The Rise of Greenflation

Extreme weather and energy uncertainty are already sending prices soaring.

A worker spreads out coffee beans to be dried in the sun on a farm in Guaxupe, Minas Gerais state, Brazil, on Wednesday, June 2, 2021
Patricia Monteiro / Bloomberg / Getty

The McMansions of the mid-2000s might be the most American form of housing, but they were not, in general, grown in America. Although the United States is home to more than 200 billion trees, the type of lumber harvested from North Carolina to Mississippi warps and twists when used as a vertical stud. Eventually it will pop your drywall. So for our home-framing needs, Americans rely on northern spruce and fir felled up north, milled into lumber, purchased by men like Stinson Dean, a Colorado-based lumber trader, and placed onto railcars bound for Dallas, Atlanta, and Washington, D.C.

In that last boom, Dean remembers, the U.S. built 2 million homes a year, and lumber prices never got much above $450 per 1,000 board feet, within the tidy range they’d stuck to since he entered the business nearly a decade ago. Now, the U.S. can’t find enough lumber to complete more than 1.3 million homes a year. Meanwhile, lumber is back up to $1,200. “The price of lumber has tripled, but we’re producing 40 percent less homes,” Dean told me. There has not been a bigger gap, in fact, between the number of homes that builders are starting and the number that they’re finishing in decades.

Since the mid-aughts boom, the North American economy actually lost productive capacity. Dean has little doubt about what is to blame. “The lumber-price story is a climate story,” he said. If a series of climate-change-aggravated disasters—including a multiyear outbreak of bark-eating beetles, back-to-back record-breaking fire seasons, and a massive November flood that washed out rail lines—had not struck British Columbia, “sawmills would be able to treat this market just like they did in 2006,” he said. “The price would never get over $500.”

“There are people who say, ‘Climate change isn’t affecting me,’” Janice Cooke, a forest-industry veteran at the University of Alberta, told me last year. “But they’re going to go to the hardware store and say, ‘Holy cow, the price of lumber has gone up.’” Taken by itself, climate change’s role in driving lumber inflation would be a fluke. But worrying signs have started to appear that these dynamics are not limited to lumber. Both climate change itself and the inevitable policy response to it—the global energy transition to low-carbon fuels—are starting to drive up prices around the world. And the world may not have the right tools to deal with it.

Over the past year, U.S. consumer prices have risen 7 percent, their fastest rate in nearly four decades, frustrating households and tanking President Joe Biden’s approval rating. And no wonder. High inflation corrodes the basic machinery of the economy, unsettling consumers, troubling companies, and preventing everyone from making sturdy plans for the future.

Given all that, you would think economists have a good, detailed sense of why it happens. But the profession’s “dirty little secret,” according to Seth Carpenter, the chief global economist for Morgan Stanley, is that they cannot predict it with ease. Economists understand that inflation arises from an imbalance of supply and demand at the absolute highest level of the economy. They even have a pithy phrase about it: Inflation is caused by “too many dollars chasing too few goods.” The fault almost always lies with the dollars.

To better understand this, think of a fairy-tale kingdom where the royal alchemist succeeded in turning lead into gold, and the delighted king ordered the royal mint to smelt more coins with it. Then he tossed the coins out the window to the populace, begging them to love him. Assuming nothing else changed about the kingdom, the king’s would-be generosity would cause prices to surge.

Now, Biden is not a king, nor does he have an alchemist on staff. But some economists believe that he accidentally did something similar last year when he passed a $1.9 trillion relief bill into an economy still constrained by the pandemic. Flush with $1,400 stimulus checks but stuck at home, consumer spending on durable goods surged. But where was all that stuff supposed to come from? America’s overeager excess of dollars leapt into the world, chasing goods from factories shut down by the Delta variant and ports clogged with shipping containers.

But it also went chasing after … scarce lumber from Canadian forests. Some of the biggest causes of today’s inflation do not seem related to the sudden surfeit of dollars. The surge in dollars can’t explain why gas prices are so high or why coffee prices are spiking. Something else is going on.

For years, scientists and economists have warned that climate change could cause massive shortages of major commodities, such as wine, chocolate, and cereals. Financial regulators have cautioned against a “disorderly transition,” in which the world commits only haphazardly to leaving fossil fuels, so it does not invest enough in their zero-carbon replacements. In an economy as prosperous and powerful as America’s, those problems are likely to show up—at least at first—not as empty grocery shelves or bankrupt gas stations but as price increases.

That phenomenon, long hypothesized, may be starting to actually arrive. Over the past year, unprecedented weather disasters have caused the price of key commodities to spike, and a volatile oil-and-gas market has allowed Russia and Saudi Arabia to exert geopolitical force.

“This climate-change risk to the supply chain—it’s actually real. It is happening now,” Mohamed Kande, the U.S. and global advisory leader at the accounting firm PwC, told me.

Want to see what climate change is already doing to prices? Look to the prairie. Last year, the United States suffered through its hottest summer ever measured, finally breaking the record set during the Dust Bowl summer of 1936. In the northern Great Plains, searing heat—combined with record-setting drought—gave rise to swarms of grasshoppers that devoured the wheat crop. Those conditions helped push wheat prices to their highest level in years. Corn prices also rose 45 percent last year.

Or look to Brazil, which sagged under its worst drought in 91 years early last year. Water levels in the Paraná River, a major shipping artery, fell so low that cargo traffic was disrupted. Then in July, a surprise frost struck Brazil’s coffee belt, lacerating already drought-weakened arabica trees. Brazil produces nearly 40 percent of the world’s coffee. The cold snap damaged two years of crops at once, burning so deep into the trees that it fringed the buds that will become next year’s flowers. Coffee prices leapt on the news; today coffee is as expensive as it’s been in 10 years and double its 2020 levels. The companies behind Nescafé, Folgers, and Café Bustelo plan to raise consumer prices in response.

In Canada, the worst single-year drought since 1961 doubled pea prices, sending them to an all-time high. France’s water-logged and record-breakingly hot summer also helped push up global pea prices. (Alternative-meat products have made peas more in demand than ever.) In Germany and Belgium, days of torrential flooding killed more than 200 people and severely damaged the potato crop, contributing to last year’s price increase of 180 percent. (Climate change helped make the rainfall that caused those floods more likely, according to the World Weather Attribution initiative.)

Climate-addled droughts even affected the high-tech sector, Kande, the PwC advisory leader, said. More than half of the world’s semiconductors are made in Taiwan, most of them at a sprawling factory owned by the Taiwan Semiconductor Manufacturing Company. TSMC, which uses 37 million gallons of water a day, faced production uncertainty last spring when Taiwan experienced its largest drought in half a century and began rationing water.

That said, even when bad weather destroys a crop, it doesn’t always lead to inflation. Russia, the world’s largest wheat exporter, produced 9 million fewer metric tons of wheat last year than it did in 2020. But Russian wheat prices fell because the country couldn’t sell enough wheat to sustain them. And even though the drought in the United States sent cattle prices crashing as ranchers culled their herds, meat prices surged. Meat-processing companies passed none of the spread along to consumers.

Given all this, you can see why Wall Street and corporate executives are more concerned about climate change than ever. But it’s not just commodity prices that are up. The economy shows evidence of a new, more inflationary regime caused not only by climate change but by the fight over how to respond to it. And as the world has begun to transition—slowly, incompletely—away from fossil fuels, it has created imbalances in the energy system.

The first mismatch is between fossil-fuel supply and demand. According to International Energy Agency data, the world has dramatically reduced its investment in oil and gas production over the past few years. This hasn’t happened only because of climate change: Yes, investors are skittish about long-term fossil-fuel demand in a decarbonizing world, but they’re also angry that oil stocks have performed so pitifully over the past decade.

Yet the world has not reduced its appetite for oil. It has continued to invest in cars, trucks, planes, ships, and plastic-dependent factories at a voracious rate, according to the IEA. Nor is it investing in zero-carbon energy fast enough to pick up the slack from declining oil investment. In 2021, the world put only $755 billion into the energy transition. By any historical measure, that was a bonanza amount—but it must more than quadruple, to $4 trillion, in the next decade for the world to avoid more than 1.5 degrees Celsius of warming while meeting its energy needs, the IEA says.

These mismatches have allowed oil producers to remind the rest of the economy of their power. Oil prices, now at their highest level since 2014, have made up 27 percent of the “excess” inflation since the pandemic began, according to the financial journalist Matthew C. Klein. Yet despite widespread Democratic agreement over its terms, Congress has not yet passed President Joe Biden’s climate and energy package, which could start to relieve this mess. If the mismatch between producers and consumers continues, higher oil prices—and higher prices for energy in general—could stick around for a long time.

That would be bad for prices. Although economists disagree over the role that fossil fuel plays in creating inflation, there’s little doubt that high oil prices trickle down to higher costs in the rest of the economy. When oil and gas prices rise, farmers need to spend more to tend their fields (because diesel prices go up), and to fertilize their crops (because synthetic fertilizer is made with natural gas), and to get their goods to market (because the packaging is made of plastic). The only way to break that cycle of cost increases is to move away from fossil fuels. But oil producers have demonstrated that they will get a veto over that transition as well.

How to respond to these problems? The U.S. government has one tool to slow down the great chase of inflation: Leash up its dollars. By raising the rate at which the federal government lends money to banks, the Federal Reserve makes it more expensive for businesses or consumers to take out loans themselves. This brings demand in the economy more in line with supply. It is like the king in our thought experiment deciding to buy back some of his gold coins.

But wait—is it always appropriate to focus on dollars? What if the problem was caused by too few goods? Worse, what if the economy lost the ability to produce goods over time, throwing off the dollars-to-goods ratio? Then what was once an adequate number of dollars will, through no fault of its own, become too many.

Imagine, now, that the kingdom’s outlying farms were destroyed by a dragon: The price of food would increase inside the castle walls, but it would be the dragon’s fault, not the royal mint’s. And the solution would be neither to raise taxes nor to slow the minting of coins from the king’s mines. In fact, if the king tried to claw back coins, then he could prolong the crisis: The townspeople would still use their meager earnings to bid up the price of food, but they would have less money to do it with, so everyone would be poorer and hungry. The king would instead need to import more grain, or ration out supplies, or plant more farms (hopefully in dragon-proof regions).

Though it might sound silly, the modern global economy is closer to that fabled realm than we might think: Yes, container ships and jumbo jets connect far-flung farms and factories to consumers, which has permitted a planetary smoothing out of prices. But ultimately globalization has stretched the castle walls as far as they can go, and the realm remains dependent on certain key and vulnerable places. A single woodland province furnishes timber for most American homes; a single highland country grows nearly half of the world’s magic beans; a single foundry on a distant island makes most of the thinking rocks that go inside American phones. Yet if something were to happen to the supply of goods from those places, we always have the same answer: The royal mint can fix it.

In truth, some combination of the two fairy tales now besets the American economy. The king probably threw too many free coins out the window last year, and some of our outlying lands are dragon-scarred. Yet if the climate scars on supply continue to grow, does the Federal Reserve have the right tools to manage? Stinson Dean, the lumber trader, is doubtful. “Raising interest rates will blunt demand for housing—no doubt. But if you blunt demand enough to bring lumber prices down, you’re destroying the economy,” Dean told me. “For us to have lower lumber prices, we can only build a million homes a year. Do you really want to do that?

“Raising rates,” he said, “doesn’t grow more trees.” Nor does it grow more coffee, end a drought, or bring certainty to the energy transition. And if our new era of climate-driven inflation takes hold, America will need more than higher interest rates to bring balance to supply and demand.