The report notes that globally, net worth has tripled since 2000, but the increase mainly reflects valuation gains in real assets, especially real estate, rather than investment in productive assets that drive our economies. The crunch question is how sustainable is this?

Rising asset prices and two decades of relatively low interest rates have helped expand the world’s “balance sheet” to high levels, far outpacing underlying economic growth and raising questions over whether this can endure, a report by the McKinsey Global Institute said.

The consultancy firm said that net worth in many countries has risen sharply over the past two decades, but not primarily from improved underlying economic performance, but more as a result of rising asset values such as residential property. 

“Not only is the sustainability of the expanded balance sheet in question; so too is its desirability, given some of the drivers and potential consequences of the expansion. For example, is it healthy for the economy that high house prices rather than investment in productive assets are the engine of growth, and that wealth is mostly built from price increases on existing wealth?” it said. 

The findings of the report highlight how, even more than a decade on from the financial crash of 2008, there remain worries about how much of developed countries’ economies depend on high asset values rather than improvements to underlying economic performance. With inflation pressures building and likely rises in interest rates, it creates asset allocation challenges for wealth managers.

“Across ten countries that account for about 60 per cent of global GDP - Australia, Canada, China, France, Germany, Japan, Mexico, Sweden, the UK, and the US - the historic link between the growth of net worth and the growth of GDP no longer holds,” the report said. “While economic growth has been tepid over the past two decades in advanced economies, balance sheets and net worth that have long tracked it have tripled in size. This divergence emerged as asset prices rose - but not as a result of 21st-century trends like the growing digitization of the economy.”

“Rather, in an economy increasingly propelled by intangible assets like software and other intellectual property, a glut of savings has struggled to find investments offering sufficient economic returns and lasting value to investors. These savings have found their way instead into real estate, which in 2020 accounted for two-thirds of net worth,” the report said. “Other fixed assets that can drive economic growth made up only about 20 per cent the total. Moreover, asset values are now nearly 50 per cent higher than the long-run average relative to income,” the report continued.

Strikingly, McKinsey said that for every $1 in net new investment over the past 20 years, overall liabilities have grown by almost $4, of which about $2 is debt.
To construct a “global balance sheet,” the firm added up real assets in the economy as well as all financial assets across all sectors (including, notably, the financial sector).

The global balance sheet and net worth more than tripled between 2000 and 2020. Assets grew from $440 trillion, or about 13.2 times gross domestic product, in 2000 to $1,540 trillion in 2020, while net worth grew from $160 trillion to $510 trillion. 

Among the ten countries, China accounted for 50 per cent of the growth in net worth, or wealth, from 2000 to 2020, followed by the US, at 22 per cent. Japan, which held 31 per cent of the ten economies’ wealth in 2000, held just 11 per cent in 2020.

The report noted that net worth is a claim on future income, and historically its growth has largely reflected investments of the sort that drive productivity and growth, in addition to general inflation. But the situation over the past 20 years has been different: net investment as a share of GDP has been low and declining, particularly in advanced economies, contributing just 28 per cent to net worth expansion. Asset price increases made up 77 per cent of net worth growth.

The report said the “smartest way forward” may be for policymakers to cut the balance sheet relative to GDP by growing nominal GDP. To do that, they need to redirect capital to new productive investment in real assets and innovations that accelerate economic growth.

“Leaders of financial institutions could seek to develop financing mechanisms aimed at deploying capital to new growth opportunities, while limiting debt creation for asset transactions at ever-rising prices,” the report said.