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The world at a crossroad
The year 2025 will most likely mark a watershed moment in global history. It is a year when the era of globalisation and a (relatively) stable world order (the Pax-Americana), which traversed the end of the Cold War (with the dissolution of the Soviet Union in 1991) to now, finally came to an end. Many events can be proposed as bringing about the end of the old order based on free trade, capitalism and liberal democracy – the polarising conflicts in Ukraine and Israel, Russia’s aggression against NATO countries, the rise of right-wing populism and the immigration crisis in the US and Europe, just to name a few. But at the heart of the breakdown is the rise in the economic, political and military power of China, and the west’s response to the threat of a China that controls strategic supply chains and threatens to pull countries into its patronage, creating a bloc that challenges the West.
Although there had been bi-partisan agreement in the US between Democrats and Republicans on the threat that China posed, it has been the newly elected Trump Administration that has escalated the push to contain China. The weapon of choice has been tariffs. However, not only has the Trump Administration struck out on its own with tariffs against China, it has also imposed tariffs more broadly on, what were once considered, strategic allies. The subsequent raft of across-the-board tariffs threatened to undermine global economic growth.
But the demise of the global economy failed to materialise as the Trump Administration was forced to pull back its tariff threats, particularly against the archrival China. From the immediate post-Liberation Day highpoint of 28%, the US effective (i.e., average) rate of tariff on its imports from the rest of the world has fallen to 18% currently. Of course, some of the decline in the tariffs has come from concessions made by its allies, such as the UK, Europe and many East Asian countries. Pushing against the appeasement strategy has been China. China responded in kind to the US tariff threat, including the use of its ace-up-the-sleeve, its control of rare earth supplies. Consequently, China has been successful in blunting the US’ trade weapon as one of China’s main customers. As the dust is settling, the additional tariff on Chinese exports to the US, which was 145% at its post-Liberation Day highpoint, has fallen to 30%.
As a consequence of China’s resistance and other countries’ appeasement, the lower than feared tariff rates have helped the global economy muddle through 2025 with what will likely be a slightly below trend growth rate of 3.1%. The Chinese economy looks as though it will achieve its growth target of around 5.0%. The other two major global economies, the euro area and the US, will also most likely achieve trend rates of growth this year of 1.8% and 1.3%, respectively. In addition to blunting the US tariff threat, China has been successful in avoiding the full impact of resulting US tariffs through the diversion of its exports to other jurisdictions. Although the value of China’s exports to the US have fallen by 27% over the year to September, the total value of exports to all destinations has increased by 8%, with total exports ex-US up by 15%.
While the performance of the global economy and its major constituents has been resilient over 2025, an air of uncertainty permeates the outlook. Burgeoning government debt levels, especially in the US, have helped maintain pressure on interest rates, augmenting the pressure on inflation driven by tariffs and a weaker USD. The AI tech boom has driven equity valuations ever higher and, in the US, this has coincided with a sharp lift in household wealth that has surged to 8 times disposable income, far in excess of the 5-times-disposable-income ratio of the dot.com bubble 25 years ago.
It is unsurprising that the boost AI stocks have delivered to the wealth of US households is driving robust US consumer spending of around 2% over 2025, accounting for around 80% of the overall growth in the US economy. Hence, a retracement in the US equity market is a large risk to the economy via its central role in supporting consumer spending. Although over 2025 AI is having its most significant impact on the economy through the equity valuation channel, the sustainability of its positive influence on the economy will depend on whether gains in productivity promised by AI are realised. AI productivity gains will also provide an important offset to the productivity sapping effects of ageing populations, shifts in industrial structure towards low productivity occupations such as aged and health care, the deterioration in public finances and the constraints this entails on the provision of infrastructure by governments. Another headwind is intensive use of energy in delivery of AI capabilities. The significant energy capex required for AI has the potential to drive an inflationary impulse through the global economy, placing upward pressure on interest rates.
This year will prove to be a crossroad for the global economy and the world order. In our view, we are headed towards trading blocs, away from free trade. The low interest rates that characterised the low inflation decade between the GFC and Covid are gone, replaced by higher real interest rates in an economy with upside inflation risks being more common than in the last 25 years. Downward pressure on productive capacity brought about by trade sanctions (such as tariffs) and the costs of onshoring manufacturing and re-industrialising in the advanced economies will be exacerbated by the deteriorating demographic backdrop. Countering these negative developments will be the ongoing development and adoption of the benefits of AI.
Which of these competing forces (AI versus the rest) dominates will determine whether the current expectations of a 2026 “Goldilocks Year” are realised. That is, a global economy neither too hot to spark another bout of inflation and higher interest rates, nor too cold to risk falling into recession, but just right - with growth at trend, inflation contained, interest rates around their long run neutral rates and rising productivity, incomes and wealth.