While we’re all obsessing over the sub-prime crisis, the credit crunch in general, the housing market’s retrenchment, the inability to mark to market CDO’s, the devilish tendency of "liquidity" to be robust when you don’t need it and nonexistent when you do, whether worldwide financial institutions’ losses and writedowns will total $150-billion, $250-billion, or some other number entirely, and the implications of all of this for our firms in terms of practice groups and geographic focus, it may make sense to stand back, take a deep breath, and look at what’s going on with global capital markets over the long run.
Stepping up to this particular plate is one of the most familiar suspects: McKinsey.
In their "Long term trends in the global capital markets," they offer the following perspective:
- Globally, financial assets are on a growth tear, and this should be expected to continue.
- As a consequence, financial markets are deeper than they ever have been.
- Cross-border transactions and investment links have never been stronger.
- Emerging markets are continuing to surge, outpacing GDP growth in those economies.
- New sources of capital are emerging.
- Japan continues to be challenged.
- The euro is emerging as a potential worldwide rival to the dollar, as European cross-border transactions accelerate.
- Nevertheless, the United States has unparalleled strengths, and despite all the ink being spilled over "sovereign wealth funds" and the like, the actual composition of foreign equity ownership might surprise you.
Now, to unpacking some of this wealth of data and analysis.
Growth of financial assets
Over the past 25 years, all financial assets (the value of all bank deposits,
government debt securities, corporate debt securities, and equity securities)
have grown strongly: From 2006 to 2007 alone, +17% from $142-trillion to $167-trillion.
Bank deposits are a decreasing share. This shows the "CAGR" (compound
annual growth rate) of equity securities’ value over the past 10 years to be
10.4%, private debt securities 10.7%, government debt 6.8%, and bank deposits
7.8%. (It’s heartening that the slowest growth has been government debt.)
Financial market growth outpacing GDP
"Financial depth" is the ratio of a country’s financial
assets to its GDP, and the good news it that it’s been increasing consistently
across all global regions. Why is this good news? More liquidity, more capital
access for borrowers, better risk allocation.
In 1990, only 33 countries had financial assets whose value exceeded GDP; by 2006, 72 did. Likewise, in 1990 only 2 countries had financial assets triple their GDP; by 2007, it was 26.
Growing cross-border links
Cross-border investments are at an all-time high, making us more financially interdependent across the globe than ever before. If cross-border investments are deemed to include foreign investments of multinationals, ownership of foreign debt and equity by investors, and foreign lending and deposits, it totals $74.5-trillion at the end of 2006, or about half of all global financial assets.
Of greater interest is the changing composition of this investment. Ten years ago the US was the predominant hub. Today, while the US is still first among equals, the eurozone and the UK have built important links to emerging markets, and the Middle East is emerging as a major player on the global stage.
Here are the schematic cross-border flows, first the $31-trillion
of such flows in 1999 and second the $48-trillion of such flows in 2006 (constant
dollars):
Of particular note here is not just the overall growth, but trends
in its composition:
- The US more than maintained its share, as did the mature economies of the
UK and the Eurozone. - In relative value, Japan lost ground.
- The strongest ties (red arrows) remained between the US and the UK and
the Eurozone. - Flows to Latin America more than doubled.
- Whereas in 1999 many of the linkages showed less than $1-trillion of movement
(light blue/grey lines), by 2005 those weak links had all but disappeared. - The emerging economies of Russia and Eastern Europe, and of "emerging Asia"
roughly tripled their participation in the global economy, on this measure. - But the most stellar performance of all came in the Middle East’s increasing
integration into the global financial economy, with flows more than quadrupling. (And
you were wondering why Latham just
announced the simultaneous opening of
three offices there, in Abu Dhabi, Dubai, and Doha?)
Emerging markets emerge
Last year, one quarter of the entire growth of global financial
assets arose from emerging market economies. And they still appear to have
substantial running room, accounting for only 14% of financial assets but 23%
of global GDP. And although bank deposits are still the most valuable
asset class, reflecting these economies’ immaturity, they accounted for 35%
of all IPO value in 2006, up from 10% in 2000. Chinese companies alone
raised as much in IPO’s in 2006 as did all companies in the eurozone combined.
New providers of capital
You would imagine that the world’s richest countries would be the pre-eminent suppliers of global capital, but just because that’s logical does not mean it’s true. In fact, emerging markets are, as we all know, the largest suppliers of capital, with outbound foreign direct investment, at $139-billion in 2006, doubling from 2005 and sextupling from 2001.
But the flow is not just one-way. A total of $700-billion of inbound foreign direct investment took place in 2006, amounting to 6.4% of those countries’ GDP. In other words, the developed and the developing world are linked in the capital markets as never before.
Here are the net capital flows (outflows – inflows) in constant
2006 dollars (billions) for 34 emerging markets including Brazil, China, India,
the Philippines, Russia, South Korea, and Thailand (among others):
The continuing ennui of Japan
There are almost too many ways to enumerate the continuing weakness
of Japan, but here are a few:
- Despite its proximity to emerging Asian economies, it accounted for just
6% of foreign funds invested there. - Its government debt is truly enormous, amounting to 150% of GDP and one-third
of all its financial assets. Not counting that debt, its financial
depth ([value of financial assets]/[value of GDP]) would essentially be at
the 1990 level. In that same period, the financial depth of the US
has increased 168 percentage points and the eurozone 173.
The sources of direct investment into the emerging Asian countries in 2006
(totaling $2.2-trillion) show the US with a commanding lead at 29%, Hong Kong
plus Singapore plus Taiwan at 24%, the UK at 18%, the eurozone at 14%, and
Japan’s slice smaller than "the rest of the world:"
The strength of the euro
While the euro’s rise against the dollar is by now old news,
what’s less well known is that in the spring of 2007 the total value of all
euros in circulation surpassed that of all US dollars in circulation for the
first time—and there may be no looking back. And while
central banks and other financial institutions still hold two-thirds of their
reserves in dollars, the euro’s share has grown from 18% in 1999 to 25% today. It
is probably already the most popular currency for companies issuing international
bonds.
The US’ relative strength
But it’s far too soon for Yanks to despair.
The US remains the most liquid and largest financial market,
with nearly one-third of all assets, and the strongest absolute growth rate
of any market in the world. Also on the positive side of the ledger is
that only 5% of US financial assets constitute government debt.
And we keep attracting nearly 25% of all global inflows, as the
largest single destination for foreign direct investment—as well as being
the largest single source of outgoing foreign direct investment.
Foreign ownership of equities
Given all the alarms raised about increasing foreign ownership
of US assets, where do you suppose the US ranks in foreign-owned equity as
a percentage of all outstanding equity, compared to, say, the Eurozone, the
UK, and Japan?
Dead last, by a long shot. Here are the figures, for 1990
and 2006:
At 14% foreign ownership (today), the US trails all other economic
regions by far, and is just barely ahead of emerging Asian markets in its proportion
of domestic control.
Where does this leave us?
At the most fundamental level, if you ever doubted globalization is here
to stay, get over it.
At the strategic and tactical levels, as
you look at the ongoing market turmoil, with new reports seemingly daily
of another name-brand institution taking a big writedown or another arcane
corner of the credit markets getting the flu, take a deep breath and have
the courage to raise your eyes above the short-term chaos towards the horizon.
- The US is not sliding into global capital markets irrelevance.
- The axis of power in Asia is shifting from Japan to China.
- The eurozone will continue to matter more than ever.
- The Mideast is emerging from its provincial, resource-heavy and passive
stance to becoming a globally aware, capital-heavy and active player. - Cross-border flows are enormous and look primed to escalate even further.
Then ask yourself what capabilities your firm has to capitalize on these
trends. If you don’t like the answer, now, when the conventional wisdom
seems to be advising "hunker down," may be the time to pick up some capability
for less than it would have cost you a year ago. And if you do like
the answer, I’d advise pretty much the same: Steal a march on your
more timid competitors so that you’re prepared to emerge from this period
of stress more capable and more broadly positioned than before.
Hard to do, you’re saying? With some of your key practice areas showing
severe signs of stress?
Yes, you must address the current smoke before it becomes a fire. But
what you cannot do is to permit "sweating the small stuff" to be the
enemy of building on the big stuff: Financial globalization with a vengeance.
