Economic crisis ‘balkanized’ global finance
By Howard Schneider,
The economic crises in the United States and Europe wiped out decades of progress in expanding the world financial system, depressing the flow of investments and loans across borders and potentially setting the stage for an epoch of entrenched low growth, according to a new study on global finance patterns.
The McKinsey Global Institute report combines databases from the International Monetary Fund, global central banks and other sources to try to sum up what has been lost in the aftermath of the 2008 Lehman Bros. failure and subsequent crisis in the euro zone.
The top findings: The amount of investments and loans flowing across international borders has collapsed. The overall value of financial assets compared to the size of the world economy is way down. And, in a sign of how government policy has struggled with mixed results to revive growth, the composition of world financial holdings has shifted away from equity investments like stocks and toward government debt.
Five years after the crisis, the report’s authors say, it remained unclear whether world financial markets would recover the depth and strength they exhibited in the decades before 2007, a historic year when $11.8 trillion in investments and loans traded hands across borders, and total financial assets in the world equaled 355 percent of world economic output.
For 2012, annual cross-border investments remained below $5 trillion and the total value of financial assets had fallen to 312 percent of global gross domestic product.
Some of that decline represents “a necessary correction” from the real estate and stock market bubbles that set the stage for the crisis, the report states. But “there is also a chance that this correction may overshoot, reducing the flow of private-sector financing needed for recovery and a return to economic growth.”
“The financial crisis continues to have lingering and profound effects,” the report concludes. “For three decades, capital markets and banking systems rapidly expanded and diversified, but now that process . . . has largely ground to a halt.”
With banks, particularly in Europe, shedding assets around the world and in many instances narrowing their businesses because of their own financial weakness or new regulations, the risk is of a financial “balkanization,” with money less likely to flow around the globe and constraints on the ability of businesses and households to finance investments and purchases.
The findings of the report reflect on a global scale some of the regional trends that have preoccupied policymakers since the crisis.
The euro zone, for example, accounts for much of the decline in cross-border finance, with banks in healthy European countries pulling out of weaker southern European locales and scaling back some aspects of their global business. But, in a sign that globalization isn’t so much reversing as changing its nature, developing nations continue to benefit from strong inflows of foreign money — evidence of their increasingly important role in the world system.
The study also demonstrates the dilemma international policymakers face as they try to develop new regulations for global finance. Much of their discussion has focused on how to set rules that would keep global banks in business and encourage them to make sound loans, while curbing the excesses that led the world into recession.
One of the central tradeoffs in that debate is between stability and growth — and how far policymakers should go to curb potential asset bubbles or other risky events, even if that means slowing sustainable economic growth in the process.
To some degree, the dynamics described in the McKinsey study may be what a more stable financial system entails — less leverage, less “fast money” running into and out of world markets, less risk.
But it also represents a setback: After a 17-fold increase in the value of world financial assets between 1980 and 2007, to $206 trillion from $12 trillion, the figure is now growing at just 1.9 percent annually; cross-border financial flows, as a percentage of economic output, are now at levels more akin to the early 1990s.
“While some of the correction is healthy, if we see a continuation of these trends, it threatens recovery,” said Susan Lund, a McKinsey principal and one of the report’s authors. “It is not the end of global banking, but it is a significant retrenchment. . . . It questions whether we will ever see a recovery.”