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Why is inflation rising and do we need to get used to it?

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At the beginning of 2020, governments around the world faced very difficult challenges and decisions.

What were they supposed to do?

Let people make their own decisions, knowing that this would have a dramatic impact on Covid related deaths?

Or impose lockdown restrictions, reducing the amount of deaths, but producing a serious impact in the economy?

Neither option was without consequences, and we now know that most governments around the world chose the second option.

So let’s explore the consequences that this had on the global economy.

The first one, and most immediate one, was a reduction in private spending. As people were forced to stay at home, their spending options were limited (although to be fair  this came alongside a huge growth in online spending habits).

Then came a dramatic increase in public spending, in the form of private and business subsidies.

And with that… the question in everyone’s minds: how are governments going to afford all these subsidies?

Financing Public Spending

Which brings us to the question at hand: how were governments able to afford the subsidies?

Well.. let’s explore this for a moment.

There are only three ways that governments can fund themselves:

  • Tax revenue
  • Borrowing (Debt)
  • “Print more money” (or the more technical term Quantitative Easing)

 

Tax Revenue

‘Most of us understand tax revenue. So we won’t spend too much time dwelling on this one. Suffice to say that when the economy contracts, increasing tax pressure on the private sector is a recipe for recession, so this was not an option.

Borrowing

Then comes borrowing, and many governments took as much debt as they were able to.

For example, in the 2021-2022 financial year, the UK alone borrowed £143.7 billions according to the Office of National Statistics.

By June 2021, New Zealand’s government had borrowed NZD$ 6.6 billions.

Australia borrowed an unprecedented debt amount estimated at AUD$ 400 billions, taking their debt to GDP rate from 20% to 40%.

But these amounts of money were not enough to satisfy the spending demands of governments during the pandemic, which leads us to the third “funding” method and the most controversial one.

Quantitative Easing (or “printing money out of thin air”)

Quantitative easing sounds complicated, but it’s actually pretty straightforward.

It basically means that the government buys back government debt (in the form of bonds), therefore increasing the value of said bonds and reducing the interest rates.

With lower interest rates, money becomes cheaper, therefore more lending is encouraged.

In short, QE is a way to increase the amount of money circulating in the economy.

It’s the kind of economic policy measure you would take if you were trying to get the economy moving at a faster pace.

And (pay attention here) is the exact opposite of what you would do if you were trying to reduce inflation, or avoid it altogether.

And here comes the million dollar question (or should I say the Billion dollar question?):

 

How much QE can you get away with, until you face the wrath of inflation?

This is a long standing debate between orthodox and heterodox economists (or Conservatives vs. Keynesians), and we are nowhere near settling the dispute.

And while we are trying to figure this out, here comes geopolitics to create the perfect storm.

War in Europe And The Rising Cost Of Food And Energy

The war in Ukraine comes with a dire consequence to the rest of Europe, UK, and the rest of the world.

Russia being Europe’s main energy supplier and Ukraine’s being Europe’s main food supplier, it’s not difficult to explain the grave consequences that this conflict has in the rest of the European economies.

The obvious (and direct) consequences are the rise in the cost of petrol and food.

But what about the indirect consequences?

Virtually every good and service in the economy requires two main supplies: food and energy.

Think about it… it’s not just the grocery and the service station bill. It’s everything else. Even a lawyer needs to eat and drive a car. So does the dentist, the store clerk, the school teacher and everyone else that participates in the economy.

The indirect consequence is a rise in costs in every chain and in every layer of the economy. Some businesses are able to absorb these increased costs, and some have no choice but to pass it on to their customers.

What Can We Expect In The Future? Is Inflation Here To Stay?

The answer to this question largely depends on the economic policies that governments are likely to adopt in the coming months and years.

Are they going to keep expanding the economy’s circulating currency so that people have higher wages and can afford rising costs of living?

This could become a slippery slope, and a self feeding loop with dangerous consequences, as more circulating currency creates pressure on prices, which triggers more inflation.

Or are they going to “bite the bullet” so to speak… and let their electorate deal with the consequences of inflation without taking alleviating measures?

The former seems unthinkable from a politicians perspective, while the latter could create even more economic trouble long term.

Only time will tell. In the meantime, it seems prudent not to discard a future with lingering (and maybe growing) rates of inflation.

Erin Sutton is an online blogger and writer, publisher of Best Catalogues, an online publication that helps UK shoppers make better and informed decisions related to spending and taking credit.

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CBDCs: the key to transform cross-border payments

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Dr. Ruth Wandhöfer, Board Director at RTGS.global

 

If you work in finance, you’ll have been hearing a lot about central bank digital currencies (CBDCs) and the moves different markets are making towards using, regulating and evaluating the viability of moving to an economy based on digital currency.

We are already seeing progress in the research, piloting and introduction of CBDCs into the financial system. The Banque de France for example, recently launched its second phase of CBDC experiments in line with the “triple digital revolution” unfolding in the financial sector. The infrastructures of financial markets and fintechs, however, are not prepared to accommodate their security, stability, and viability.

This could be an issue in the not too distant future. Each year, global corporates move nearly $23.5 trillion between countries, equivalent to about 25% of global GDP. This requires them to use wholesale cross-border payment processes, which remain suboptimal from a cost, speed, and transparency perspective. In fact, the G20 cross-border payments programme considers improving access to domestic payment systems that settle in central bank money, as one of the key components in facilitating increased speed and reducing the costs of cross-border payments.

The current state of cross-border payments

International transactions based on fiat are currently slow, expensive, and highly risky due to today’s disconnected financial infrastructure, messaging, and liquidity. Wholesale cross-border payment settlement can take 48 hours or longer, which is not practical in today’s digital world. Even if not every market moves to CBDCs, in an increasingly digital era, cross-border settlements between central banks will unavoidably involve dealing with CBDCs. So, not only will we have different currencies, we’ll have different technical forms of currency being exchanged – digital and fiat – as markets adopt CBDCs at different rates, adding another layer of complexity to cross-border settlements.

While there is much anticipation about the opportunities CBDCs can bring, the adoption of this technology will only be widespread if payment and settlement capabilities are overhauled to allow for new innovations in currencies.  This need for transformation represents an opportunity to redesign existing infrastructure to support cross-border CBDC transactions.

The current cross-border payments system involves correspondent banks in different jurisdictions using commercial bank money. Uncommitted credit lines used in cross-border transactions are a potential risk for any bank that relies on credit provided by a foreign correspondent bank. Interestingly, there is no single global payment and settlement system, only a complicated network of interbank relationships operating on mutual trust. While trust has allowed financial systems to function smoothly, when it begins to fail, as it did during the 2008 financial crisis, the result can be catastrophic.

Following the crisis, the Bank for International Settlements (BIS) implemented the Basel III agreement, which required banks to maintain additional capital against correspondent banking account exposures. These risk-weighted assets impose a costly capital charge on positions held by banks at other banks under correspondent arrangements. While this framework helps combat risk, it neglects to address the inherent problems in traditional correspondent banking that contribute to these risks.

Making the case for CBDCs

CBDCs can offer an improvement in settlement risks and are certainly thought to have potential benefits by the BIS. If implemented correctly, wholesale CBDCs can indeed accelerate interbank transactions while eliminating settlement risk. They can also encourage a more efficient and straightforward method of executing cross-border payments by reducing the number of intermediaries.

It is likely the evolution towards CBDCs will initially see the financial market supplement rather than replace existing payment instruments with new types of digital currency. CBDCs will coexist with current forms of money in a wholesale context, and their payment rails will also work alongside the existing payment systems. In simple terms, CBDCs will need to be linked to the broader capital markets ecosystem and applications such as securities settlement, funding, and liquidity.

If built with an innovation-first mindset, the future of banking infrastructure should provide full interoperability and convertibility between fiat, CBDCs, and any other type of digital money used in wholesale payments.

The future of CBDCs

To unlock the full potential of CBDCs, a ‘corridor network’ will need to be formed. This involves combining multiple wholesale CDBCs into a single, interoperable network under common governance agreed upon by all central banks involved. The legal framework of this platform would then allow for payment versus payment (PvP) or, where applicable, delivery versus payment settlement.

Practical wholesale CBDCs appear to be on the horizon, either as a supplement to existing financial systems or as part of a transition to a digital, cashless world. Looking ahead, central banks would benefit from collaborating with fintechs that provide innovative cloud native technology to enable seamless wholesale cross-border payments without interfering with the flow of funds. If wholesale CBDCs are to become a reality, fintechs must be prepared to accommodate them.

 

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Green growth: The unstoppable rise of climate technology investment

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With the investment community focusing more and more on renewable technologies, investor interest is at an all-time high. Ian Thomas, managing director, Turquoise, reviews the current investment landscape and highlights the opportunities for investors keen to capitalise on this growing trend.

Green, or climate, finance is a label for providers of finance who are supporting investments seeking positive environmental impact. The label covers investments in green infrastructure, venture capital investment in clean technologies and renewable energy. Green finance has grown by leaps and bounds in recent years, supporting public wellbeing and social equity while reducing environmental risks and improving ecological integrity.

Worldwide, energy investment is forecast to increase by 8% in 2022 to $2.4 trillion, according to a new report by the International Energy Agency, with the expected rise coming mostly from clean energy – $1.4 trillion in total. To put this rocketing figure into some perspective, clean energy investment only rose by 2% annually in the five years following the signing of the Paris Agreement in 2015. Energy transition investment has some way to go, however – between 2022 and 2025, to get on track for global net zero, it must rise by three times the current amount to average $2,063 billion. [1]

Turquoise has been active for almost 20 years as a venture capital investor and adviser to companies in the climate technology space that are raising capital and/or selling their business to a strategic acquirer. Reviewing current industry investment news, as well as drawing on examples from the portfolio of Low Carbon Innovation Fund 2 (LCIF2), managed by Turquoise, I have commented below the latest on the renewable energy trends most piquing investor interest.

 

Solar PV

Renewable power is leading the charge when it comes to investment, with wind energy and solar PV emerging as the cheapest option for new power generation across many countries, and now accounting for more than 80% of total power sector investment. Solar power is responsible for half of new investment in renewable power, with spending divided roughly equally between utility scale projects and distributed solar PV systems.

This huge increase in solar spending, which continues in spite of supply chain issues affecting raw material delivery, has been driven by Asia, largely China (BloombergNEF, 2022). Meanwhile, Europe is re-doubling its efforts to achieve an energy transition away from Russian gas and other fossil fuels, building on investment that was already rising steadily prior to the outbreak of war in Ukraine. Germany, the UK, France and Spain all exceeded $10 billion on low-carbon spending in 2021.[2]

 

Wind

Last year was a record year for offshore wind deployment with more than 20GW commissioned, accounting for approximately $40 billion in investment. The first half of 2022 saw $32 billion invested in offshore wind, 52% more than in the same period in 2021 (BloombergNEF, 2022). Taking into account also onshore wind, in 2021 investment was spearheaded by China, followed by the US and Brazil.[3]

In the UK, suggested targets include plans to host 50GW of offshore wind capacity, as well as 10GW of green and blue hydrogen production, by 2030. Investors will naturally be encouraged by proposals to simplify the planning process across the board for renewable projects.[4] France and Germany have also increased their offshore wind targets, signalling further support for investment.

 

Decarbonising housing: the business opportunity

The need to decarbonise residential housing, made all the more urgent by current energy prices, also offers substantial scope for investment. The gas price spike is naturally increasing interest in technology such as electric heat pumps, which had already enjoyed 15% growth in 2021 albeit from a very low base.

Recently, Turquoise announced an investment by Low Carbon Innovation Fund 2 (LCIF2) in Switchd, which operates MakeMyHouseGreen, a data-driven platform that allows homeowners to source and install domestic renewable energy generation, including solar panels and battery storage with other energy saving products in the pipeline. The investment will enable Switchd to roll out the MakeMyHouseGreen platform to a much larger number of customers. The latest episode of the Talks with Turquoise podcast series saw us interview Switchd co-founder Llewellyn Kinch about the UK energy market and national transition to decarbonisation, covering the rise of residential renewable energy and energy efficiency.

 

Adapting to the low-carbon economy

Meanwhile, investors should not forget opportunities on the other side of the energy market. Renewables are undoubtedly exciting investors, but there are also opportunities for fossil fuel companies to adapt their business models to the low-carbon economy. Turquoise advised GT Energy, a portfolio company from our first fund that develops deep geothermal heat projects, on its sale to IGas Energy, a leading UK onshore oil & gas producer. Under IGas ownership, GT Energy will progress its flagship 14MW project to supply zero-carbon heat to the city of Stoke-on-Trent through a council-owned district heating network.

 

A broad investment landscape

Forecasts show that renewables will increase to 60% of power generation in Europe by 2030, and 40% in the US and China by the same date.[5] As demand rises for climate technology, the investment opportunities in green finance are far broader than they ever have been. Undoubtedly, as the energy crisis continues, investor interest will continue to soar to even greater heights.

[1] https://www.iea.org/news/record-clean-energy-spending-is-set-to-help-global-energy-investment-grow-by-8-in-2022
[2] https://ihsmarkit.com/research-analysis/global-power-and-renewables-research-highlights-july-2022.html
[3] https://dialogochino.net/en/uncategorised/56938-global-wind-energy-council-vice-chair-brazil-offshore-wind-accelerating-2/
[4] https://www.edie.net/uks-clean-energy-investment-ranking-rises-after-government-sets-95-low-carbon-electricity-target-for-2030/
[5] https://www.spglobal.com/en/research-insights/featured/energy-transition-renewables-remain-the-cornerstone-of-future-power-generation

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