Wednesday, October 22, 2008

Market meltdowns and the drawbacks of trading carbon

There are valid economic arguments on either side of the carbon tax vs. cap-and-trade debate. If implemented properly, either policy instrument could accomplish the goal of pricing carbon and gradually reducing greenhouse gas emissions.

One common conclusion after the Canadian Liberal Party's electoral drubbing is that a carbon tax will never sell. It is deemed a political loser, because of the public's knee-jerk reaction to any invocation of that dirty little three-letter word. People much prefer the idea of industrial caps on emissions and a market system. Let the market solve the problem, not the government is a common refrain.

Right. How well are our markets do today?

There's a reason that many of the major investment banks from Goldman Sachs on down are in favour of establishing a carbon market. And it ain't polar bears or coral reefs. They see a massive opportunity for profit in trading of carbon permits.

It is incredibly naive to think the same problems that sunk the financial system won't arise in a carbon market. This article from the Wall Street Journal investigating sales of landfill "carbon offsets" on the voluntary Chicago Carbon Exchange offers a window into how profit-seeking would win out over greenhouse gas reductions in a freely traded carbon market.

I'm not against a cap-and-trade system. But we need to wake up and realize that a carbon trading system will be fraught with the very complications that have created and burst financial bubbles in the past twenty years. Traders will come up with complicated derivatives and trading instruments that regulators do not understand. Companies will propose offsets and reduction measures that cannot be guaranteed. And so on and so on.

Sure, a carbon tax may look like a political loser. Given the way lack of regulation and open cross-border financial trading is causing a meltdown of the global financial system, is the really public is willing to open a multi-billion or trillion dollar carbon trading system, not to mention the future of the planet, in the hands of the markets and investment firms?

Call me crazy, but I think the Liberals should save the Green Shift from the shredder.

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