Housing wealth soars while productivity lags

A century ago, the roaring ’20s were a time of hedonistic excess. After the horror of World War I, people wanted to rebuild, but also to forget. Wealth increased, and so did prices.

While we like to think we are smarter, or at least more knowledgeable than 100 years ago, there are worrying similarities between the two periods. If anything, the excesses this time around are much greater.

A recent report by McKinsey Global Institute lays bare the magnitude of the problem. It shows that in the past 20 years, wealth has increased dramatically in the world, but this growth has been completely disconnected from actual productivity.

The report looked at wealth and production in 10 countries that together make up about 60 percent of global gross domestic product (GDP): Australia, Canada, China, France, Germany, Japan, Mexico, Sweden, the United Kingdom, and the United States.

In the last two decades, net worth tripled, reaching $510 trillion, which is more than six times global GDP. The final owners of this wealth are households, accounting for 95% of it.

Two-thirds of this net worth are stored in real estate, with the value of housing reaching almost half of global net worth in 2020 and an additional 20% made of business and government land and buildings.

In the same two decades since the turn of the century, average annual growth in GDP was 4% in nominal terms, and 2% in real terms (accounting for inflation) in the 10 countries. As a comparison, GDP expanded by 4% in real terms in the last three decades of the 20th century.

The McKinsey Global Institute report shows that asset prices are now almost 50% higher, relative to income, than the long-run average.

“Asset price increases above inflation propelled by low interest rates drove this divergence, while saving and investment accounted for only 28 percent of net worth growth,” it says.

Real estate dominates global wealth. Source: McKinsey Global Institute

With the pace of economic growth halving, how did wealth manage to triple in size? One clear factor has been the loose monetary policy — low interest rates and purchases or bonds or even stocks from the markets by central banks.

“In an economy increasingly propelled by intangible assets, a glut of savings has struggled to find investments offering sufficient economic returns and lasting value to investors,” the report also says.

One obvious and worrying consequence of this has been the sharp rise in inequality. In only two decades, the gap between the rich and the poor has deepened dramatically.

In the world’s two biggest economies, the US and China, the top 10% of households own two thirds of the wealth.

This is unsustainable over the longer term. With the odds stacked against them, those with less money are getting deeper into debt, while productive investment also relies on borrowed money.

For every dollar in net new investment, the global economy created almost two dollars in new debt, the McKinsey Global Institute report shows.

Loan-to-value ratios are about 80% on average, but more than 100% in the UK, Canada and Japan. It is true that debt is currently cheap, but low interest rates are not guaranteed to last forever.

We all know what happened almost a century ago as inflation got out of control and asset prices collapsed. Central banks will want to avoid such a scenario at all costs, but the big question is whether they will be able to.

Like they do every time uncertainty mounts, the markets are again testing the power of central banks. Having driven asset prices and debt through the roof, the gods of monetary policy must now find a solution to bring them back down to more manageable levels.