Because "stagflation" sounds a hell off a lot scarier than "recession," you'll probably be hearing a lot about it in the financial media over the coming weeks. By definition, stagflation is a period of time characterized by high inflation and slower growth. This presents a major problem for central banks, as they need to decide which problem (growth/inflation) to tackle first. Periods of extended stagflation can cause great damage to central bank credibility because, when economies go sour and politicians start playing the blame game, central banks are the obvious (and easiest) targets.

If Morgan Stanley is correct about the link between climate change and stagflation, it means that climate change could indirectly damage central bank credibility. This could have important implications for the European Central Bank and the Euro currency.

"The role of the European Central Bank might prove to be the most controversial of the next decade. While one can argue that the economies of the euro zone, from Naples to Helsinki, are no more diverse than those from Boston to Birmingham in the US, "the United States has a political unity to go along with a common currency," says Floyd Norris in a New York Times editorial. He continues:

All that means that the challenges confronting the European Central Bank in bad times could be of a different order of magnitude than those that confront the Fed, simply because the nonmonetary means of stabilization are less developed. It is conceivable that a prolonged economic downturn [in our case, stagflationary pressure caused by climate change] could lead one European country or another to elect a government that blamed the central bank and wanted out of the euro, thereby precipitating a crisis since no exit from the euro is supposed to be possible.

Is this why Europeans have been much more aggressive about implementing environmental policies than the United States? Is Brussels worried about climate change undermining the unity of the European Union? If this is the case, investors can expect Europe to step up its political commitment to alternative energy, which should be reflected in alternative energy valuations.

Of course, the European Central Bank will not be the only bank to take a beating if climate change causes an extended period of stagflation. What will happen if the mix of climate change and stagflation undermines central bank credibility to the point where markets start looking for alternative ways to manage currency values? If you want to profit from climate change, maybe you should ignore solar or wind power investments and just buy gold, the only true currency. In that case, buy GLD, an Exchange Traded Fund that tracks the price of gold.

Eric Johnston, once the president of the U.S. Chamber of Commerce, said that “the dinosaur's eloquent lesson is that if some bigness is good, an overabundance of bigness is not necessarily better.” Some experts claim that climate change wiped out the dinosaurs. If the world's climate is changing, will paper currencies go the way of the dinosaur?

Disclaimer: I have no currency or commodity exposures.

Climate Change  Currency  Eben Esterhuizen  Inflation 

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