Global balance sheet faces 4 directions shaping economy to 2030

By Phillip Isakpa

Global balance sheet’s relation to gross domestic product (GDP) is projected to head in four directions between 2023 and 2030 and this will shape the economic health and wealth of the global economy, according to a report by McKinsey Global Institute (MGI).

For the first time in 30 years the state of the world’s wealth and health showed signs of a shrinkage last year when, after continuously rising for three decades, the global balance sheet used to measure these conditions, lost $20 trillion in the third quarter.

In those three decades when the relations between the balance sheet and global gross domestic product (GDP) had been measured, the global balance sheet had been shown to fare better, expressed in the way that it has accelerated faster.

And part of the traits seen in the three decades story of growth in global balance sheet, according to the MGI report, is how in the intense two years of the global pandemic, 2020 and 2021, the balance sheet pushed the acceleration gear to see $100 trillion being added by households to global wealth ‘on paper’ as asset prices soared and $39 trillion in new currency and deposits were minted.

But looking ahead this year and up to 2030, in order to achieve positive economic outcomes, public and private sector leaders and financial authorities are being urged to closely monitor and manage the balance sheet.

According to the authors of the MGI report, the forces of secular stagnation could mean that after this brief intermezzo in 2022 and part of this year, the balance sheet will resume its rise, thus adding to global wealth, but also leading to some concerns about the health of the balance sheet.

“Alternatively, the world could step up efforts to boost productivity growth and reallocate capital to productive capital formation in order to grow out of a supersized balance sheet. If the world does not go down either of these two routes, an unwinding of the balance sheet via inflation—as in the 1970s—or via more sustained asset price corrections, deleveraging, and debt write-offs, as happened during the global financial crisis, may result,” the report warned.

The call for public and private sector leaders and financial authorities to closely monitor and manage the balance sheet appears to come from the thinking that the possible pathways have potential for different economies to take differing paths.

With the balance sheet having shown sign of deceleration in 2022, the four scenarios being projection are about what would play out should the growth resume; secondly, if the world sees growth in productivity; thirdly, should inflationary pressure become entrenched; and fourthly, a scenario of asset price correction and deleveraging that sees central banks battling high inflation with sharply higher interest rates.

Providing further explanations for these scenarios, the MGI report noted that in the case where the global balance sheet resumes its rise, where inflation proves to be transitory and global saving and ageing effects return real interest rates, inflation, and real GDP growth to very low levels; secular stagnation continues, it stated that, “in this scenario, a savings glut is stymied by a lack of attractive investment opportunities and is therefore channelled into existing assets, boosting the values of equity and real estate. Low interest rates encourage further growth in debt. Wealth keeps growing “on paper,” and so do leverage and balance sheet risk, as we have experienced in recent decades.”

For the scenario involving productivity acceleration, the report provided the picture thus: “In this scenario, the world economy experiences a persistent acceleration in productivity growth and a reallocation of funds to productive investment. In this scenario, the benefits of rapid digitization and technological advances would, at last, show in GDP growth; energy system reconfiguration would not only lead to greener and more secure but also, eventually, cheaper energy; and policy changes would help unleash investment in areas like future mobility and affordable housing. Macro-prudential policy helps contain further debt and asset price growth, and global GDP growth outpaces balance sheet growth,” noting that such productivity acceleration was visible in the United States in the late 1990s, “although the balance sheet was much smaller then.”

Pointing to the scenario involving inflationary pressure, the report explained that here, “inflationary pressures become entrenched, as high energy prices continue to cascade through the economy; labour market shortages persist, not least due to demographic shifts; expectations become unanchored; and the velocity of money grows. Wages grow faster than productivity, and corporate pricing power allows companies to pass cost increases on to consumers. Central banks would intervene with higher rates, but not enough to get inflation back below 2 percent, as they face financial stability risks, distributional issues, and weak growth. This leads to a decline in the ratio of the global balance sheet to GDP as high inflation leads to fast nominal GDP growth while monetary tightening limits asset price growth and debt formation. This scenario would have some parallels with the 1970s stagflation era,” the report noted.

The fourth picture painted by the authors of the report is pinned on a scenario of asset price correction and deleveraging. According to them, here, “central banks battle high inflation with sharply higher interest rates. Highly leveraged sectors—starting with the public sector—tighten belts and attempt to reduce debt burdens, muting growth. Asset prices contract given high interest rates, rising risk premiums and a dampened growth outlook. Where debt service costs become too large and assets are underwater (that is, their value is lower than the debt held against them), defaults and write-offs or even a financial crisis potentially unfold. This scenario could unfold somewhat in combination with the inflationary way out. It would be somewhat similar to what happened during the tightening cycle in the United States in the 1980s (although the balance sheet was much smaller then) or after the global financial crisis of 2008.”

They noted that significant variation in these scenarios and pathways should be expected for different economic regions that have dissimilar starting points, trajectories, and macroeconomic parameters.

In the case of the United States, for instance, the authors said it has particularly large balance sheet positions in equity and public debt, and a macroeconomic environment of high inflation and rapid central bank tightening. The eurozone has relatively high public debt and real estate values, coupled with high inflation and, so far, less central bank tightening than in the United States. China has a large balance sheet in real estate and property debt,” they stated.

According to the report, the different scenarios that may unfold over the next ten years will have different implications for households, governments, and corporations. But the report asked, “Will net worth continue to grow faster than GDP, continuing the expansion in the balance sheet observed over the past 20 years, or will productivity catch-up bridge the gap and power growth in the real economy?”