Wealth Immunity, China’s dual circulation strategy and an outlook on inflation scenarios

As we are winding down before the Christmas holidays, we took stock of our reports over the past quarter and decided to share with you some of the ones with a longer shelf-life that you might like to (re)read: our Allianz Wealth Report that analyzes the asset and debt situation of households in almost 60 countries. Our take on China's dual circulation growth strategy. And our look at different inflation scenarios. Stay safe wherever you are & Happy Holidays!

Allianz Global Wealth Report 2020: Wealth Immunity

Our ‘Global Wealth Report’ analyses the asset and debt situation of households in almost 60 countries, the main results in a nutshell:

A bumper year: In 2019, central banks saved the day and gave stock markets around the globe strong tailwinds, bestowing households with the fastest growth in financial assets since the Great Financial Crisis (GFC): Gross financial assets jumped by +9.7% in 2019 and reached EUR192trn.

Crisis? What Crisis? Then, Covid-19 hit the world economy and sent it into the deepest recession in 100 years. But will this wipe out huge chunks of wealth? Our estimates suggest that private households have been able to recoup their losses of the first quarter, recording a slight +1.5% increase in global financial assets by the end of the second quarter of 2020 as bank deposits, fueled by generous public support schemes and precautionary savings, increased by a whopping +7.0% since the end of 2019. It’s very likely that private households’ financial assets could end 2020 in the black.

Up in the air: Not surprisingly, securities were the best performing asset class in 2019: Booming stock markets led to an increase of +13.7%, after a decline of -5.1% in 2018. Growth was never faster in the 21st century. The growth rates of the other two main asset classes were lower but still impressive: Insurance and pensions reached +8.1%, mainly reflecting the rise of underlying assets, and bank deposits increased by +6.7%. In fact, all asset classes clocked growth significantly above their long-term averages since the GFC.

To whom they have been given: The regional growth league table used to be dominated by Emerging Markets. Not so in 2019. The regions that saw the fastest growth in 2019 were by far the richest: North America and Oceania. In both regions, gross financial assets of households increased by a record +11.9%. As a consequence, for the third year in a row, Emerging Markets were not able to outgrow their much richer peers in the industrialized world. The catch-up process has stalled.

Debt is inching up: Worldwide household liabilities rose by +5.5% in 2019, a tad below the previous year's level of +5.7%, but also well above the long-term average annual growth rate of +3.9%. As debt grew slightly faster than GDP, the global debt ratio (liabilities as a % of GDP) inched up to 65%.

Trend reversal: The prosperity gap between rich and poor countries has widened again. In 2000, net financial assets per capita were 87 times higher on average in the industrialized countries than in the Emerging Markets; by 2016 this ratio had fallen to 19. Since then, it has risen again to 22 (2019). This reversal of the catching-up process is widespread: for the first time, the number of members of the global wealth middle class has fallen significantly: from just over 1 billion people in 2018 to just under 800 million people in 2019. This negative trend could be further exacerbated by Covid-19.

A rich man’s world: The richest 10% worldwide – 520 million people in the countries in our scope with average net financial assets of EUR 240,000 – together owned roughly 84% of total net financial assets in 2019; among them, the richest 1% – with average net financial assets of above EUR 1.2 million – owned almost 44%. The development since the turn of the millennium is striking: While the share of the richest decile has fallen by seven percentage points, that of the richest percentile has increased by three percentage points. So the super-rich do indeed seem to be moving further and further away from the rest of society.

You’ll find the full report here.

Growth strategy: Dual circulation – China’s way of reshoring?

Over the long run, the Chinese economy is facing two key challenges: declining potential growth and a deteriorating external environment. Our growth potential model suggests China’s GDP growth is likely to average between +3.8% and +4.9% over the coming decade (after +7.6% in the 2010s), due to declining labor supply and slowing productivity and capital investment. Meanwhile, China is also bracing for a long-term standoff with the U.S., which is currently its top export destination and the most innovative country at the global level. Looser economic ties with the U.S. will thus pose additional risks to China’s slowing economy.

In this context, the “dual circulation” strategy is likely to take center stage in China’s 14th five-year plan as a way towards more sustainable growth, making the country less reliant on factors outside of its control. First introduced by President Xi Jinping in May 2020, this strategy prioritizes “domestic circulation” (increasing domestic demand and lowering dependence on foreign inputs), while “international circulation” (maintaining export market shares and liberalizing capital flows) works as a complement. While rebalancing towards domestic demand is not a new principle in China’s economic planning, China will aim in the long run to use domestic production to provide for increasing domestic demand, rather than imports. Taiwan, Malaysia, Singapore, Thailand and Chile are set to incur the most potential losses in the medium run as China moves towards industrial autonomy. Conversely, goods from the U.S., Japan and Germany are exposed to very limited risk of being substituted by Chinese goods in the medium term, thanks to their technological advancement. Losses for the Eurozone overall could amount to up to 0.9% of GDP in the medium run, with machinery & equipment, construction, agrifood and electronics the most exposed sectors. China is likely to increase direct investment into innovating emerging economies, such as the electronics sector in Indonesia, India, Thailand, Mexico and Chile. Chinese outward investment has slowed but not stopped in the past years, and the Belt and Road Initiative remains part of Chinese authorities’ long term vision. Implementation challenges (e.g. related to financial risks) mean that Chinese policymakers are likely to aim for outward direct investment to be more disciplined around national economic targets (e.g. industrial autonomy). Long-term risks include rising debt, zombification and slow technological advancement. China’s R&D spending relies far more on government funding compared to the U.S., Japan and Germany. Strong government intervention could risk leading to overcapacity issues and resource misallocation towards the overall less profitable and less innovative state-owned enterprises.

Please find the full report here.

Inflation: Back to the 1970s?

The immediate impact of the Covid-19 shock on inflation has been decidedly deflationary, but in light of the brewing cocktail of post-pandemic economic trends, the probability of an inflationary overshoot has also risen. In fact, ambivalent market signals suggest that participants are pricing in a higher risk of extreme inflation scenarios – on both the downside as well as the upside.

In our base case, we see the inflation outlook moving through three phases of varying supply and demand pressures: 1) Messy data in the immediate crisis aftermath; 2) A disinflationary recovery in 2021 (U.S.: +1.6%, Eurozone: +0.9%) due to substantial slack in the economy and a swift rebound in supply; 3) A temporary inflation overshoot in 2022 (U.S.: 2.1%, Eurozone: 1.2%) following a recovery to pre-crisis activity amid gradual supply headwinds but no policy paradigm change on wages or fiscal and monetary policy .

What would it take for a scenario of persistently high inflation (probability: 15%) to materialize? We see a risk that supply-side issues, including rising unit labor costs amid weak productivity growth and the extent of the economy’s longer-lasting scarring, could be underestimated.

While a 1970s wage-price spiral would be difficult to imagine, given labor unions’ loss of influence, a push for higher wages and more redistribution amid heightened social discontent, together with more state intervention in economic affairs and rising protectionist tendencies, could well exacerbate prevailing supply bottlenecks and lead to a notable and persistent acceleration in inflation. In such a situation, central bank complacency should be particularly monitored. Central banks could indeed be reluctant to engage in an abrupt and aggressive policy U-turn to rein in inflation given (i) a ‘recency’ bias towards a long period of subdued inflation, coupled with (ii) the U.S. Federal Reserve’s recent strategy switch to Average Inflation Targeting (AIT) and (iii) the fear of a major market tantrum. Under such circumstances, our model on long-term inflation projections suggests that inflation could reach 6.2% in the U.S., compared to 4.5% in the Eurozone, by 2024.

Please find the full report here.