Commentaries

Trends We're Tracking: Climate Change, Inflation, and the Ethereum Merge

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Drought in northern hemisphere
Climate change is known to worsen extreme weather events and is expected to carry high economic cost. The latest example is the severe drought impacting countries in the Northern Hemisphere. The U.S., Spain, France, Germany, Italy, India, and China are seeing droughts, which are not only impacting water supply, but are also disrupting transportation, hydroelectric power generation, and overall industrial productivity. Incessant heatwaves are also putting additional strain on power grids in places like California.1,2 

Europe’s worst drought in at least 500 years has resulted in a reduction in forecasts for maze, soybean, and sunflower production, which may further food inflation. Falling water levels are threatening to cause disruptions in water transportation, which ferries food, chemicals, and energy across major European ports. Elsewhere in Asia, droughts in India have reduced the rice planting area by around 13 percent and hydro power shortfalls in some places in China have resulted in manufacturing plant disruptions. In the U.S., shrinking snowcaps in the Rocky Mountains and severe drought has resulted in falling water levels in the Colorado basin, thus impacting hydro power generation in the Southwest region. While a loss in hydro power can be compensated with solar power and power rationing, a prolonged heat wave can put additional pressure on the grid and result in extended blackouts.3,4,5

Biggest winners and losers of the inflation reduction act
The Inflation Reduction Act of 2022 was passed and signed into law in August. The total spending of $437 billion over the next decade is only a fraction of the $3.5 trillion originally proposed in the now-defunct Build Back Better bill, which should greatly reduce inflation pressure over the next ten years. In that regard, the biggest winners of the new bill are actually the U.S. economy and the Federal Reserve, as they get much needed relief in fighting inflation.

As for the impact on specific industries, renewable energy and electric car producers are no doubt the biggest beneficiaries of the bill, as $369 billion will be spent on areas of energy security and climate change. On the other hand, pharmaceutical companies are likely to be most adversely affected by the bill as $265 billion will be raised through the prescription drug pricing reform, essentially cutting drug prices they can charge for Medicare. The IRS is another notable winner, as it will get additional funding of $80 billion over the next decade.7

Ethereum merge
After years of planning, the Ethereum Network is scheduled to be updated in the middle of September. The major change to Ethereum will be the shift in consensus mechanism, as the network transitions from proof-of- work to proof-of-steak. The proof-of- work mechanism was first used by Bitcoin, where computers process difficult mathematical problems to process transitions and earn mining rewards.  The new proof-of-steak consensus will be less energy intense as network validators lock up their coins in order to process transactions and secure the network. Within the digital asset space, a network update of this size has never been attempted, and excitement around the upcoming merge is evident in the price to ETH.8 Since hitting its 52-week low in June ETH is up over 80 percent, outperforming bitcoin. Within the digital asset space this will be a closely watched event and is likely to impact the broader digital asset ecosystem.

An alternate take on the state of the economy
While the verdict is still out there on whether two consecutive quarters of Gross Domestic Product (GDP) contraction constitutes a recession, new data on Gross Domestic Income (GDI) takes on a more optimistic view and suggests that we are instead closer to an economic stall. Over the first two quarters of the year, GDP contracted at a 1.1 percent annual inflation-adjusted rate, while GDI expanded at a 1.6 percent annual inflation-adjusted rate.9 

GDP is the value of all goods and services measured on the production side, while GDI is the aggregate of all wages, profits, and investments measured on the earnings side. In theory, GDP and GDI are just two sides to the same equation and should be equal; but when roughly $20 trillion dollars is being accounted for, this has historically led to some minor differences. Therefore, whether or not we are in a recession might just boil down to which measure you are looking at. In the end, the one thing we can probably all agree on is that the economy is going through a rough patch, no matter which way you look at it.

Sanction effects on Russia
After Russia invaded Ukraine nearly six months ago, Western countries unleashed various sanctions designed to hurt Russia’s economy in the short term and curtail their ability to compete in the long term. These economic measures have had mixed results. In the short term, Russia has experienced some pain. Western brands have left along with some of the most talented people in the country. Although short-term discomfort has been felt, the effects of the sanctions have not stung as hard as had been hoped. Their GDP is likely to contract about 6 percent for the year, a far cry from the 15 percent that had been predicted. Much of their economy has been propped up by energy sales, as costs have soared, and is further buttressed by the skirting of the embargos by over 100 countries.10

Sources:
1. “China's Fragile Economy Is Being Hammered by Driest Riverbeds Since 1865,” Bloomberg, August 23, 2022, https://www.bloomberg.com/news/articles/2022-08-23/worst-drought-in-decades-threatens-china-s-economic-recovery#xj4y7vzkg

2. “How Europe is dealing with worst drought in 500 years — what's in store,” CNBCTV18.com, August 26, 2022, https://www.cnbctv18.com/world/how-europe-is-dealing-with-worst-drought-in-500-years--whats-in-store-14597911.htm

3. David R Baker, Brian K Sullivan, Kim Chipman and Mark Chediak, “The End of Snow Threatens to Upend 76 Million American Lives,” Bloomberg.com, August 3, 2022, https://www.bloomberg.com/graphics/2022-western-us-snowpack-drought/

4. “Lakes and rivers in Germany, Italy, France, Spain, China and US run dry as drought and water shortages grip Northern Hemisphere,” ABC.net.au, August 20, 2022, https://www.abc.net.au/news/2022-08-21/northern-hemisphere-drought-germany-italy-france-photos/101341444

5. Sam Meredith, “Europe’s evaporating rivers wreak havoc for food and energy production ahead of winter,” September 1, 2022, https://www.cnbc.com/2022/09/01/europes-evaporating-rivers-wreak-havoc-for-food-and-energy-production.html

6. Summary: The Inflation Reduction Act of 2022, August 11, 2022, https://www.democrats.senate.gov/imo/media/doc/inflation_reduction_act_one_page_summary.pdf

7. Laura Davison, Erik Wasson, and Ari Natter, “Winners and Losers in Democrats’ Signature Tax and Energy Bill,” Bloomberg News, August 7, 2022, https://www.bloomberg.com/news/articles/2022-08-07/winners-and-losers-in-democrats-signature-tax-and-energy-bill

8. Vicky Ge Huang, “What Ethereum’s Big ‘Merge’ Means in Crypto Land,” The Wall Street Journal, August 20, 2022, https://www.wsj.com/articles/what-ethereums-big-merge-means-in-crypto-land-11660958351

9. John Hilsenrath, “A Different Take on the U.S. Economy: Maybe It Isn’t Really Shrinking,” The Wall Street Journal, August 29, 2022, https://www.wsj.com/articles/a-different-take-on-the-u-s-economy-maybe-it-isnt-really-shrinking-11661696041?mod=Searchresults_pos3&page=1

10. “Are sanctions on Russia working?” The Economist, August 26, 2022, https://www.economist.com/leaders/2022/08/25/are-sanctions-working 

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