As the world enters a new geo-economic era, the growth of the global balance sheet – the value of all real assets that constitute net worth, as well financial assets and liabilities of households, corporations, governments and financial institutions – may come to an end.
The pandemic accelerated the multi-decade expansion of the global balance sheet, but the spike in inflation exacerbated by Russia’s invasion of Ukraine in 2022 and the corresponding rise in interest rates may finally have led us to an inflection point. How leaders manage the way ahead will be critical for growth, wealth and financial stability.
For several decades, the world’s balance sheet has grown inexorably. From 2000-21, global wealth – at $630tn in 2022 – has grown by 170 percentage points relative to gross domestic product. This has been mostly due to asset price inflation (more than three-quarters) rather than net new investment (less than one-quarter of wealth growth).
Real estate prices have climbed to 5.1 times GDP from 3.8 on the back of declining real interest rates. Equity prices were pushed up by low rates and higher earnings as the labour share of income declined; the value of all equity grew to 2.3 times GDP from 1.2. At 2.7 times GDP in 2021, debt reached levels well above the highs of the 2008 financial crisis. Net new debt growth exceeded net investment by a factor of two, and debt is now equivalent to 90% of the value of all produced assets on the planet.
Far from knocking this growth in wealth and debt off course, the pandemic – or rather the response of governments to it – accelerated the rise in 2020 and 2021. In those two years, the world added another $100tn to wealth ‘on paper’. This owed primarily to unprecedented levels of government support for economies they feared were imploding as the pandemic took hold. Asset prices soared, and net worth relative to GDP grew the fastest in nine decades. Around $50tn in new debt and $39tn in new currency and deposits were created, and debt growth exceeded net investment by a factor of 3.4.
In 2022 as political and economic turbulence erupted, early signs of a possible inflection point appeared. As inflation and interest rates rose, global equity, bond and real estate prices came under pressure and servicing debt became more costly. While these developments may prove transitory, there is also a scenario where shifts in geopolitics and global supply chains, energy system transitions and ageing populations mean that tighter labour markets, higher inflation and higher interest rates become more entrenched.
The ramifications for the global balance sheet and global wealth are enormous. In a significant and sustained policy-tightening scenario, the world could experience large and persistent corrections in asset prices and a drawn-out period of deleveraging. In a stagflation scenario the global balance sheet would converge back to historic levels relative to GDP by means of higher inflation. Only a scenario of accelerated productivity growth would set the balance sheet onto a more desirable pathway.
These balance sheet pathways are critical for financial institutions. Central banks are key actors in managing the path ahead. Asset managers will need solid, long-term scenarios to understand implications for portfolio allocation, long-term balance sheet risks and long-term asset and revenue growth. Banks face vastly different scenarios for growth and economically sustainable lending in 2023, but they have an important role to play in channelling funds to productive uses.
Jan Mischke is Partner and Senior Fellow at McKinsey Global Institute.