Our deeper, more liquid, planet

Once again, I refer to the collective genius that is McKinsey's Quarterly publication to discuss the big picture of everything we are talking about. This report will come from two articles, the first being a Mckinsey Quarterly study entitled "Mapping the Global Capital Markets." The authors were Diana Farrell, Aneta Marcheva Key, and Tim Shavers.


This blog discusses financials and economics, mostly around the US equities market. Well the truth is less than 30% of the world's capital is in equity, the rest being in corporate or government debt, or bank deposits. And then in the US, only about 33% of capital is in equities market. Still, it is a sizable portion - around $15 trillion, according to McKinsey. How much capital is there in the world? Currently ~$118 trillion, up from $53 trillion in 1993 and only $12 trillion in 1980. Damn! And if trends carry on, we should be looking at passing $200 trillion by 2010! Along with that growth is a shift in where the money is going. In 1980, 45% of all capital was held in bank deposits, this has dropped down to 30% today, as the proportion shifted to debt and equity securities. Clearly, this has increased liquidity, as the money was freed from bank vaults into trade-able contracts offering higher returns.

Now, don't confuse this with global GDP. The amount of capital in a country is supposed to be larger than the country's GDP. Like DLight and Dyer will tell you, financial assets are meant to reflect the expectation of future value, while GDP ain't. This means that capital markets should be many times greater in value, or, in economics terms, deeper, than a country's GDP.

The article goes on to explain:

Financial depth alone, however, doesn't indicate the strength of an economy or its financial system. The financial depth of the United States is nearly twice that of Norway, for example, though both countries have similar GDPs per capita. Germany and Thailand, by contrast, have similar financial depth at greatly different income levels. Financial depth also doesn't necessarily mean that an economy's financial system is in relatively good health. Japan, for instance, has great financial depth but struggles with nonperforming bank loans and with shrinking corporate-bond and equity markets. Asset price bubbles and the issuance of excessive government debt can lead to an unhealthy financial deepening—and painful corrections.

Interestingly, the depth of an individual country is becoming less and less relevant as globalization continues. McKizzle notes:

Today, for example, foreigners hold 12 percent of US equities, 25 percent of US corporate bonds, and 44 percent of Treasury securities, up from 4, 1, and 20 percent, respectively, in 1975. Since 1995, cross-border capital flows have more than tripled, and they now total upward of $4 trillion annually, including foreign purchases of equity and debt securities, foreign direct investment by corporations, and cross-border bank lending.

Unfortunately, this can hurt markets as much as it can help them, due to the increased competition between financial markets. We've already discussed the importance of depth in a market - shallower regions may attract less investment attention. A more direct concern is low turnover (the rate at which shared are traded). This, along with dated infrastructure and technology, results in each trade costing more. This is also known was the cost of liquidity, and is a closely watched measure of financial health. Globalization can allow for a trader in Kuala Lumpur to focus on trading on the NYSE instead on his own native Bursa Malaysia.

According to the the McKinsey Quarterly report "Why ASEAN's stock markets must work together," written by Emmanuel V. Pitsilis, Andrew Sheng, and James Twiss, this could be a big problem for, say, Malaysia.

ASEAN may be in trouble, due to these concerns. There are no immediate threats, but in the long run, as the global markets evolve, we may see a drain in the liquidity of the exchanges in ASEAN. This could be disastrous for their economies, as economic complacency settles in. What are possible solutions? Well, the exchange could simply be purchased by one of the larger ones (e.g. NYSE Euronext), or they could try to bond together.

As the report describes, this hasn't been very successful, historically. Combining and compromising on all the different regulations , national agendas, and stakeholders (i.e. shareholders) have made actual mergers a huge headache. Furthermore, building alliances or creating cross listings hasn't brought the desired results either. McKinsey instead suggests a merger of what is an actual area of synergy: operations and technology. This has apparently worked well for NYSE Euronext as well as OMX.