Global wealth is booming, but it is on increasingly shaky foundations.

Last week the McKinsey Global Institute issued its annual global balance sheet. It estimated that global wealth hit almost $US1.8 quadrillion ($2.6 quadrillion, with a quadrillion equalling a thousand trillion) last year. In 2024, it was $US1.7 quadrillion.

While that might be regarded as an indicator of an increasingly prosperous world, McKinsey referred to the “mounting detachment” of the balance sheet from the global economy, with several asset classes growing further out of balance with the underlying growing economy.

Essentially, it is saying that most of the increases in wealth are being driven by paper gains, rather than by real economic growth.

It singled out US equities, where values “soared” to 2.4 times corporate net assets, with profits double their share of GDP relative to their shares in 2000. China’s corporate debt, it said, grew to 80 per cent of real assets against a global average of 50 per cent, while government debt was near all-time highs in the US and was growing most rapidly in China.

Of the global increase in household wealth to $US570 trillion, only 20 per cent came from real capital formation – new investment in machinery and equipment, buildings, infrastructure and intellectual property – with valuations of existing assets growing 4 percentage points faster than already high consumer price inflation.

It is valuations and inflation driving the balance sheet expansion, not economic growth.

Macquarie Capital’s Viktor Shvets has long spoken and written about “hyper-financialisation” and “a cloud of finance” in which the growth of financial assets far outstrips, and is disconnected from, real economies.

He’s also written of what he calls the “Fujiwara effect” (when several hurricanes merge), or the fusion of deep financialisation with a disruptive acceleration of the Information Age.

The coincidence of financialisation and technological advancement, he has argued, generates an over accumulation of capital, displacement of labour by technology, rising inequality and social tensions and intense disinflation.

McKinsey detailed the implications of a balance sheet outrunning the underlying economy and there are echoes of Shvets’ view of the world in its conclusions.

When real estate and equity values rise faster than GDP, it says, weaknesses can be exposed, capital can flow disproportionately to asset repurchases, sometimes with a lot of leverage and while, valuations might rise, the real economy might be deprived of the investment that drives long-term growth.

“For households, wealth rises but merely on paper, with heightened risk of eventual corrections. Growing asset values also tend to exacerbate wealth inequality, as existing owners of wealth see large gains while entering asset markets becomes harder for others.”

It nominates three ways in which an overly-inflated balance sheet might correct.

One, the most benign, is with productivity-driven growth in the real economy that boosts income to validate high asset valuations and high levels of debt.

Artificial intelligence holds out that promise, although at present it is probably doing more to exacerbate asset values and leverage than to increase productivity and boost real income.

The other two options aren’t as palatable.

Sustained inflation would erode the real value of assets and debt while producing higher nominal GDP while a balance sheet “reset” – a sharp drop in asset values, significant deleveraging, corporate and personal defaults, losses of wealth and employment and lower economic growth – would also shrink the balance sheet.

That’s what happened when the dot-com bubble burst in 2000, and when the global financial crisis occurred in 2008. An abrupt shrinking of the global balance sheet to realign it with the underlying global economy would, as it was in those past instances, be traumatic.

The world could, of course, just muddle along with the kind of stagnation that developed during the period after the 2008 global financial crisis, with low growth, low interest rates, low investment and increasing leverage, although it is hard to see how that could be a sustainable condition.

A breakdown of trends within the McKinsey balance sheet shows equity is now 2.8 times global GDP, against an average of 1.9 times over the preceding 24 years since 2000.

Government debt, at 0.9 per cent of GDP, has edged up from 0.8 times and corporate debt has done the same.

Household debt has edged down from 0.8 to 0.7 times, while currency and deposits have risen from 1.5 times GDP to 1.7 times.

‘Growing asset values also tend to exacerbate wealth inequality, as existing owners of wealth see large gains while entering asset markets becomes harder for others.’McKinsey report

The largest asset class within the balance sheet is real estate, where values (except in Australia, at least until very recently) have been correcting relative to GDP and the second-largest is equity, where values relative to GDP are at all-time highs in some countries.

That’s most notably the case in the US, which accounts for nearly half of the total of global equity and where equity values are 2.4 times net assets. In most other countries they are around 1.0 times net assets.

The other big element in the balance sheet is debt, where household debt has been trending down, but corporate debt in China has nearly doubled the global average and government debt, relative to GDP, had the fastest growth. Government debt was above 100 per cent of GDP in Japan, the US, Italy, France, Canada, Belgium, Spain and the UK.

In the US, massive deficits, debt levels that are swelling inexorably, inflation and rising bond yields are raising threat levels while in other parts of the world unbalanced or weak growth, when combined with high levels of government debt, also threaten.

The world’s two key economies – the US and China – face different challenges. The US needs to consume less and save more, while China needs to save less and consume more (and perhaps invest more productively).

The best-case scenario is for artificial intelligence to deliver, benignly, on its promise of a leap change in productivity, although how those benefits, if they do emerge, are shared will have profound social implications.

The world doesn’t need – and probably wouldn’t tolerate – the wealth from those productivity gains being captured by a handful of trillionaires.

It remains plausible, however, that an AI sector that is still in a development phase and built on access to equity at ever-inflating valuations and access to ever-increasing amounts of cheap debt won’t reach a level of maturity, with positive cashflows and maybe even actual earnings, before investors run out of patience or capacity to support it.

That’s the year 2000 scenario, which would be a setback, albeit not necessarily a permanent one, for a productivity-led resetting/rescue of a global balance sheet that, on McKinsey’s analysis, appears vulnerable and, perhaps, unsustainable.

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