Where market liquidity is really coming from

So you think the world is drowning in liquidity, don’t you?

That all depends on where you look.

Global cross-border capital flows between 2007 and 2016 declined almost threefold, from $12.4 trillion to $4.3 trillion, according to a new report by McKinsey&Company’s McKinsey Global Institute. Cross-border lending and other banking activities were the hardest hit, but on the ruins of the 2008 housing crisis, a more risk-sensitive, rational and sustainable integration model emerged among financial players worldwide. Some guys took two steps back. Others, took 10 steps forward.

A major symptom of the post-crisis financial system has been the sharp reduction in cross-border lending. European banks were the biggest scaredy cats, primarily euro area banks, report authors found. The volume of their international credit transactions since 2007 dropped 45% to $7.3 trillion. Over the course of 10 years, euro banks have gotten rid of over $2 trillion in assets, often at the request of regulators, with most of that occurring throughout Europe, even in non-euro countries like the U.K.

On the contrary, Canadian and Japanese banks raised their foreign lending to $5.3 trillion from $2 trillion, and the Big Four Chinese banks were the standouts.  China banks have gone completely gangbusters with $86 billion in foreign loans in 2007 to $1 trillion last year. This is where the new liquidity is coming from, particularly into emerging and frontier markets. China is in the drivers seat over there.

China’s foreign bank lending is expected to grow now that it has embarked on its One Belt One Road initiative to develop new markets across Eurasia. China banks’ foreign assets are only 9% of total bank assets in China, compared to 20% or more for banks in advanced economies. This suggests more scope for Chinese banks to expand globally, if they follow the path of the world’s other large banks, McKinsey’s team attests.

The largest banks in Brazil, India and Russia also expanded cross-border lending and McKinsey thinks that trend will also continue. Like in China, nearly all of those cross border deals are state controlled banks like Brazil behemoth BNDES (big money to Cuba, Angola and Venezuela) and Russian lenders in Eurasia and Ukraine.

Despite the decline from money center banks, Western globalization continues unabated. Sorry, globalist haters.

Total volume of foreign investment is about 180% of world GDP. In absolute terms, the volume of investments increased from $103 trillion to $132 trillion over the last 10 years. More than a quarter of all securities in the world belong to foreign investors, whereas in 2000 their share was only 18%. Portfolio capital is dominated by the U.S. and Europe.

For example, earlier this year, Russia toy store giant Detsky Mir launched on the RTS Micex stock exchange in Moscow. Well over half of the shares sold went to non-Russian entities and individuals.

Of course most of the world’s foreign banking is run by the U.S., U.K., Germany and The Netherlands. Their banks are in better shape now than they were in 2009.

The post-crisis era of financial globalization will be more stable, McKinsey believes. The share of direct foreign investment – the least volatile type of capital flows due to its long term focus – increased from 36% of total capital flow to 69%. The deficit in current, financial and capital accounts decreased from 2.5% to 1.7% of world GDP, which reduces the chances for a new financial crisis as Fed Chairwoman Janet Yellen noted a month ago.

One sidebar from the report, advanced economies like the U.S. are now attracting much more corporate capital from emerging markets like Mexico (guess who owns Sara Lee brand?) and China (guess who owns AMC Movie Theaters?).

Moreover, central banks in those countries have increased their reserves of capital and liquidity. China has more money in central bank reserves than the GDP of Brazil and Argentina combined. This helps countries avoid currency shocks and gives them ample cash if foreign flows were to dry up and money for strategic projects like oil and gas development suddenly stopped coming into their countries.

Nevertheless, capital flows remain volatile with securities markets in some countries looking overheated, McKinsey’s authors warned. “With more countries participating in global finance, financial contagion remains a risk—especially for developing countries that lack deep, transparent, and liquid domestic financial markets,” they said.

This article was written by Kenneth Rapoza from Forbes and was licensed by Bloomberg.

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