International Finance Dilemma: Excess Liquidity Versus Freshwater Shortage

When Central Banks gathered in Washington, Frankfurt, and London last week, their central focus was response strategies to contain a double-headed crisis: hard-to-abate inflation and the potential onset of a global financial crisis. The focus was particularly sharp on monetary aggregates, financial conditions in the credit default swap markets and, in the case of the Fed in Washington, the volume uptake of the Bank Term Funding program. This collateralized relief program was created by the Fed in the aftermath of the Silicon Valley Bank collapse.

That same weekend Bern-based Swiss FINMA regulators and the Swiss Central Bank, in close cooperation with shareholders, key executives and global central banks, salvaged the fate of Credit Suisse (CS) by authorizing UBS to acquire the scandal ridden entity for $3 billion CHF. Topics “du jour” were the fate of the Credit Suisse as an independent institution and its CoCos. The $17 billion contingent convertible capital instruments, while senior to equity, were fully marked down to zero per regulatory language provisions of the instrument. The markdown protected the remaining CS common stockholder, prior to the takeover by UBS, but left many observers puzzled.

The common theme here was excess liquidity, as an outcome of more than a decadelong of quantitative easing (QE) policies and near-zero interest conditions. Banks pursued extra-risk, in the case of CS in the form of more malign banking practices, in search for extra-yield. When Central Banks started to adjust their monetary policies, certain financial institutions were wrongfooted and faced with virtual zero solvency positions. Others like CS were caught up in the contagion.

The next Monday morning, barely 100 miles away, the Intergovernmental Panel on Climate Change (IPCC) released its 6th Assessment Report out of Geneva. The report included the following:

“……Widespread and rapid changes in the atmosphere, ocean, cryosphere and biosphere have occurred. Human-caused climate change is already affecting many weather and climate extremes in every region across the globe. This has led to widespread adverse impacts and related losses and damages to nature and people (high confidence). Vulnerable communities who have historically contributed the least to current climate change are disproportionately affected (high confidence)…”

And on the other side of the pond, a report by the Global Commission on the Economics of Water was released at the start of the UN 2023 Water conference in New York the next day.

The report contained seven major recommendations in the face of water’s deepening connection with climate change and the loss of biodiversity, with each reinforcing the other. For the first time in 50 years heads of state gathered around the emergency topic of global freshwater water access.

The reaction of central banks and regulatory authorities could not be further from the concerns conveyed by the IPCC, the Global Commission’s report or the UN Water conference. There is still reluctance on the part of central banks to include manmade climate change and the ensuing freshwater supply shortage in the broader price stability equation. Central bankers are failing to pay attention to the physical (supply chain) disruption risks emanating from the several poly-crisis strands. The absence of deep system think leaves the hidden systemic risk unrecognized in the overall monetary review and decision process. This lapse in prudential concern and cautionary approach misses an opportunity to allow for risk repricing and re-allocation of capital to tackle a complex crisis threat at scale.

Under the noses of the central bankers and supervisors the Great Salt Lake, the Colorado river, the Rio Grande and the Rhine are drying out.

Further away, in Uganda, 38 million people (83% of the population) out of a population of 45 million population lack access to a reliable source of water.

Internationally, a 2018 study, declared eight rivers where the risk of strife over the use of limited water access is particularly intense: The Nile, Euphrates, and Tigris, as well as the Ganges, Brahmaputra, Indus, and Colorado Rivers.

When will central bankers, supervisors and global financial markets take a more responsible and accountable role in climate change and strategic water management? When will droughts and freshwater water access be calibrated as risks, potentially impairing supply chains with vast potency to disturb price stability?

How could that strategic void be brought to the forefront of the international financial architecture review process?

The global water crisis, in line with Global Commisions’s report, brings three essential truths to the surface:

First, the mortgaged access to global freshwater sources is creating economic, social, and political instability. Second, the scale and impact of extreme conditions is unprecedented in human history. Third, policymakers and financial organizations lack tools and means to adequately respond to the challenge.

So, which measures could the global finance undertake and what should the international financial architecture review process recommend?

· World Bank

o The Global Commission on the Economics of Water recommended a redesign of the multilateral governance of water.

o At the upcoming IMF/World Bank spring meetings global strategic water management should be positioned under the immediate remit of the president of the World Bank.

o The World Bank, in cooperation with regional multilateral development banks, should play a leading role in procuring long term financing in the form of Just Water Partnerships. The proceeds should foster investments in water access, resilience, and sustainability in low- and middle-income countries.

o The World Bank could undertake a global monitoring by releasing a monthly color-coded dashboard of the major freshwater supply stress points, including overlay of emerging trends and identification of major water users. The research undertaken by the Global Institute of Water Security at the University of Saskatchewan would be a solid starting point.

· Central Bank Monetary Policies

o If central banks are assumed to be focusing on price stability, could they also consider next to Green Targeted Long-Term Operations (TLTROs), per initial proposals stipulated by Rens van Tilburg and Jens van ‘t Klooster, blue Targeted Long-Term Operations? The facilities would offer eligible banks preferential rates to fund customer loan activity aimed at building or improving water infrastructure, circular water waste management loops and innovative water capture technology. Such focus should address future price inflation caused by excessive water shortages.

· Private Equity Companies

o Water management, steered as a common good, used to be managed by utilities. Recent privatizations saw ownership transfer into the hands of global, private equity and wealth management firms. In the case of the UK, the water industry, a key security asset, is now 70% in foreign owned per findings of Dr Kate Bayliss, affiliated with the department of economics at SoaS University of London.

o Weak regulation and revenue extraction have been prioritized over longer term infrastructure investments. Enhanced regulation could impose a ban on share buy backs and dividend pay outs by the underlying portfolio companies. The ban could be lifted until sufficient annual capital expenditure is deployed to address leaks, overuse of raw sewage discharge and increased contribution to high quality recycled water supply.

· Regenerative Agriculture Practice

o The Global Commission on the Economics of Water endorsed the removal of water subsidies to the farm industry to the tune of $700bn.

o Agriculture in California, for example, uses 80% of the state’s water supply. In Texas, the Rio Grande, due to excessive water use by farmers, did not reach the Gulf of Mexico for the first time in history in 2000. How could indigenous peoples’ water management expertise be re-applied? How could water intense fruit and foods, the likes of avocados, pistachio nuts, and alfa-alfa (food for livestock) be cultivated through less water-intense practices? Should they be limited, until then, to domestic consumption, and subsidies curtailed, ensuring water consumption is recognized as a scarce resource?

· VC and Water Tech

o How could the comprehensive life-support system for the International Space Station (ISS) centers be commercialized? The water recycling technology, consisting of specially designed filters and chemical processes, converts waste liquids, including astronauts’ urine and perspiration, into refreshing, drinkable water. The circular process, which produces 2,800 liters of water per year, is essential to keeping six ISS crew members in orbit and avoids considerable amounts of fresh water to be blasted off from Earth inside the Space Shuttle. Why is circular water waste management not a main feature in the overall industry? Is it still cheaper to pollute than to recycle wastewater?

o About 71% of the earth’s surface is water, of which 96.5% is salt water. How can Dutch startup Desolenator, expert in next level water purification, powered by the photons of the sun and without the use of any chemicals, be accelerated to scale? Or for that matter the ten selected top innovators from the Global Freshwater Challenge (World Economic Forum)?

o German Chriwa group specializes in customized water waste management. In Mecca, Saudi Arabia, the company used a combination of anaerobic and aerobic biological treatment to re-use wastewater to high environmental standards for a global soft drink manufacturer. How could this water filter technology be shared globally through smart franchising of their intellectual property?

· Shareholder Engagement and Differentiated Firm Valuation

o Semi-conductor companies in Taiwan and data centers in the UK attracted scrutiny because of their vast claims on drinking water supplies to respectively clean silicon wafers and to cool servers generating surplus heat. With the magnitude of the decarbonization and digitization processes, including digital media usage, the strains on water supply and access, if left unattended, will only augment.

o Ceres, in cooperation with a working group of investors, a range of NGOs and scientific stakeholders, has developed a set of six expectations for investors to deploy in their engagement with investee companies on valuing water.

o The six expectations center around water quality, water quantity, ecosystem protection, access to water and sanitation, board oversight and public policy engagement.

o How could Wall Street adjust fairness opinions and firm valuation methodologies to positively account for both nimble carbon and water usage footprint?

Conclusion

Central banks are currently bogged down by crisis management imperatives, attempting to stave off further consumer price escalation and wider financial crisis contagion. Central banks have not been spurred by the prospect of the poly-crisis, of which freshwater supply access is a substantial thread, to start addressing systemic problems for the long term.

The international financial architecture review process could change that path, by recommending that excess liquidity, offered by the QE policies, be redirected towards increased capital and infrastructure funding needs for global water management. The recommendations are urgent to avoid undue price inflation, social misery, and cross border strife. A start could be the review of global water management as part of a new remit at the World Bank.

In the meantime, nothing prevents individual initiative to scale down personal water use of 150 liters (15 buckets) a day, a UK statistic, to 100 liters (10 buckets) a reduction by 30% with easy to implement changes.