The fate of the global balance sheet

Andrew Sheng and Xiao Geng January 04, 2023 09:57

Just as a corporate balance sheet can provide insights into a company’s financial health, a “global balance sheet” (GBS), tallying the assets and liabilities of governments, corporations, households, and financial institutions, can do the same for the world economy. That logic drove the McKinsey Global Institute (MGI) to begin compiling, and regularly updating, a GBS covering ten countries that together represent more than 60% of world GDP.

MGI’s first GBS, released in late 2021, showed that during the first 20 years of this century, global assets grew faster than output. In 2020, assets on the world’s balance sheet totaled more than $1.5 quadrillion (about 18.1 times their GDP) – about triple the total in 2000 (when assets amounted to about 13.2 times GDP). The growth of global wealth also outpaced (rather tepid) GDP growth, implying that wealth became increasingly concentrated among those with real estate and financial assets.

In 2020 and 2021 – the first two years of the COVID-19 pandemic – these trends accelerated, with the global balance sheet swelling even as GDP growth stalled. In fact, despite billions of dollars in income losses, $100 trillion was added to global wealth during this period, fueled largely by unprecedented fiscal and monetary expansion. As $39 trillion in new currency and deposits were minted, asset prices skyrocketed. Meanwhile, debt liabilities grew by about $50 trillion, and equity liabilities by $75 trillion.

Since the beginning of the twenty-first century, the expansion of the financial sector, mainly through debt creation, has played a major role in boosting net worth (assets minus liabilities), mostly via the price effect. In the 2000-21 period, 50% of the increase in net worth came from asset-price increases above inflation, 29% from general inflation, and only 23% from net investment. So, though global net worth grew, investment in the real economy remained relatively low. Excessive financialization thus undermined productivity growth.

The picture changed significantly in 2022. While financialization continued, the GBS shrank relative to GDP for the first time in decades.

Russia’s war against Ukraine, which has driven up energy and food prices, exacerbated inflation, spurring major central banks to hike interest rates. Real global equity and bond prices declined by about 30% and 20%, respectively, sapping net worth in many countries, especially Australia, Canada, China, Germany, and Sweden. Meanwhile, a declining real-estate market reduced not only net worth (wealth), but also consumption, particularly in China, where real estate constitutes some 60% of household assets.

As 2023 begins, the obvious question is: Will 2022 mark a turning point, after which the GBS will continue its slide, or will global assets and wealth resume their climb relative to GDP? The answer depends significantly on policies in China, which accounted for 18% of world GDP and global net worth in 2021.

Judging from the recent Central Economic Work Conference – where the economic-policy agenda is decided each year – Chinese policymakers will focus on stimulating demand, stabilizing the housing market, and supporting growth using fiscal and monetary tools. For example, Vice Premier Liu He announced plans to boost fiscal support and increase liquidity for the stressed real-estate sector.

But the challenges for Chinese policymakers extend much further. The zero-COVID policy proved highly disruptive to China’s economy. But the relaxation of pandemic restrictions – a process that has just begun – will also prove disruptive, threatening to undermine public health and confidence. As the government works to protect public health, it must also secure people’s livelihoods and safeguard social stability.

A global slowdown – caused partly by the Ukraine War – may also be a drag on global aggregate demand, hurting Chinese trade, while continued supply-chain disruptions will compound the damage. And then there is the demand-crushing impact of natural disasters, which are becoming increasingly likely as climate change progresses. (It is worth noting that the GBS fails to account for natural capital – which is declining precipitously – as valuation standards were set only last year. Human capital is also excluded.)

Making matters worse, economic relations with the United States are becoming increasingly fraught, with the US implementing measures – such as restrictions on sales of semiconductors and the machines that produce them – aimed at starving China’s economy of advanced technologies and components. That is why China’s leaders have signaled support for private business and state-owned enterprises, including the easing of regulatory actions that disrupted business confidence in various sectors.

US policies targeting China point to a bigger problem: international economic cooperation is becoming increasingly difficult to sustain. But the GBS shows that, while policy mistakes in large, systemically important economies can push down the entire global economy, no single economy today can lift it. In other words, cooperation is vital to prevent a classic balance-sheet recession (when asset markets deflate, and liquidity is tightened).

Just as the use of nuclear weapons promises “mutual assured destruction,” lack of economic cooperation will lead to “mutual assured deflation,” because no single country can revive global demand. Worse, as conditions deteriorate, governments might be tempted to pursue even more protectionist policies – forgetting the lessons of the Great Depression. Understandably, economic planners in China and elsewhere are preparing for recession.

Copyright: Project Syndicate
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Andrew Sheng and Xiao Geng

Andrew Sheng is a distinguished fellow at the Asia Global Institute at the University of Hong Kong; Xiao Geng is chairman of the Hong Kong Institution for International Finance