Let us examine two ongoing debates, one over the past three decades, and the other over the past 150 years. Ever since the individual net worth of the world’s richest gripped our imaginations since the 1990s, we have been floored by the almost-simultaneous gains of some, and sensational billion-dollar drops within hours and days. For example, Tuesday’s Forbes real-time list of billionaires shows that Larry Page of Google, and Francoise Bettencourt Meyers of L’Oreal lost almost $5 billion each on a single day. The world’s richest, Elon Musk of Tesla, is worth nearly $500 billion. These mind-numbing numbers, which are largely on paper, dazzle our imaginations.
Since the late 1800s, the discussions among economists, within the boardrooms, and among the shareholders is about whether firms create real or transient wealth. The stocks are worth multiple times their net worth, or earnings, but the value of the productive assets are minimal. This is the fiercest allegation against takeovers. They drag stock valuations to absurd levels, even as the underlying worth of the assets is minimal. The takeover predators create a giant out of nothing, and those who work towards setting up factories lose control over the empires that they assiduously built over decades.
As we explain in the above article, Our Take, a McKinsey study on Global Balance Sheet, reaches similar conclusions. It states that the world’s sum of assets, liabilities, and wealth has outrun gains in the real economy, or combined GDPs of nations. When this happens, there are positives, as households, buoyed by an abnormal increase in paper wealth, spend more, which helps the economy. The red signals flash during volatile times, when hundreds of billions of dollars are wiped out in a few days. Musk became an official billionaire in 2012, and his wealth zoomed by 20 times. Between 2021 and 2023, the
value dipped by almost $200 billion, before it recovered.
According to McKinsey, there are four distinct directions that the world’s balance sheet can take in the future which, ironically, reflects what has happened in the past. The first is an unusual acceleration in productivity, which will obviously shrink the balance sheet vis-à-vis GDP due to actual growth, and rise in real assets and real wealth. But this requires huge investments, and across-the-board tech adoption. This happened during the 1990s in the US, when the information and tech boom, largely led by the Internet, created a productivity boom. Artificial Intelligence and robotics, apart from chip-making and semiconductors, and green tech can create similar situations in the future. Investments hold the key.
For the global consumers, this means a mixed bag. According to McKinsey, higher productivity will slay the demon of inflation, which will moderate closer to the US and Europe’s targets. As prices remain in control, buyers can access more goods and services. This will further catapult growth. On the negative side, interest rates will creep up, and remain higher than the pre-pandemic period. These will be influenced by high investments, or demand for more money to create assets. High interest rates will drag retail consumption, as also private corporate investments. Thus, there will be a tussle between inflation and interest, more demand for money will push up prices, and high interest rates will pull down investments.
Sustained inflation will shrink the global balance sheet due to nominal growth. Even as productivity-led growth remains muted, high demand and low savings propel prices. The high demand is constrained by supply-related problems, which moderates the real growth. Hence, inflation remains above the US and Europe’s targets, and interest rates are higher than pre-pandemic rates. This is not an ideal or desired solution because it will hurt global consumers. The world, and particularly the US, witnessed this scenario in the 1970s, thanks to the oil shocks as the Middle East eased supplies, and prices shot up. No nation will want the situation to repeat in any form.
“Sustained inflation brings decent economic growth while devaluing assets, and debt in real, inflation-adjusted terms, thus shrinking the balance-sheet-to-GDP multiplier. But it carries a host of well-known, damaging side effects on business planning, interest rates, and household budgets, especially for those with lower incomes,” stated the McKinsey study. Most nations perceive inflation as a danger. Central banks are willing to tame prices, and rein in the growth tiger, if they need to. In India, in the past bi-monthly meetings, the central bank did not reduce the interest rates despite low inflation, which came after a frightening period of high food inflation.
A return to the past era of “secular stagflation” is a possibility. The US, Europe, and several other nations faced this stark scenario during the Great Global Recession, or the years after the Financial Crisis of 2008, and 2020 pandemic. This is an era of low inflation coupled with low growth. The rise of the balance sheet resumes, and the economy witnesses weak investments, and high savings. While the growth rate in the US and Europe may be one per cent, even China will face the ghost of two per cent growth. While inflation falls below targets, interest rates can turn negative.
Low investment and high savings, in a-return-to-the-past situation, “leads to weak demand, pushing down inflation and interest rates…. But it would be new territory for China, which has experienced rapid demand, and economic growth for the past 25 years. Wealth would continue to grow under secular stagflation, on paper at least. But this scenario brings sluggish economic growth as savings bid up asset prices rather than flowing towards more productive uses. And while the low interest rates that tend to accompany secular stagflation make a large balance sheet look less daunting, vulnerability to any eventual balance sheet reset would remain,” explained the report.
Lastly, there can be a major balance sheet reset, as was the case with Japan in the 1990s after the bursting of the real estate bubble. Economists dub the past three decades in Japan’s economic life as the lost decades, when everything it achieved unraveled rapidly. Japan remained outside the elite group of major powers, despite its economic size, and manufacturing strength. This is an era of large corrections in asset prices, and potential deleveraging which shrinks the world’s balance sheet. There is absolute loss of wealth. Deep recession is followed by stagnant growth, and low confidence. Interest rates spike, and fall to near-zero or negative terrain.
“Only the productivity acceleration scenario combines growth in output and wealth while supporting balance sheet health. Under this scenario, economic growth outpaces debt, and asset value growth. The economy essentially catches up with the balance sheet, providing a sturdier foundation for high asset valuations and debt,” concludes the McKinsey report. The other scenarios are murkier.
