third pre-2008
overseas development assistance, hence the temptation, in a tight financial context, of greenwashing
existing transfers.
This is all the more embarrassing as the real ‘funding gap’ at stake to achieve a low carbon transition
is significantly higher. The US $140–$175 billion a year by 2030 appraised by the World Development
Report (World Bank 2009) actually correspond to US $264–$563 billion upfront financing needs. The
former figure assesses the payments due over the duration of the projects to cover capital and
operation costs, including the interest to be paid to a patient lender; the latter is the cash necessary
to cover the cost of the equipments before they enter into operation. Hence, the funding gap is not
one to three but one to between 5,7 and 9,6.
Moreover, these amounts are only the tip of the ‘financial iceberg’, the incremental investment
costs. Its hidden part is the redirection of investments flows. If the capital cost of a given quantity of
‘clean’ electricity is say 30% higher than this of a coal plant, the real amount of investment to be
redirected is 130%. Moreover, the total incremental costs for the energy systems result from a
combination between higher upfront costs of low-carbon energy supply and lower energy demand
due to changes in energy efficiency and consumption behaviors which will not be achieved without
redirecting investments in sectors like building and transportation. These sectors represent 41% of
the world gross capital formation (see www.EUKLEM.net). A back of the envelop calculation 1 shows
516G$ incremental investments costs in 2020 (3% increase against 2,5% by the International Energy
Agency (1989)) corresponding to a far higher amount (4100G$) of redirected investments.
This reassessment of the orders of magnitude at stake does not mean that the challenge is
impossible to meet in turbulent times. It means that, unless the UNFCCC objectives are de facto
abandoned, climate finance is not bound to remain a marginal department of global finance.
1.2. What does scaling up climate finance really mean
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We assume that, in 2020: a) 25% of the investments of the households, business and financial intermediaries in
residential and non residential infrastructures is redirected towards low carbon options with an extra unit cost of
5% b) 10% of the investment of the transportation sector (a low percent because of the low substitutability
between rail based and road bases transport) with an extra unit cost of 10% c) 33% of the electricity and gas
investment with an extra unitary up-front investment of 20% d) a decrease by 10% of the investment in mining
and carrying d) 20 % of the investments in machines
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There is no consensus on the measures listed by the High-level Advisory Group on Climate Change
Financing (AGF, 2010) established by UN Secretary-General Ban Ki-moon (levies on the revenues
from auctioned allowances or on international aviation and shipping emissions, taxes on financial
transactions, levies on credit trades and carbon taxes). This lack of consensus cannot be
disconnected from a ‘donor fatigue’ exacerbated by the return of ‘depression economics’ (Krugman,
2009), the rebalancing of economic powers in the world and the fact that the division line between
the rich and the poor coincides less and less with the North/South division (Chakravarty, 2009).
This fatigue is reinforced by doubts about the viability of low carbon investments. The cash flows
from the Clean Development Mechanism depend on the demand of carbon offset and the limited
size of this demand is precisely today’s cause of concern. Moreover, yielded at the end of the
projects they fail to reduce the “upfront investment” risks in a context of large uncertainty. The
Public Finance Mechanisms (PFMs) do bring funds during the incubation phase of the projects but
cover only the ‘’extra costs” and not the bulk of low carbon investments (Neuhoff et al., 2009),
assuming implicitly that without these costs the projects would have met positive risk-adjusted
returns.
This is the “additionality principle” applied since the early nineties to secure that the aid to
environmental policies in developing countries will not crowd out conventional overseas assistance.
Its consequence is that the ‘carbon-based PFMs’ do not address the usual risks of any development
project: technical and regulatory uncertainty, currency risks, long pay-back periods, volatility of
market prices and uncertainty about future demand. Their leverage ratio of public money on private
investment (AGF 2010) is lower than those of traditional PFMs: US $2 to US $4 for every US $1
compared with US $3 to US $15 (Maclean et al. 2008; Ward et al.2009). Continuing along this logic
would make it impossible to redirect the amount of low carbon investments at stake; no matter
indeed whether these investments are blocked by carbon specific risks or usual risks. The challenge is
to improve their overall risk adjusted cost-benefit ratio in order to reach a “statistical additionality”
of investments instead of project based additionality2.
1.3. Turning the approach upside-down
Since climate finance is not bound to stay a marginal department of global finance, let us examine it
through the lens of the climate agnostics primarily concerned by the stability of financial systems and
of the world economic recovery after the 2008 crisis. Their concerns are legitimate because the
symptoms that led to unstable financial dynamics are still prevalent:
- The ultra-low interest rate policy of the main central banks in advanced countries has
exacerbated the search for yield higher than ‘public bonds’ by holders of cash (financial departments
of multinational companies, institutional investors like mutual funds or pension funds). Those holders
have moved in and out of capital assets because they are very sensitive to tiny changes in the
communication of central banks that might hint to future changes in interest rates. In whole sale
short term money market, prior to 2008 these volatile capital flows were channeled through
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For the discussion of the difference between project additionality and statistical additionality, see Hourcade &
al., 2012)
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wholesale funding instruments (ABS and CDOs) issued by shadow banks (broker-dealers, conduits
and SIVs3). These instruments have disappeared but the mistrust in the banking system has
motivated continuous build-up of institutional cash pools. The high demand for safe short-term
instruments provoked an increase of the value of bonds and driven to zero their interest rate. The
shortfall of such instruments was aggravated because foreign central banks buy them for reserve
keeping. Ultimately there is a higher mass of liquidity than sovereign bonds that can be issued
backed on public assets.
- The way governments and central banks have dealt with casualties due to excessive risk- taking
did not succeed to combat the too-big-to-fail syndrome and public authorities the imposition of a
higher equity capital ratios on total assets to hedge against the risk of losing control (S.D. King 2010)
remains an unachieved business. Therefore existing cash pools are largely outside banks because of
widespread distrust. They have been estimated by the IMF (Polszar, 2011) at $3400bns in 2010
against $3800bns in 2007 and $100bns in 1990)4.
- Firms operating in a business environment which prioritizes, since the eighties, the
shareholder value against the maximization of the long-term growth typical of a ‘managerial
economy’ (Roe 1994). This a main cause of the obsession for liquidity. The profusion of cash in large
companies fuelled bursts in dividend distribution and share buyback to boost equity prices. It
contributes to exacerbating unqualities of income distribution. Investment rates have thus declined
with lack of effective demand and flagging credit demand by SMEs is met with bank reluctance to
lend. Investors face a kind of ‘‘Buridan’s donkey dilemma5, the donkey which died of hunger and
thirst because it hesitated too long between eating oats or drinking water: they do not know in what
long term investments the money should go.
Viewed through this lens, the financing problem posed by the low carbon transition does not comes
from a ‘lack of fund. It comes from the inability of the present system of financial intermediation to
fund productive investments. Higher and more stable growth would be possible by resorbing excess
liquidity via heavy taxes which is highly unlikely, matching treasury bill issuance and the volume of
cash pools which is not a recommendable solution in time of consolidation of public debts and
expanding the umbrella of the LOLR4 to non-banks which is not a palatable solution either. The only
viable solution is creating intermediaries able to bridge long-term assets and short-term cash
balances, the preferred support of saving, so that they will be invested productively, without
incurring the risks of excess leverage, maturity mismatch and interconnectedness (illiquid long-term
assets financed by short-term, unsecured liabilities of money market funds) that have fostered the
systemic crisis.
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ABS stands for Asset-backed securities
CDOs stands for Collateralized Debt Obligation
SIV stands for Special Investment Vehicle
LOLR stands for Lender-of-last-resort
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They are held by 1) global non-financial corporations and institutional investors outside the banking system 2)
mutual funds and hedge funds (managed liquidity and cash collateral associated with securities lending) 3) the
overlay of derivatives linked to derivatives-based investment 4) wealthy individuals and endowments.
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This legend is a caricature of Jean Buridan, a theologian at the Sorbonne in the 14th century, who argued that a
wise conduct is to postpone decisions up to the availability of the necessary information. The legend counts the
sad story of a donkey whodies hesitating between oats and the pail of water placed at equal distance from him. A
non-directed inflow of money comes to add more oats and water in front of it without breaking its hypnosis.
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The question though is whether climate finance can provide the opportunity to create such an
intermediation. If it can lower the investment risks of low carbon projects and redirect savings
towards productive activities, it will reduce the magnitude of the cash-pools and fuel the world
growth engine by shortening the trickling down of current generations to productive investments.
This would be all the more timely that the globalization pattern is changing. What the OECD
development department calls “shifting wealth” is indeed taking a new course. Export-led growth
and reserve accumulation in emerging economies fuelled by excess credit growth in a host of OECD
countries is being replaced by more inward-focused growth with the widening middle class in
emerging economies, pressures for higher wages and services and a huge investment demand driven
by urbanization and environmental concerns.
This mutation also concerns international financial intermediation. European banks have retrenched
on their home borders since the Euro zone crisis and no longer borrow dollars via their US
subsidiaries to relend worldwide. Faced with this vacuum Asian development banks and sovereign
wealth funds are stepping up their ventures. A financial model emerges, based on long-term bilateral
financial contracts at agreed upon prices backed by government guarantees and on Bond issuance
substituting national currencies to dollar.
2. A carbon-based financial device backed by monetary refinancing
In this context, options to prime the funding pump of the low-carbon transition despite limited
carbon markets are many. However, given the tensions on public budgets and on the banking
systems, there is no other margin of freedom than internalizing the “social value” of avoided carbon
emissions into the economy by means of a carbon-based monetary instrument. For the climate
agnostics, compared with the “unconventional monetary policies” implemented to restore
confidence on the monetary and financial systems after 2008, this value is of interest only if it is used
in a system helping the banks to develop their credit activities towards productive investments.
The basic wrinkle consists in injecting central bank liquidities into the economy, provided that they
are used to fund low-carbon investments. Governments would provide a public guarantee on a new
carbon asset, which allows the central bank to provide new credit lines refundable with effective CO2
emissions abatement. This targeted credit facility makes it possible to expand credit to LCPs as it
offsets LCPs' financial risk perceived by the banks and investors relatively to BAU projects and would
make these projects more attractive.
Figure 1: The key elements of a climate-friendly financial architecture
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How to transform this general perspective into an operational system is out of the scope of this
paper. However, any such system will hardly avoid following the principles pictured in fig 1.
1 A political compromise on the valuation of carbon externality;
The valuation of the climate change damages, theoretically necessary to calculate the social cost of
carbon (SCC) along an optimized trajectory is highly controversial (Tol, 2008; Dumas et al., 2010)
damages if not impossible. It depends indeed on a large set of parameters amongst which the pure
time preference, assumptions about the costs of carbon-free techniques and beliefs about the
climate change damages. However, the objective of preventing a temperature increase greater than
2 degrees above pre-industrial levels is equivalent to acknowledge a social value of the carbon
externality (SVC) since it means that risks to go significantly beyond these 2°C are worth to be
avoided with and without transitory overshoot.
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The uncertainty about mitigation costs is still large but orders of magnitude lower than on climate
change damages. The last IPCC report provides corridors of such costs6 within which a choice can be
made. The level of the SVC will be ultimately political in nature and translate the willingness of
governments to act for mitigating climate change, like the carbon values adopted by the UK
(Watkinson et al. 2008), the US, and France (Quinet et al.,2009) (respectively US$ 42, US$ 60, and
US$ 130 in 2030).
Should this value be specific to each country or unique at the world level is an open question. Let us
notice however that a political agreement on a SVC should be easier than on a carbon price. First, it
serves as a notional value for low-carbon investments and does not impose an immediate extra cost
on firms and consumers. Second each government will value its SVC in function of its own perception
of the domestic co-benefits of climate mitigation (air pollution, benefits of the recycling of the
revenues of carbon pricing, energy security). Hence countries might agree the same SVC for various
reasons and since this SVC will be revised every five years, it seems preferable to trigger a process
which will allow for further correction in function of the arrival of new information.
More important is to hedge against the vagaries of market exchange rates. The SVC value would be
nominally similar to the 35$ per ounce of gold under the Bretton Woods regime. But, since the
exchange rates are the relative values of the SVC in national currencies will thus differ from one
country to another and will be submitted to variations large enough to generate time inconsistencies
of investment projects funded in several countries overtime. This is why the world SVC should be the
weighted average, in purchasing power parity (PPP), of national prices. The internal returns of
investment projects, would then all be implicitly computed in PPP price system (reviewed every five
years) which would minimize the inefficiencies caused by the volatility of exchange rates.
2: A carbon-based money issuance
Together with this political agreement on a SCC, volunteer governments announce that they accept
to back a new class of “eligible assets” recognized by their Central Bank: the carbon assets. Their
unitary value is the SVC and their quantity is an overall volume of emission reduction corresponding
to governments’ commitments (see Hourcade et al. in this issue).
The central banks then can announce that they will a) allow commercial and development banks to
draw on new credit lines provided that they use the liquidities to fund low-carbon projects b) accept
as repayment “carbon certificates” (CC) testifying effective carbon emission reduction and valued at
the SVC c) transform them into carbon assets.
The carbon-based liquidities will then be gradually injected as the banking system draws on the
credit line to fund low-carbon projects. Carbon assets will be incorporated into the central bank’s
balance sheet when the bank returns the carbon certificates, i.e. the monetary value of the emissions
reduction yielded by the project (see appendix 1 for a description of the credit line -> CC -> carbon
assets circuit through the balance sheets of the central bank, commercial banks, and the
entrepreneurs). In this way the money issuance is automatically backed on a ``real wealth'' in the
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form of low-carbon equipment and infrastructure in addition to future benefits of emission
reductions.
Step 3: A Supervisory Body to select the projects and monitor effective CO2 emission reduction
The new credit facility is meant to help both projects that can pay for themselves but suffer from a
credibility gap inhibiting their adoption and projects that need a specific support because of the
additional costs and uncertainties. The credibility and the accuracy of the MRV process is then critical
including the guarantee that the funded projects are aligned with the development objectives of the
recipient country and to yield effective CO2 emission reduction.
An Independent International Supervisory Body, similar to the CDM Executive Board, is thus needed
which would first determine eligible mitigation projects and policies (technology, sector, time
horizon) in function of their consistency with the NAMAS presented by the countries to the UNFCCC.
Second, since the objective is to trigger GHGs abatements which would not have been realized
otherwise, it will fix the allocation rules of carbon certificates per type of projects in participating
countries in function of their expected emission reductions. Those rules are necessary to avoid the
transaction costs of project-based assessments and to secure a statistical additionality of the wave of
projects triggered by the system without securing that each of them would not have been realized
without its support (Hourcade et al. 2012).
The last responsibility of this Supervisory Body should be to monitor the conformity of a project at
the time of its launching and to confirm ex-post its level of completion. It has then to cancel part of
the carbon certificates if it judges that the project did not fulfill the ex-ante performance criteria.
Step 4: An incentive to mobilize entrepreneurs and banks
Accepting as repayment certified emission reduction instead of cash entails the cancelling out of
entrepreneur’s debt at the height of the value of the certified emission reductions. This is the
primary lever to strengthen the solvency of low-carbon projects, to lower their risk level and to
enhance their attractiveness for the entrepreneurs and project contracting authorities. One
important point is that a SCC growing with time would counterbalance the effect of the discount rate
and enhance the social value of long-lived infrastructures. For commercial banks in a process of
deleveraging, this new credit facility will encourage them to expand their lending activity, instead of
accumulating liquid reserves. An additional regulatory incentive for the banks might be that a high
share of LCPs in their loan book would make their balance sheet less risky, since this share of their
assets would benefit from a public guarantee. One could even imagine that they keep part of the
carbon assets. Banks would then be rewarded with a reduction of the cost of their prudential capital
constraint. They could be indeed allowed to apply a zero risk coefficient – in the same fashion as for
sovereign bonds – to the fraction of the loan that comes from central bank liquidities backed upon
the value of emission reduction.
Step 5: Redirecting saving towards long-term climate-friendly investments
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In addition to redirecting bank credit to support a low-carbon transition, the success of the system
will depend on its capacity to redirect private saving toward LCP&P. To do so banks or specialized
climate investment funds could use the carbon-based monetary facility to back highly rated climatefriendly financial products attractive for households and institutional investors, such as “AAA”
climate bonds with a return on investment slightly above the usual safe deposit rate in order to
attract long-term savings. Well-tailored paid-in capital makes it possible to issue a multiple of this
capital in highly rated climate bonds. The proceeds of those bonds would then fund loans to a pool of
LCPs (with say a mean rating of “BBB”). The paid-in capital acts as a buffer against loss given default
of the pool of LCPs and thus sustains the good rating of the climate bonds. Sovereign Wealth Funds,
public private and corporate pension funds, insurance companies, endowments and investment
management companies could be interested in AAA-rated ‘‘climate colored’’ bonds (like the green
bonds of the World Bank) instead of speculative financial products for both ethical and regulatory
purposes. Like describes in figure 2 the wrinkle is to fill up the paid in capital with carbon certificates.
Figure 2: Climate finance as a means to redirect long term saving toward low-carbon investments
One major tool for mobilizing savings kept by institutional investors and households would be to use
a share of the carbon assets to capitalize the GCF independently from the only goodwill of the tax
payers of the developed countries. The potential leverage effect of this multilateral tool is potentially
high. As suggested by De Gouvello and Zelenco (2010) the GCF could issue Green Bonds worldwide.
If the Fund could accumulate $100bns up to 2030 and if it invested in well-diversified projects, so
that one can assume that the probability density function is Gaussian, it would have 99.9%
probability that its capital base could absorb its losses. Hence, it could issue $1trn bonds to back
credit facilities to developing countries on real wealth.
3. Climate finance: contributing to sustainable globalization
One legitimate reflex is to suspect this system to generate inflationary risk and to nurture
speculation. The first risk only exists in case of generalized failure of the LCPs or embezzlement of the
funds since liquidities will be gradually injected in the economy as ‘real wealth’ produced by the
projects. But the existence of a Supervisory Body to certify the projects provides a good safeguard
against this risk. As to the second, it is controlled by the fact that the total volume of carbon-based
liquidities is bounded by a given amount of emission reduction and by the fixed value of the SVC.
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More difficult to address is the legitimate fear of diplomats regular to climate negotiation to venture
it in uncharted domains. It can be overcome only if this perspective might get support amongst
climate agnostic policy-makers because they are convinced that it might contribute to a stable
monetary order in these times of knife-edged equilibrium between monetary laxity fueling
speculative bubbles and monetary rigor fueling sluggish growth.
3.1 Economic rationale of an international recognition of Carbon Assets
Figure 1 visualizes one major problem of the growth regime triggered as soon as deregulation has
started: the ‘Great Moderation’7 of business cycles and financial cycles of far larger magnitude and
far longer times span than in the past 8. Financial cycles are measured by the gap relative to trend of
an index combining credit growth and asset prices (a mix of equity, bonds, real estate price indices).
Figure 1. Business and financial cycles in the US (1980-2011)
This misalignment, over decadal periods, of asset prices and very long run benchmarks has pervasive
efficiency costs. Together with the volatility of exchange rates, it swamps the signals on which
investors should base their decisions. It is propelled by private credit dynamic fed and its magnitude
is caused by the self-fulfilling beliefs of market participants that prices will go on moving the way
they have gone just before. Financial intermediaries are governed by the same self-fulfilling
expectations as their borrowers; they lend money to finance speculative positions on asset prices
and took the assets as collaterals of their loans. More credit thus led to higher asset prices, higher
value of collateral and lower perceived risk premiums on loans.
The asset prices thus cannot be vectors of adjustment in the macro economy. Their volatility
exacerbates real disequilibria, as shown by the cumulative global imbalances in the balance of
payments and in the balance sheets of financial institutions, which receded only in the financial crisis.
The first appearance of the label “great Moderation” can be found in the paper by James Stock and
MarkWatson (2002), “has the business cycle changed and why?”, NBER Macroeconomics Annual.
See also P.M. Summers (2005), “What caused the great Moderation? Some cross-country evidence”. Federal
Reserve Bank of Kansas City Economic Review, n°90
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Schularick M and Taylor A. (2009), “credit booms gone bust: monetary policy, leverage cycles and financial
crises, 1870-2008”, NBER Working Paper, n°15512
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Price reversals arise only through crises that are endogenous as “booms gone busts” while unknown
tipping points shift the mood of market participants from euphoria to panic.9
If the macro prudential policies are not strong enough to mitigate the impact of the reversal in asset
prices, finance is not self-stabilizing and a monetary policy only focused to low inflation alone is not
conducive either to macro stability. Real imbalances are even magnified by the Great Moderation in
inflation, because the huge gyrations in asset prices are real price changes10.
One response is a renewed version of the Chicago Plan but it is politically demanding since it implies
that banks are treated as public utilities. To be safe in any circumstances, banks would be required to
buy Treasury securities for a large share of their deposits and lend only to highly-rated borrowers.
The bulk of credit would then be channeled through from securitized lending and corporate bonds.
Narrowing the scope of bank activities, this plan widens the role of financial intermediaries on the
wholesale money market with shadow banks playing the role of liquidity suppliers. It thus moves
fragilities from one compartment of the financial system to the next.
Another response is to anchor money on a basket of commodities like in the Keyne’s Bancor proposal
at Bretton-Woods. The obstacles to such a Bancor remain but carbon-based assets have the
advantage of incentivize financial intermediation to do its job of financing the real economy instead
of pursuing capital gains magnified by higher and higher leverage. They are not a substitute for
stricter financial regulation and will not suffice in preventing financial crises which arose even in the
Gold Standard era. However, they can contribute to the search for a more stable financial context
and this is the reason why, although the issuance of carbon assets should result from the voluntary
initiative of countries, their international recognition matters.
Carbon assets would then de facto acquire the status of world reserves and this opens a wider
perspective to lower one source of tensions in the economic globalization process, i.e. the distortions
in exchange rates due to the ‘‘war-chest’’ of official reserves accumulated in the emerging world
after the 1980s/1990s financial crises in Latin America and Asia. Those reserves invested mainly in US
Treasury securities were built to protect export-led growth strategies against exchange-rate
appreciation and as self-insurance against currency crises. Carbon-based reserve assets could allow
these economies to increase and diversify their foreign exchange reserves in a way conducive to
cooperation against a global externality. This concern was underlined by Zhu Xiaochuan, the
governor of the People’s Bank of China when he called for a SDR reserve-based system in 2010. C.
Jaeger, A. Haas and K. Töpfer (2013) show how this proposal could contribute to sustainable
development.
9
Adrian T., Covitz D. and Liang N. (2013), « Financial Stability Monitoring », Fed NY Staff Reports, n°601,
February
10
Michel Aglietta (2014), “l’aggiornamento des politiques monétaires”, in les Banques Centrales,
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If countries with non-convertible currencies have access to internationally recognized carbon-based
assets, they would be less inclined to run balance-of-payment surpluses, since they would get their
reserves in proportion to emission reductions they finance domestically.11
3.2 Clearing up a foggy business environment and getting the world out of the doldrums
The virtuous cycle cannot be fully understood without coming back to the paradox of the current
coexistence of a vast pool of savings and of over-indebtedness and its impact on real economies.
Since the financial crisis the world economy has languished. The stimulating plans after 2009
succeeded in supporting 3% growth rate in the US in 2010, after two years of recession. But this rate
was only 1,8% in 2011 and 2.5%,in 2013, fostering a debate on “secular stagnation”. Real GDP growth
of EU-27declined to 0.6% from 2007 to 2012 and an almost zero growth is in 2013. The large
emerging countries (Brazil, India and even China) suffered a lackluster performance in 2013,
expected to be prolonged according to the latest World Economic Outlook (April 2014).
One key underlying mechanism is the deleveraging of the private sector. Planning horizons of firms
and households have not adjusted to the length of the downward phase of the financial cycle and the
economic landscape has become fragmented in developed countries. Households are still digesting
the impact of the property bust in many countries. Small and medium size enterprises struggle to get
credit, while big corporations are awash with cash they do not know how to use productively. As a
consequence investment has decreased more than overall growth (-14% in the EU from 2008 to
2012).
A carbon-based financial architecture, instead of crowding out productive investment, could thus
help overcoming the ‘‘Buridan’s donkey dilemma’’ by indicating where to invest in this subdued
business climate. This will be of interest for the pension funds for example which currently tend to
avoid getting involved in investments that look safe while masking ventured assets.
A natural question is why not to rely on price signals given by carbon trading systems. The answer is
that, for investments on long lived infrastructures, these signals are swamped by the regulatory
uncertainty about the long run carbon prices, the currency exchange rates and the strategies of
OPEC countries (Waisman et al., 2013). A carbon based financial device could overcome the part of
these uncertainties through transmitting upfront the social value of avoided carbon emission.
To understand why this transformation of the financial system might trigger a “green growth” regime
let us recall, with Schumpeter, that financial crises pinpoint transitions in growth regimes: the
upward momentum preceding crises piles up distortions in market structures and income
distribution, while the downward phase is the search for adaptating to an incipient innovation wave.
Industrial revolutions are the sources of long-term growth cycles. They reshape capital accumulation
over the long run and transform the consumption patterns and the social institutions. However a
new wave can take off only when its promises have captured the animal spirits of finance.
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This would also spread the gains from seigniorage and reduce the perverse effect that forces the United States
to pump out more US$ assets forglobal reserves.
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The capacity of low carbon transition to be a frontier of innovation supporting a new growth regime
is real because the concerned sectors (energy, transportation, buildings) represent a dominant share
of investments and because they are critical for social inclusiveness and for an inward oriented
growth. Over the past decades emerging economies grounded their economic catching up on exportled strategies sometimes at cost of backwardness of domestic infrastructures. Since 60 % or more of
carbon savings investment (World Bank 2009) would take place in developing countries, a carbonbased finance would reorient domestically a fraction of the savings that currently flow into the world
financial system. A more ‘‘endogenous,’’ inward oriented, growth pattern might become less risky
political and economic reasons, thanks to the expansion of domestic investment opportunities.
3.3. Reconciling well-perceived nation’s interest in an adverse context
The perspective described in this paper will never reach the diplomatic agenda, unless it is perceived
by the high level policy-makers as responding to the specific problems of each region.
Let us start with the emerging countries which exert de facto a vetoing power, because their lack of
involvement is a convincing argument in the US and the EU to mobilize public opinion against
significant international commitments. Actually, these countries have the same interest in receiving a
support to redirect their infrastructure policies towards low-carbon and less energy-intensive choices
(Shukla and Dhar, 2011). This is a matter of energy security, of inclusive regional and urban
development and of less exposure to turmoils of currencies and domestic asset prices by sudden
changes in the direction of cash flows. China has a specific problem due to the inversion of its
pyramid of age between 2020 and 2030 and the fall of its saving rate12. It might be trapped, at this
time horizon, in a high energy intensive carbon pathway which might turn it vulnerable energy
shocks. This is why it has embarked in a new wave of reforms, including carbon pricing, urbanization
policies targeting multi-polar cities over 20 years and reducing energy and carbon intensity in
industry. It will benefit from an international system helping to reorient its savings and foreign capital
flows.
The Eurozone is currently debating about how complementing its ‘fiscal compact’ by a ‘green growth’
compact to reinforce a unity undermined by imbalances amongst partner countries. A carbon-based
money emission would help it to find the narrow pathways between monetary laxity and excessive
rigor and trigger an inclusive economic dynamic by creating jobs through the productive structure.
Such a policy has the additional merit of reducing energy intensity, abating carbon emission,
stimulate regional demand and diminishing dependency of Europe towards primary commodity
producers. Europe could thus match its own interest with a leading role in climate negotiations to
recover the leadership obtained with the Kyoto Protocol (Jaeger et al., 1998).
Policy lines might move in the US where multiple climate catastrophes, including Sandy that hurt
badly New York City, have revealed the decay of public infrastructures and the lack of public services
in adverse conditions. Yet, vested interests in the US bet on cheap energy due to massive investment
in fracking shale gas. The core issue is whether shale gas will be used as a “manna from heaven” to
maintain their historical development pattern, or as a tool to facilitate the switching towards low
12
Quote the IMF/WB report
13
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energy-intensive patterns. The upgrading of climate finance sketched in this paper might incite them
to follow the second option given its economic and geopolitical side-dividends.
One cannot either disregard the palatability of the suggested perspective for the oil and gas
exporters which are the other key players of a long term energy transition under climate constraints.
Depending on the design of the post-2015 climate regime (including the absence of effective regime),
they might perceive climate policy as a threat because of their adverse impact of the prices of fossil
fuels or as a way of escaping the resource curse by using long lasting rents to switch towards viable
industry, agriculture, transport and energy systems.
Conclusion
This paper delineates a carbon-based monetary device, which is tantamount for the central bank to
buying a service of carbon emission reduction at a price justified by the politically agreed SCC, and
eventually society’s willingness to pay for a better climate. Carbon-based liquidities can be therefore
considered as ``equity in the commonwealth''. The equity pays dividends in the form of ``actual
wealth'' created by productive low carbon investments and averted emissions in the short term, a
stronger resilience of the economy to environmental shocks in the longer term.
This device can produce tangible benefits over the short run through lowering the investment risks
on low carbon projects and policies and redirecting towards infrastructure part of the savings which
is currently floating in speculative investments. This redirection can foster what has been repeatedly
referred to as a Green Marshall Plan13. Whatever the metaphor, it remains that this redirection could
contribute to recover from the financial crisis without reproducing the drawbacks of past
development patterns. It could also contribute in turn to calming down some of the current and
future tensions in economic globalization by a more inward oriented industrial strategy in the key
emerging economies, lesser risks of currency wars and less potential conflicts about resources.
An additional note has to be made in this conclusion about the link between this mechanism and the
common but differentiated responsibility principle. Pragmatically this would be done through the
rules adopted for ‘carbon assets issuance’ and through the share of carbon assets contributing to the
Green Climate Fund. Perhaps as importantly, if another share of these carbon assets are accepted as
an additional countries contribution to the IMF accounts, OECD countries would them accept to
support the consequences of their past responsibilities not only in climate change but also in the
triggering of a financial crisis of an unprecedented magnitude since 1945.
One counter-argument might be that such reforms exceed the competences of the Climate
Convention and that the approach developed in this paper is a diplomatic non-starter. But, ignoring
the importance of climate finance to break the mistrust circle that blocks climate negotiations and
the adverse economic context that impairs generous large scale North-South transfers is also a
diplomatic non-starter. Actually a fully-fledged system is not needed over the short run. What is
needed is to launch a virtuous confidence cycle, even though only modest steps can be walked at
13
Find references … incuding Thomas Schelling
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COP21. To do so, it will suffice that a group of countries takes the initiative of creating carbon-based
assets under the UNFCCC and of demonstrating the palatability of a system on which the climate
agnostic policy-makers will be interested in hanging on deeper evolutions of the financial systems
and of the economic globalization over the century. The overall perspective is to allow for the
continuation of the ‘commerce of promises’ but to ground it on something recognized of value, the
avoided climate change damages and the development benefits of the corresponding infrastructures.
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Appendix 1: The banking canal of the monetary device
Tables 1,2, 3, and 4 offer a numerical example of the balance sheet consequences for the central
bank and a commercial bank of a 1000 loan to a low-carbon entrepreneur expected to realize 10
units of CO2 emission reduction. The SCC is set at 10, which values the expected emission reduction
at 100.
Table 2 indicates that the loan to the entrepreneur is divided into two credit lines. On the first line,
the commercial bank borrows 900 deposits at rate rd and lends 900 at rate rl. The second line refers
to the 100 liquidities equivalent to the value of expected emission reduction lent by the central bank
to the commercial bank that can be paid back with certified emission reduction. Prudential rule
about minimum capital requirement only applies to the first credit line (900 rl), as a zero coefficient
risk is applied to the line coming from the carbon-based liquidities. Then net worth increase of the
bank should only be +0.08*900rl instead of 0.08*1000rl as in the BAU case, that is the funding of a
conventional project.
The central bank owns a new 100 claim on the commercial bank. Thanks to the 1000 loan, the
entrepreneur launchesa project with expected returns RLC which makes the total expected revenues
amounting to 1000 RLC. Two lines appearIn the liability side of the entrepreneur’s balance sheet
corresponding to two types of debt: 900 will be paid back with the monetary revenues of the
projects and at the interest rate rl, and 100 paid back with effective emission reduction14.
14
In this example, we assume the project realizes the 5 units of expected emission reductions.
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Table 1: Balance sheets at the opening date of the low-carbon loan
During the pay back period of the loan, the entrepreneur gradually reimburses the loan with
monetary revenues of the project as suggested by table 3. As the project realizes emission
reductions, the entrepreneur receives carbon certificates.
Table 2: Balance sheets at mid-maturity of the low-carbon loan
At the end of loan maturity, table 4 indicates that the entrepreneur has paid back the entire 900 debt
with the monetary revenues of the project and has gotten 10 CC for the emission reduction her
project has achieved. Capital constraint for the commercial bank gets null and only the second credit
line remains unchanged in the balance sheets.
Table 3: Balance sheets at the end of the payback period of the low-carbon loan before the asset
swap
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The last step of this process is an asset swap performed by the central bank who accepts the 10 CC as
repayment of its 100 financial claims. This results in cancelling out the second credit line
corresponding to the “carbon debt” of the low-carbon project. Total amount of carbon-based
liquidities that the central bank can issue is reduced by 100.
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Table 4: Balance sheets after the carbon asset swap
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