Integrating Ecological Risk into Sovereign Credit Ratings

The United Nations Economic Program’s Financial Initiative (UNEP-FI) in collaboration with the Global Footprint Network and a number of leading financial institutions, has decided to investigate the linkages between ecological risk and sovereign credit risk.1 This is a long overdue step towards greater transparency in global bond markets and a fresh affirmation of the new renaissance thinking in business and economics.

That renaissance is defined by a shift from narrowly focused linear thinking to more holistic non-linear thinking. To sovereign credit analysts it means looking beyond narrow measures of economic health, such as GDP, to more complex indicators of systemic health, which increasingly impact future GDP and debt carrying capacity.

According to the collaboration’s overview: “The project aims to assess the financial materiality of ecological risks relevant for the credit risk evaluation of government bonds, and to develop a methodology to enable credit rating agencies, investors and financial information providers to integrate ecological data in their respective models.”

The UNEP-FI collaboration continues a theme introduced in my March 2009 essay, “From Systemic Collapse to Rebirth,” concerning the acceleration of financial risk as the ecological footprint moved into overstep.

Disturbing Correlations

In 1985 the ratio of debt/GDP in the US was roughly 2.08 meaning there was roughly twice as much debt in the system as there was GDP. Derivative trading at the time was not formally measured because it was used primarily for hedging currency or commodity risk, in which case the notional value of derivatives outstanding was probably much less than GDP.

When I looked at these two financial leverage ratios against ratios of GDP/bio-capacity over successive 5-year periods it became clear that ecological overstep had a magnified impact on financial risk. In the 23 years between 1985 and 2008 while ratios of GDP/bio-capacity grew by roughly 39%, the US debt/GDP ratio grew by 74% and the derivatives/GDP ratio exploded at least 11-fold.

The same general pattern holds today. In the 25 years since 1985 the ratio of GDP/bio-capacity grew by roughly 50%, but the derivatives/GDP ratio increased more than 17-fold.2 Because of the secrecy and dubious accounting of government economic bailouts, an accurate debt/GDP ratio is difficult to compute; but anecdotal evidence suggests this too has vaulted much higher.

Consider the forced August 22 disclosure of $1.2 trillion in Federal Reserve advances to some elite Wall Street banks a fact Bloomberg uncovered in a Freedom of Information Act battle with the Fed. This sum was in addition to: the $16.1 trillion in emergency loans disclosed by the first-ever (one-time only) GAO audit of the Fed under the Dodd-Frank Act; the $2 trillion quantitative easing program; and the $700 billion Troubled Asset Relief Program (TARP). Add it all up and we get $20.1 trillion in rescue operations roughly 1.4 times the nation’s GDP.

Based on this information is it any wonder that Standard & Poor lowered the credit rating on US government debt? Or that The US once considered the world’s safest credit risk has fallen to 15th place in the Euromoney Credit Risk rankings.3

The UNEP-FI focus on sovereign debt is timely because governments are increasingly called upon to bail out politically powerful corporations. Such bailouts shift the burden of private sector liabilities onto taxpayers and government bondholders without addressing the fundamental question of ecological overstep.

The Emerging Renaissance in Economic Thinking

The UNEP-FI collaboration reflects an emerging trend in economic thinking: that perpetual growth in resource consumption is impossible on a planet with finite resources. The incontrovertible fact is: world supplies of oil, water, minerals, forestland, arable soils and fisheries are limited. When these resources get pushed beyond their capacity to regenerate, we, and the ecosystems on which we depend, cannot survive.

This awakening is transforming our worldview from one of humanity in control of Nature (anthropocentric) towards one of living and working in harmony with Nature (bio-centric). The earlier command and control mindset was an extension of Newtonian physics, which led us to believe that our knowledge of science and our technological innovation made us pre-eminent. The new thinking is metaphysical in the sense that it seeks a deeper understanding and appreciation of our inherent relationships with the web of life.

The Golden Rule of doing to others as we would have them do to us is central to this metaphysical awakening. Such thinking looks to the value of whole systems as distinct from the physical objects that we can measure or control. It is concerned with the unity of all things rather than the value of isolated components at a given point in time. In these respects it resonates with the moral reasoning of all cultures and religions.

Debt as a moral system

Whether we borrow from a lender or borrow from the earth, we are morally obliged to repay in order to maintain the health and continuity of the system. The UNEP-FI group implicitly recognizes this. By relating sovereign credit risk to ecological risk, they move us in a more moral, sustainable direction and set a new standard of economic behavior.

  1. For more information, see:
  2. At mid-year 2011 the top 25 US banks had a notional $249 trillion in derivative contracts outstanding nearly 17 times national GDP of $15.0 trillion. (For derivatives exposure, see Table 1 at:
  3. Andrew Mortimer, Euromoney Country Risk September 2011: Emerging sovereigns converge with the US, UK and France,” Euromoney Magazine, September 30, 2011.