Weekly Global Economic Update

Week of January 19, 2026

• China’s massive trade surplus: Is it a good thing for China?
• Is fiscal dominance coming to the United States?
• US inflation is surprisingly tame
• The US administration addresses the affordability issue
• Germany’s economy grew in 2025 for the first time in three years

China’s massive trade surplus: Is it a good thing for China?

• Last year, China reported a substantial trade surplus. Is that a good thing for China and a bad thing for the rest of the world? Or is it the opposite? Or is it none of the above?

First, let’s look at the data:

The Chinese government reported that, in December, exports (denominated in US dollars) were up 6.6% from a year earlier. And this was despite a notable decline in exports to the United States. Thus, China managed to significantly boost exports to the rest of the world.

For all of 2025, China had a US$1.2 trillion trade surplus (excess of exports over imports)—the largest surplus ever and much bigger than the US$993 billion surplus in 2024. This came about as China’s exports were up 5.5% while imports were flat. Plus, exports to the United States fell 20%. This was offset by an 8.4% increase in exports to the European Union, a 13.4% increase to Southeast Asia, and a 25.8% increase in exports to Africa. The US share of Chinese exports fell to its lowest level since the 1990s. In fact, exports to the United States are now significantly lower than exports to Southeast Asia.

The word “surplus” implies something good, while the word “deficit” suggests something bad is happening. Yet, if a country has a perpetual trade surplus (as is the case with China), it means that it is perpetually producing more than it consumes. Rather than acquiring imported goods and services in exchange for its exports, it is acquiring foreign currency that can be invested in or loaned to the rest of the world. For other countries, such as the United States, a trade deficit means they are consuming more than they produce and are making up the difference by selling assets or borrowing money internationally.

While politicians often bemoan a trade deficit, suggesting it is hurting domestic production and, consequently, workers, another way to look at it is that a trade deficit is often a sign of economic strength, as it indicates strong demand. Often, countries with weak demand, such as Japan and Germany, have trade surpluses. In the case of China, relatively subdued domestic demand—particularly low levels of consumer spending as a share of gross domestic product—has contributed to its reliance on exports and investment-led growth. China has accumulated a vast quantity of foreign assets, while its households have seen weaker consumption than would be the case if China’s trade was in balance.

While the Chinese government has long recognized the need to boost domestic demand, it continues to take steps that boost exports. It has provided incentives for investment in, and production of, key manufactured goods. And, with insufficient domestic demand and declining ability to export to the United States (because of tariffs), Chinese companies are engaging in promotional pricing to unload excess production onto other export markets. While this has boosted the trade surplus, it has also created disinflationary pressure and contributed to a sharp decline in corporate profit margins. Meanwhile, the measures taken to boost domestic demand have been insufficient.

Notably, many observers had expected the US tariffs to cause China’s exports to decline, leading to a drop in China’s trade surplus. This did not happen. Moreover, the persistent trade surplus is mostly not the result of trade policy. Rather, it is mainly a reflection of China’s high savings rate and policies that suppress domestic demand, leading to more production than consumption. Meanwhile, other countries, sometimes, attribute their own trade deficits to China. Yet, these deficits are often due to low savings rates and policies that boost domestic demand. In any event, persistent imbalances often lead to political conflict and, ultimately, trade restrictions and/or efforts to shift currency values. For example, the European Union is considering the imposition of import restrictions on China; the United States has already imposed substantial tariffs on the country.

Is fiscal dominance coming to the United States?

• President Trump has urged the Federal Reserve to rapidly cut short-term interest rates. Why?  He has been explicit in explaining his reasoning. He has said that lower interest rates would reduce the cost of funding government debt, thereby reducing the budget deficit. The Wall Street Journal reported that, in an interview in December, Trump “said rate cuts would help the US Treasury reduce the costs of financing US$30 trillion in government debt."

This is an unusual argument about US monetary policy. The Federal Reserve is mandated by the US Congress to minimize inflation and maximize employment. The Fed also has a role in regulating member commercial banks with the goal of maintaining financial stability. Using interest-rate policy to manage government’s debt-service costs, however, is what is sometimes referred to as “monetizing government debt.” It is not uncommon in other countries, especially emerging countries, but can often lead to much higher inflation than desired.

This raises the issue of fiscal dominance, which is when governments have such large debts that they pressure their central banks to keep interest rates low, even when higher interest rates are warranted by inflationary concerns. This often happens in emerging countries with large budget deficits but rarely in advanced economies. In the United States, the only time it happened previously was during World War II, when the Fed put a cap on bond yields by purchasing large quantities of government debt. The inflationary effects were suppressed by wage and price controls. During the Korean War, the Truman administration sought a similar arrangement, but the Fed said no. The result was a Treasury-Fed Accord in 1951, which led to more than 70 years of Fed independence.

Former Fed Chair and Treasury Secretary Janet Yellen said that “fiscal dominance is dangerous because it typically results in higher and more volatile inflation or politically driven business cycles.” And yet, higher inflation is sometimes the goal as it helps to reduce the ratio of government debt to GDP. Yellen added that “fiscal dominance is also likely to raise term premia and borrowing costs as investors become concerned that the government will rely on inflation or financial repression to manage its debt.” Indeed, if keeping short-term interest rates unusually low leads to higher expectations of inflation, longer-term borrowing costs would likely rise. That could have negative consequences for interest-sensitive sectors of the economy, such as housing, thereby leading to slower economic growth and lower tax revenue than otherwise.

Meanwhile, the president has continued to call for the Fed to cut short-term interest rates rapidly. If, in the coming months, Fed Chair Powell is replaced with a chair who wants to follow the president’s lead, one of two things could happen. One possibility is that the new chair may have limited support from other members of the policy committee to cut rates rapidly. The committee is already significantly divided. If the majority of members reject the new chair’s views, the committee might wind up voting against the chair for the first time ever, which would create higher uncertainty about monetary policy in the minds of investors.

Alternatively, if the new chair is successful in getting the committee to cut rates rapidly, investors might perceive it as the Fed being politicized and acting as the administration prefers. They will, in that case, likely boost their inflation expectations, thereby leading to higher bond yields, which would, in turn, push up mortgage interest rates and corporate borrowing costs. As such, the result could be the opposite of what the administration desires.

US inflation is surprisingly tame

• Inflation in the United States is surprisingly tame, although it remains above the Federal Reserve’s target of 2%. This raises the question as to when, or if, tariffs might be fully passed onto consumers in the form of higher prices. While there has been some pass-through, it has been modest. Many companies have held off on boosting prices significantly, hoping to retain market share and offsetting the negative impact on margins by cutting costs, including hiring. Indeed, job growth has been very modest in the past year.

However, there is a view among some analysts that the limited pass-through of tariff costs cannot continue indefinitely. If companies ultimately adjust prices, the US inflation rate could increase by 1 to 1.5 percentage points in the coming year. For now, however, inflation appears tame. Let’s look at the data:

The government did not produce an inflation report in October, while November numbers were affected by the government shutdown. However, last week, the government reported data for December. Inflation evidently was unchanged from November. There remains uncertainty as to the degree to which the shutdown continues to influence the data. The government reported that, in December, the consumer price index was up 2.7% from a year earlier—the same as in November and the lowest since July. Prices were up 0.3% from the previous month. When volatile food and energy prices are excluded, core prices were up 2.6% from a year earlier—the same as in November and the lowest since March 2021. 

Among major categories, food prices were up 3.1% from a year earlier, energy was up 2.3%, electricity was up 6.7%, pipeline natural gas was up 10.8%, shelter was up 3.2%, medical care was up 3.5%, and new cars were up only 0.3%. Durable goods prices were up 1.2%, nondurable goods were up 1.9%, and services were up 3.3%.

What does this report imply for monetary policy? Following the inflation report, the futures market–implied probability of the benchmark interest rate remaining steady this month increased compared with the day before the data release. On the other hand, the five-year breakeven rate, which measures bond investor expectations of average inflation over the next five years, has risen in the past two weeks, possibly due to concerns about Fed independence. For now, investors appear confident that the current Fed leadership will be cautious about interest rates. However, much could depend on the composition of the Fed’s policy committee later this year.

The US administration addresses the affordability issue

• One of the biggest political issues in the United States at this moment is affordability. That is, voters continue to signal that the cost of living is too high, thereby limiting the ability of voters to own homes or make discretionary purchases. President Trump has recently taken several steps meant to address the issue. These actions include the following:

President Trump announced that he is ordering Fannie Mae and Freddie Mac to purchase US$200 billion in mortgage-backed securities. The idea is to reduce the supply of mortgage-related securities, thereby putting downward pressure on mortgage borrowing costs. Yet, Fannie Mae and Freddie Mac exist, in part, to bundle mortgages and issue securities. The idea is to boost liquidity in the market and thereby increase the ability of households to obtain mortgages. Some observers note that removing securities from the market could undermine liquidity and reduce mortgage availability.

Also, on the housing front, the president said he will seek to ban institutional investors from purchasing single-family homes. This includes private equity companies that have been active in the residential property market. The idea is that investor demand for homes is driving up prices. However, institutional investors own only about 1% to 2% of single-family homes. Moreover, industry demand weakened following a steep rise in borrowing costs in the last few years. Institutional investors have mostly recently been net sellers of houses.  Industry experts say that the main problem is a lack of supply relative to demand. The solution will be to build more homes, possibly by removing regulatory obstacles to construction. Many of the obstacles, however, are at the state and local levels.

President Trump announced that he wants a two-year 10% cap on credit card interest rates.  The challenge with doing this (and this would require an act of Congress) is that an interest-rate cap would force banks to limit the availability of credit cards to those with high incomes and good credit scores. Thus, availability of credit would probably decline. In response to the president’s proposal, shares in companies that issue credit cards fell sharply.

The President is keen to lower energy costs by boosting the supply of oil and gas. That is probably why he wants US energy companies to invest in Venezuela. Yet, the reality is that the world is well supplied in oil, which is why oil prices are down sharply from a year ago.  Moreover, oil companies will only invest in new sources if the price is high enough to generate a profit. When the US administration recently held an auction for leases of land in Colorado, under which there is oil, there were no bids. The price of oil is simply too low.  Thus, it seems unlikely that the administration will be successful in driving up oil production.

Germany’s economy grew in 2025 for the first time in three years

• The German economy has traditionally been Europe’s growth engine. Unfortunately, Germany’s economy contracted in both 2022 and 2023. Now, it is reported that, in 2025, the economy finally grew—but just barely. Real GDP was up 0.2% from the previous year. Germany has long been a manufacturing powerhouse and is a big exporter of manufactured goods. Yet, exports declined sharply in 2025, while imports grew strongly. Automobile exports performed especially poorly, likely due, in part, to US tariffs as well as competition from Chinese electric vehicles.

The modest rebound in growth in 2025 was likely due to a shift in fiscal policy. Although the current government had initially focused on fiscal probity, it shifted gears in early 2025, when it became concerned about US support for NATO allies and Ukraine. Along with other NATO governments, Germany consequently chose to allow a significant increase in government borrowing to fund increased spending on infrastructure and defense. It is likely that the 2025 rebound reflected the initial phases of this spending. Moreover, as spending heats up in 2026, it should boost economic growth even more.

Going forward, fiscal stimulus and an easy monetary policy are expected to be positive factors for German growth. On the other hand, troubled and uncertain trade relations with the United States will likely be a negative factor. Also, increasing competition from Chinese producers of automobiles and capital goods could hurt Germany. One of the bigger issues facing German industries is the price of energy. The good news is that energy prices will likely face downward pressures given weak global demand and strong supply increases. If German growth accelerates in 2026, it will probably have a positive spillover effect on other European economies.

Week of January 12, 2026

• US productivity surges because of the tech industry
• The US job market shows signs of cooling even as the economy has grown rapidly
• Southeast Asia’s economy has performed well despite headwinds
• The US dollar has weakened considerably in the past year
• Inflation in the Eurozone remains subdued

US productivity surges because of the tech industry

• The US economy appears to be generating significant gains in labor productivity. Yet most of those gains appear to be heavily concentrated in the tech industry, while the rest of the economy has not kept pace. As such, the economy appears to be bifurcating. For a while, some observers have talked about a K-shaped economy in which high-income households do well while others do not. This is real. Yet there now appears to be another K-shaped aspect to the economy, involving the divide between tech and non-tech. Let me explain.

In both the second and third quarters of 2025, labor productivity grew rapidly. Does this mean that the long-hoped-for productivity gains from AI have arrived? Probably not. Rather, productivity gains are mainly increasing in the technology sector while non-tech sectors see only limited gains (figure 1). This likely reflects big increases in tech output combined with only limited gains in employment. When data centers open and start spitting out insights (or hallucinations), this is an increase in output. Yet data centers employ very few people. Hence, productivity rises very rapidly.

Yet with productivity gains being so concentrated, most of the US economy is yet to experience the beneficial aspects of these gains. Normally, widespread gains in productivity would lead to significant wage gains and, consequently, improvements in living standards. For the US economy, this can only happen when productivity gains shift from the tech industry toward most other industries. And that will happen when AI adoption in other industries generates productivity gains. The evidence suggests this transition is not yet happening and may take some time.