Macro risks

Climate change is an example of macro risk. Some of its impacts, especially financial, need to be considered, eg

- losses in insurance system (the insurance system is the economy's shock absorber, ie its role is to spread the impact of losses from those affected to those with the wherewithal to bear the shock.

"...In good times, the insurers earn handsome returns from accepting this risk. They cover their own liabilities by taking out reinsurance, further spreading losses......the business is profitable as long as the risks remain within familiar limits and largely uncorrelated with each other..."

Adam Tooze 2019)

- Algorithm risk

"...By removing human oversight from important decision-making processes......relying on machine-to-machine interactions, governance and transparency become inherently difficult. Any flaws in algorithm......were difficult to spot or fix......these risks increase with the use of machine self-learning techniques, which impart greater predictive power to the algorithms but make them significantly more complex. This opaqueness is already being targeted by cyber criminals seeking to corrupt either the algorithm, or data used to train it, in order to manipulate its conclusions..."
Geoff Summerhays as quoted by Alice Uribe, 2018

This is further highlighted with the emergence, and significant increase in use, of advanced data analytics and AI in a range of activities such as loan applications, insurance underwriting, etc.
The ramifications for business, government, society, etc are huge, especially when biases occur and there is poor learning from the AI.
"...AI capabilities are growing at an unprecedented rate and despite having beneficial applications, vigilance is required from policymakers and technical researchers to prevent and mitigate malicious uses..."

Report entitled The Malicious Use of Artificial Intelligence: forecasting, preventing and mitigation as quoted by Alice Uribe, 2018

Some examples of malicious use include
- trying to influence the 2016 US presidential election
- online ad for high-paying jobs gave a bias to men

There is the need to
"... Create comprehensive inventory of algorithms and risk controls as well as documentation setting out strategy, architecture and kill-switch control procedures - to challenge and mitigate any potential risk..."
British Prudential Regulation Authority as quoted by Alice Uribe, 2018

Safety (stability)

The Australian Reserve Bank has a sharp focus on financial safety and stability, rather than competition.

- climate change liability (green agenda;

"...Since the 1980s, the scale of weather-related insurers' losses has risen fivefold to around $US 55 billion a year. Uninsured losses are twice as much again......a recent modelling exercise by the ratings agency S&P suggested that the insurance industry may still be underestimating possible losses from extreme weather by as much as 50%......research sponsored by Lloyd's of London calculated that the 20 cm rise in sea level near Manhattan in the previous decades increased the insured losses inflicted by hurricane Sandy in New York by 30%......potential changes in average annual temperature, whereas a 2°C world might be insurable world, a 4°C world certainly would not be..."

Adam Tooze 2019)

If climate change becomes a problem

"...Disaster will be so frequent that there will be no alternative to either abandoning insurance protection or to nationalise risks and transfer them to taxpayers at large..."

Adam Tooze 2019

"...From the viewpoint of humankind's collective seems obvious that the world needs in every possible way to mitigate the risk of climate disaster. But that comes with its own costs, so-called 'transition risks'..."

Adam Tooze 2019

On the other hand, decarbonisation will offer new business opportunities for renewables and low carbon technologies.

"...There is no reason why environmentally sustainable economy should be one of zero growth. Nevertheless, there are bound to be losers. Investment in renewables is not free. If undertaken on the scale needed, which will run into tens of trillions of dollars over several decades, it will squeeze consumption and investment spending in other activities..."

Adam Tooze 2019

- problems of stranded assets (eg legacy energy assets like fossil fuel reserves (oil, gas, coal, etc) will need to stay in the ground to handle climate change. This will mean around $US 28 trillion in lost revenue. Yet

" third of equity and fixed income assets issued in global financial markets can be classified as belonging to the natural resources and extraction sector as well as carbon-intense power utilities, chemicals, construction and industrial goods firms. Decarbonisation will essentially ground these and associated assets..."

Adam Tooze 2019

Hyman Minsky developed a way to understand the 2008 financial crisis

"...The way that unsustainable financial bubbles tend to expand on waves of confidence and then burst, threatening not just a recession and financial heart attack, a crippling blow to bank balance sheets that radiate to the entire economy..."

Adam Tooze 2019

Need to be careful of unleashing uncontrollable financial chain reactions, like in 2008.

The decline of the coal industry has led to a string of bankruptcies and did not trigger a system-wide crisis. In the developed world, coal has already been priced out of the market by much cheaper gas, oil and renewables. Oil is another problem as it is cheaper and very convenient; ending its consumption will require deliberate government action.

The resistance by the fossil fuel interest groups to block things like proactive decarbonisation, etc will only increase the risk of a buildup of large-scale stranded assets.

There are 2 divergent economic scenarios for the transition away from fossil fuels, ie

i) active government involvement (government regulates for zero emissions like taxes on carbon. This will encourage a move away from fossil fuels to renewable energy and full-scale decarbonisation

"...Fossil fuel assets face losses, but those losses are clearly identified and can be efficiently priced..."

Adam Tooze 2019

This will allow for a smooth transition.

China and India are 2 countries following this path, eg China has

"...government-assisted.....away from fossil fuels that prevents stranding of fossil fuel assets. Beijing has supercharged its solar, battery, and electrical car industry. But overall economic growth remains Beijing's main priority, and it has struggled to contain the runaway construction of coal-fired power plants by regional governments..."

Adam Tooze 2019

A similar story for India.

Since the global financial crisis, rather than look at climate change, central bankers and financial regulators have focused on macro-prudential regulation, ie overseeing private balance sheets, conducting resilience and stress tests with financial stability and resilience as their top priorities.

"...Central banks are using the same conservative approach to climate change that were lacking when it came to financial reform. In the years since 2008 financial crisis, they have perfected their tools of crisis management but without addressing the root cause of the problem: that banks are too big to fail. More than a decade on, they still are..."

Adam Tooze 2019

The central banks and financial regulators need to move beyond financial stability being the principal concern. They
"...Should instead be urgently exploring what they can do to alter the course of economic growth so that the world can rapidly decarbonise and thus prevent worse-case climate change - and the related financial fallout - in the first place..."

Adam Tooze 2019

ii) passive government involvement (governments talks only and takes no action, ie don't 'walk the talk', so fossil fuels still dominate in transport, electricity generation, etc, especially in developing countries. Oil exploration and fracking revolution continues.

"...the low cost of fossil fuels makes it hard to believe that politicians are serious about a zero emissions future..."

Adam Tooze 2019

The second scenario is a doomsday one, ie climate change will affect the very basis of human existence on this planet, eg most likely to create hundreds of millions of refugees

"...This kind of scenario - protracted denial followed by panic-driven decarbonisation - is what concerns......most. And it is closest to reality..."

Adam Tooze 2019

In summary

"...If the world is to cope with climate change, policy makers will need to pull every lever at their disposal. Politicians will need to abolish carbon subsidies and replace them with a steep and growing carbon tax. Only when carbon is properly priced will there be a major economic incentive to large-scale generate substantial private investment, governments will need to establish a credible commitment to decarbonisation..."

Adam Tooze 2019

NB It is of interest that in late 2019, the idea of a pandemic (COVID - 19) sweeping havoc throughout the world was not a general expectation for 2020!!!!!!

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