Weekly global economic update

Week of October 27, 2025

• US inflation accelerates modestly
• US demographics are shifting dramatically
• China’s economy decelerates
• Japanese exports have strengthened
• British inflation eases

US inflation accelerates modestly

• US inflation levels continued to accelerate in September, but more slowly than many analysts anticipated. The government published its report on the consumer price index (CPI) a week late due to the government shutdown. But now that the data is available, the Federal Reserve can deliberate next week with confidence. Without the data, it would have been like driving blindfolded. Moreover, there remains uncertainty as to whether there will be a report on October inflation, depending on the length of the shutdown. In any event, given that the September data was better than expected, equity prices rose sharply on heightened expectations of monetary easing and relief that inflation remains moderately subdued. Bond yields, however, barely budged. Let’s look at the data:

In September, the CPI was up 3% from a year earlier, the highest annual inflation level since January. The last time it was higher was in May 2024. The CPI was also up 0.3% from the previous month. The sharp acceleration of the CPI was mostly due to rising food and utility prices. The subindex for food at home was up 2.7% from a year earlier, the highest since August 2023. This acceleration in food prices reflects the impact of immigration policy.

With many undocumented workers not showing up at farms and meat packing plants, production has been disrupted, thereby leading to higher prices. The price of meat, for example, was up 8.5% from a year earlier. In fact, the Trump administration acknowledged that there is a problem in a report issued by the US Department of Labor.

The report stated that “the near total cessation of the inflow of illegal aliens” is threatening “the stability of domestic food production and prices for US consumers.” It added that “unless the department acts immediately to provide a source of stable and lawful labor, this threat will grow.” On the other hand, the US Secretary of Agriculture predicted that US farm work will become “100% American.” Either way, food-price inflation is likely to accelerate.

Energy prices were up 2.8% from a year earlier and up 1.5% from the previous month. Yet this was not due to falling gasoline prices. Rather, it was due to electricity and other utility prices. The price of electricity was up 5.1% from a year earlier and the price of piped natural gas service was up 11.7%. These utility price increases partly reflect the impact of increased demand for electricity by data centers.

When volatile food and energy prices are excluded, core prices were up 3% from a year earlier. This was lower than in August but higher than in each of the previous four months. Core prices were up 0.2% from the previous month. It was the data on core prices that pleased many investors. It demonstrated that underlying inflation, while accelerating somewhat in recent months, remains tame. The expected pricing impact of tariffs has not yet taken place as many companies absorb the cost of the tariffs.

On the positive side, the subindex for prices of services was up only 3.6% in September versus a year earlier, the lowest reading since September 2021. Given that many services are labor-intensive, this suggests that the weakening of the labor market is helping to ease wage pressure. Indeed, the Fed has indicated that the main reason to keep cutting interest rates is the weakness in the labor market.

US demographics are shifting dramatically

• The United States could be on the verge of a dramatic shift in demographics that would have significant economic and public policy implications. The US population has almost always grown since the early days, even during wars and pandemics—the only exception was 1918, during the so-called Spanish flu epidemic. Even when deaths exceeded births, population grew because of immigration. There have been times when net immigration declined sharply, but these were usually during crises (wars, depression, pandemics).

Now, however, it is reported that the US population might decline this year. Although births still exceed deaths (which is set to end in 2031), net immigration has likely turned negative. This means that the population might decline in 2025 after having grown by more than 3 million people in 2024.

An analysis conducted by the Pew Research Center said that the foreign-born population of the United States fell by roughly 1.5 million people during the first six months of this year. That likely reflects not only deportations but many undocumented foreigners choosing to leave in fear of being detained by immigration authorities. A separate study by the American Enterprise Institute predicts that US net migration in 2025 will be negative 525,000. That just roughly offsets the excess of births over deaths, rendering no change in the US population.

No matter whichever estimate is correct, either way, there is about to be a major change in US demographics, almost entirely due to a change in US immigration policy. That policy has involved deportations, reducing access for refugees, and discouraging foreign students among other things. The policy has already led to a sharp slowdown in the size of the labor force, thereby slowing employment growth. Naturally, this means slower economic growth, all other things being equal. In addition, this will likely create shortages of labor in key industries, leading to higher wages and higher prices. This is already happening in some areas of agriculture as well as construction.

A continuation of the current immigration policy could have significant longer-term implications. Currently, 28% of the under 18 population of the United States are either immigrants or the children of immigrants. If there is net-zero immigration going forward, the under 18 population will shrink by 14% by 2035. This means that, in the 2030s and 2040s, the number of workers will decline sharply while the elderly population continues to rise. The impact on pensions and health care could be very onerous. Already the US government has a large fiscal imbalance that, in part, is driven by the rising cost of caring for the elderly. Less immigration will exacerbate that problem, potentially requiring tax increases and/or spending reductions lest investors become wary of holding US government debt.

Advocates of restricting immigration have stated that immigrants increase the demand for housing, thereby boosting home prices. Yet immigrants account for between 30% and 60% of construction-related jobs. A sharp reduction in the immigrant population could lead to a big increase in the cost of construction and/or a reduction in construction activity, thereby boosting home prices.

Also, immigrants account for a sizable share of US health care workers. According to the Kaiser Family Foundation, 27% of US physicians are immigrants and so are 22% of nursing assistants. A net-zero immigration policy could lead to significant shortages of labor in health care and home care. This will create an incentive to invest in robotization of various health-related tasks. This is already happening in Japan and South Korea—two countries with labor shortages and very little immigration.

Finally, immigrants in the United States have recently accounted for 38% of Nobel prizes won by US scientists and accounted for about half of the billion-dollar startups created. A net-zero policy could undermine scientific innovation and the entrepreneurship that follows, which, in turn, could negatively affect economic growth.

China’s economy decelerates

• China’s economy decelerated in the third quarter of this year, growing at the slowest pace recorded since the third quarter of 2024. The slowdown largely reflected the impact of a further weakening of the property market. Notably, real (inflation-adjusted) investment in property in the first nine months of 2025 was down 13.9% from a year earlier. The slowdown also reflected weak consumer demand. Although the Chinese government does not break down quarterly GDP into expenditure categories, separate releases on investment and retail sales demonstrate where there is strength or weakness. Let’s look at the details:

In the third quarter, China’s real GDP was up 4.8% from a year earlier, the slowest growth in a year. Real GDP was up 1.1% from the previous quarter. The latter was a slight improvement from the second quarter but was relatively slow compared to the past year.

The weakening of GDP growth probably reflected weakness in consumer spending. The government reported that, in September, retail sales were up only 3% from a year earlier, the slowest growth since August 2024. Retail sales were down 0.18% from the previous month. In part, the weakness of retail spending reflected the phasing out of government subsidies for appliance purchases. Indeed, appliance sales were up only 3.3% versus 14.3% in August. The subsidies had previously been introduced to boost domestic demand.

Consumer hesitancy was likely due to the impact of declining home prices, which has a negative impact on consumer perception of wealth. The government reported that, in September, new-home prices in 70 major cities fell 0.4% from the previous month, the biggest decline in 11 months. In addition, prices were down 2.7% from a year earlier. Given that Chinese household wealth is heavily weighted toward residential property, the decline in home values reduces perceived wealth, likely leading households to spend less and save more.

In addition, the Chinese government reported that fixed-asset investment fell 0.5% in the first nine months of 2025 versus a year earlier. This was the first such decline since the pandemic. In addition, investment fell 0.07% from August to September. The decline in the first nine months included a 13.9% drop in property investment, a modest 1.1% increase in infrastructure investment, and a 4% increase in investment in manufacturing. Excluding property, overall investment in the first nine months of 2025 grew only 3%. Weak investment likely reflects weak consumer demand, uncertainty about trade relations, and existing excess capacity in some industries.

Regarding excess capacity, it could become exacerbated by the strong growth of industrial output. The government reported that, in September, industrial production was up 6.5% from a year earlier, the best performance in three months. Manufacturing output was up a very strong 7.3%. There was particular strength for automotive (up 16%), computers and communication (up 11.3%), and railway and shipbuilding (up 10.3%). The very strong growth of automotive production contrasts with the modest 1.5% increase in retail automobile sales.

Japanese exports have strengthened

• After several months of weakness, Japan’s exports have returned to growth. The government reported that, in September, exports (measured in US dollars) increased 4.2% from a year earlier. This was the first time exports have grown since April and the strongest growth since March.

There was visible growth despite a 13.3% decline in exports to the United States, likely due to tariffs. This decline included a 24.2% drop in exports of automobiles to the United States. The trade deal that the United States and Japan reached includes a 15% US tariff on most imports from Japan. Although lower than the 25% tariff that had been threatened previously, the 15% tariff is still historically high and evidently affecting trade flows. Exports to South Korea and Australia were also down from a year earlier. However, exports were up 5.8% to China, 5% to the European Union, 8% to Southeast Asia, and 18.5% to the Middle East.

Meanwhile, Japanese imports grew 3.3% in September from a year earlier. It was the strongest growth since January. The rebound in imports probably reflects an improvement in domestic demand. It might also reflect the impact of accelerated exports. After all, many imported inputs are used in producing exports.

Imports were up 7.1% from the United States, 9.4% from Taiwan, 13% from the European Union, and 9.8% from China. However, imports declined sharply from Australia and the Middle East due to reduced demand for commodities.

British inflation eases

• The Bank of England (BOE) has put a hold on easing monetary policy as inflation accelerated in the United Kingdom, despite economic weakness. Now, a new inflation report from the government suggests that inflation is starting to ease, potentially setting the stage for the BOE to return to a more accommodative monetary stance. Let’s look at the data:

Over the past year, the annual rise in the CPI in the United Kingdom accelerated sharply. Yet, in the past three months, it stabilized, with prices up 3.8% from a year earlier in July, August, and September. Moreover, prices were unchanged from August to September, the first time there was no monthly increase since January. When volatile food and energy prices are excluded, core prices were up 3.5% in September from a year earlier, the lowest rate of core inflation since March. In addition, core prices were unchanged from August to September, the lowest reading since January. Evidently, underlying inflation is now decelerating.

On the other hand, services inflation held steady at 4.7%, the same as in five of the last seven months. Services tend to be labor-intensive, thus, the direction of service inflation is a reflection of underlying pressure in the labor market. Service inflation remains too high, but at least it is not accelerating. Moreover, the overall deceleration of core inflation could be due to economic weakness.

The favorable inflation numbers led investors to push down bond yields on expectations of lower inflation and of a potential easing of monetary policy by the BOE. In fact, the yield on the 10-year bond fell to the lowest level since December. Futures markets boosted the implied probability that the BOE will cut the benchmark interest rate in December from 40% yesterday to 70% today. The probability of an interest rate cut in November increased from 14% to 40%.

The favorable inflation report is good news for the government, which faces serious obstacles to achieving fiscal probity. Lower bond yields will lower the government’s cost of servicing its large debt. Plus, if the BOE starts to cut interest rates again, this could have a stimulative effect on economic activity, thereby generating improved revenue.

Week of October 20, 2025

• The artificial intelligence bubble and US economic growth
• Electricity and the AI race
• Rare earths and the race for economic dominance
• Tariffs and US consumer prices
• Chinese exports remain strong

The artificial intelligence bubble and US economic growth

• When do you know that an asset price bubble is on the verge of popping? The answer is, you don’t. You don’t necessarily know that a bubble even exists until it pops. And, even when you’re certain that there is a bubble, you cannot easily predict how long it will last.  Indeed, some bubbles last quite a long time, enabling investors to make a small fortune—at least on paper.

Which brings us to what is increasingly called the “AI bubble.” Prices of AI-related equities have soared, playing the most important role in the big increases in US and Chinese equity prices. This increase in valuations comes alongside massive investments in AI infrastructure.

In conversations with clients, I have been repeatedly asked if this situation resembles that of the dot-com bubble a quarter-century ago. My answer is that there are some similarities and some differences. One interesting comparison is the degree to which venture capital (VC) funds are financing AI-related investment. In 2000, VCs spent US$10.5 billion on internet companies, which translates to about US$20 billion in today’s dollars after adjusting for inflation. In 2025, VCs have already spent US$160 billion on AI—a number expected to reach US$200 billion before the year is over. Thus, VC spending on AI is about 10 times more than on the internet during the dot-com days.

Moreover, VC spending on AI now forms about two-thirds of all VC spending. Thus, VC funds are making a big bet on AI—as is everyone else. And, as in the dot-com days, much of the money is going to small companies that have no profits and only modest revenue. There appears to be a view that, if funds invest money in a large number of companies, while only a few might pay off, those that do pay off could generate substantial gains, thereby justifying the gamble. Some observers have called the investment strategy “FOMO” (or, fear of missing out). No one wants to be left behind when fortunes are made.

The challenge is that, if and when the weakness of multiple companies becomes apparent, equity prices could decline while investment spending could be curtailed. That is what happened in 2000, when investors became worried about massive investments in fiber optic cable. It led to a minor recession. Moreover, it is likely that some of the current strength of consumer spending by high-income US households has been fueled by the rise in equity prices. If this reverses, it could have a negative impact on consumer spending.

On the other hand, enthusiasm for AI and its potentially transformative properties continues, contributing to an unusually strong investment surge that is fueling US economic growth and partially offsetting the potentially negative impacts of trade and immigration policy. This could go on for quite a while, or it might not. No one knows.  What we do know is that, even with the AI-related investment surge, the US economy has already decelerated sharply from 2024. This is expected to continue, especially if importers pass on more of the cost of tariffs to their customers in the coming year.

• An important question is why the US economy has been relatively resilient in the face of disruptive and challenging shifts in policy. In a previous note, I suggested that investment in AI is a major explanation. Now, the International Monetary Fund has offered an upwardly revised forecast for the United States and global economies. It said that AI investment is shielding the US economy from the impact of trade and immigration policies. However, while the IMF upwardly revised its forecast for US growth in 2025, its forecast for 2026 remained relatively stable and weak.

Specifically, the IMF had previously (in April) predicted that the US economy would grow 1.8% this year, after having grown 2.8% in 2024. Now, it says that the US economy will grow 2% this year—still modest compared to last year but much stronger than the other G7 countries. The chief economist of the IMF, Pierre Olivier Gourinchas, said that the principal reason is “a very significant AI-related, tech-related investment surge.” In addition, he said that the surge in equity valuations of tech companies has boosted the wealth of higher-income households, thereby fueling their strong household spending.

When asked whether the current surge in AI investment and equity market valuations is similar to the dot-com bubble a quarter-century ago, Gourinchas said that “we are not yet at the levels of the surge investment that we saw in the dot-com boom; we’re not yet at the level of stretched valuations in equity markets. But we’re maybe half, or two-thirds of the way there.” However, he said that, as in the dot-com boom, households have an incentive to spend more even though the economy is not producing more. He said that “the economy is not really producing more yet; it’s promises about the future. So that creates demand pressures.”

Electricity and the AI race

• Which country has a bigger economy: China or the United States? Well, China’s economy is still smaller than that of the United States when measured using an exchange rate that reflects the purchasing power of each countries’ currency. Yet, notably, China produces more than twice as much electricity as the United States. This suggests that, from a supply rather than a demand perspective, China’s economy is bigger. Moreover, the most serious obstacle to developing generative AI is electricity supply. China is clearly in a more favorable position from this perspective.

Before jumping to too many conclusions, it is worth recalling that, during the Cold War, the Soviet Union boasted that it produced more steel than the United States—which was true. Yet the highly inefficient Soviet economy was unable to translate that success into a healthy consumer economy. The Soviet economy produced few cars and appliances, and consumers had to wait in long queues to obtain poor-quality goods. Only the Soviet military had easy access to steel. This is not to say that China’s electricity is put to poor use. It is only to say that we should be cautious when celebrating strong production.

In any event, the lion’s share of the increase in US capacity in recent years involved renewable sources of energy. This form of output has nearly doubled in the past three years. Now, however, incentives have been reduced while the US administration has canceled permits for some producers of solar and wind energy. Instead, it wants to promote more production of oil, gas, and coal. Yet oil and gas production are largely driven by prices that, currently, are suppressed due to weak global demand and excess capacity. Thus, the outlook for increased electricity production in the United States is modest, at best.

Meanwhile, China continues to invest massively in renewables. China’s wind capacity has increased fivefold since 2014 and is now more than three times that of the United States. China’s ability to rapidly boost electricity-generating capacity positions it favorably to meet the demands of AI-related data centers as well as electric vehicles.  This ability could have an impact on the rate of economic growth in the future. At the same time, a US failure to boost capacity will likely lead to further large increases in prices.

Rare earths and the race for economic dominance

• In 1992, then Chinese leader Deng Xiaoping said “the Middle East has its oil, China has rare earths … it is of extremely important strategic significance.” He was very prescient.  After all, few people had heard of rare earths in 1992. Even today, most people have not heard of antimony or gallium. Yet, today, rare earths are at the heart of the trade dispute between the United States and China. More broadly, rare earths are of critical importance to the world’s most sophisticated and important industries and products.  This includes batteries, smartphones, semiconductors, and sophisticated weapons.

China dominates production of rare earths but not reserves. As of 2023, China held 38% of rare earth reserves but was responsible for 68% of the production. The United States accounted for 2% of reserves and 12% of production. However, India, Vietnam, and Brazil, together, accounted for 43% of reserves but only 1% of production. As such, China’s dominance has more to do with production than reserves. There is potential to boost production outside of China. However, the three countries noted above have all recently been hit by steep US tariffs. This might limit the ability of US companies to develop new production capacity.

For now, though, the world depends on China. Chinese rare earth imports account for 78% of US imports, 91% for Germany, 89% for the United Kingdom, and 58% for Japan. Consequently, China’s decision to tighten exports of rare earths and to sanction companies that ship rare earths is clearly a concern around the world. The US response of threatening a 100% tariff on Chinese imports did little to ease the situation.  Moreover, China’s decision to act suggests confidence that it has significant leverage.

On the other hand, restrictions on Chinese exports could, over time, lead other countries to invest more in production of rare earths, potentially reducing China’s role in this market altogether. Meanwhile, China has a relatively slow-growing economy that depends on exports for a large share of growth. Yet exports to the United States are falling sharply, while exports to other countries are expanding rapidly—but at what cost?

A study published by the Brookings Institution suggests that the rapid growth of Chinese exports to other countries has been at the cost of diminished profit margins. The study said that China’s exporters are “making steep discounts to generate demand in new markets or facing higher transportation costs for transshipment to the United States. Either way, China’s export sector is likely suffering through a very severe shock.” The study concludes that Chinese exporters’ profit margins are down. The study concludes that “China is an export-dependent economy that’s on borrowed time. It’s hardball tactics on rare earths stems from weakness, not strength.”

Tariffs and US consumer prices

• One of the important questions about the impact of trade policy is why we have not yet seen a big increase in US inflation, given the magnitude of the tariffs imposed. A new research study by three economists from major universities (Harvard, Northwestern, and Universidad de San Andras) used high-frequency retail-price data, detailed country-of-origin information, and tariff classifications to determine what happened to prices of imported goods. Notably, the study found that most prices of imported goods have increased significantly in response to tariffs. The study said, “We find that the tariff announcements led to rapid, though still moderate, price increases. Imported goods [prices] rose by about 4% since early March.” The study also found that prices of domestically produced goods increased, especially when they were exposed to foreign competition.

Meanwhile, the degree to which prices increased varied by country of origin. The study found that “Chinese goods experienced the largest and most persistent price increases. In contrast, goods from Canada and Mexico—where tariffs were perceived as more temporary or less binding—showed smaller adjustments. Other countries, including Turkey, Poland, the United Kingdom, Japan, and Italy, saw even larger price increases. However, because China accounts for 36% of all products in our sample, most of the aggregate effect is driven by Chinese imports.” In addition, the study found that, by merchandise category, the biggest price gains were in furnishings and household goods.

The study also found that “retail prices began rising within a week of the March 4 announcement, with cumulative increases of up to 2.5% over the following months—consistent with gradual, yet sustained, pass-through.” In other words, tariffs did not lead to a one-off increase in prices. Rather, the process appears to be gradual, meaning that inflation could rise significantly, but only over a prolonged period of time. Why did businesses boost prices only gradually? The study said that “several factors likely contributed to this measured pricing response. These include concerns about consumer backlash, the front-loading of inventories, trade-diversion strategies, exemptions or delays in implementation, and, most notably, heightened uncertainty about the scope and duration of the measures.” In any event, the study suggests that US inflation is expected to gradually accelerate in the coming year, potentially creating new uncertainty about the path of monetary policy.

Chinese exports remain strong

• The Chinese government reported that exports, denominated in US dollars, increased strongly in September, up 8.3% from a year earlier—the fastest pace in six months.  This was despite a 27% decline in exports to the United States. As such, China’s exports to the rest of the world did very well. For example, exports were up 14.2% to the European Union, up 15.6% to Southeast Asia, and up a more modest 1.8% to Japan.

By category, Chinese exports were up 23.3% for integrated circuits, up 10.8% for automobiles, and up 21.4% for ships. On the other hand, exports of rare earth minerals were down 7.6% from a year earlier due to a restrictive set of regulations. The volume of rare earth exports (excluding the impact of prices) declined 31% from August to September.

Also, Chinese imports were up 7.4% in September versus a year earlier, the strongest growth since April 2024. This reflected healthy domestic demand in anticipation of holidays, increased spending on infrastructure investment, and the impact of strong exports. That is, many imported goods are used as inputs in exportable products.

Going forward, China appears able to absorb a big increase in the US tariff on its imports. Currently, China faces an average tariff of 40%. Exports to the United States have already fallen sharply and exports to other countries are doing very well. Thus, China is not likely to make major concessions to avoid US tariffs. Moreover, China’s dominance of the global rare earth market gives it leverage with the United States that other countries cannot match. Plus, China’s decision to shift purchases of agricultural goods from the United States to other countries (Australia, Brazil, Argentina) has created challenges in crucial Midwestern farm states.

On the other hand, China remains too dependent on exports to drive economic growth.  Most indicators of domestic demand have lately been weak, despite government efforts to boost domestic demand through fiscal and monetary stimulus.

Week of October 13, 2025

• Artificial intelligence is driving the US economy
• Japanese politics drive a new economic direction
• Gold price surge tells us something about the economy
• The latest on trade

Artificial intelligence is driving the US economy

• To the extent that there is strength in the US economy and in the US asset markets, it is almost entirely due to the big bet on AI. Absent the performance of AI-related equities, US equity prices would have underperformed European equity prices. In fact, it has been estimated that AI-related companies were responsible for 80% of the recent gains in the S&P 500 index of US equities. And absent investment in AI-related equipment and software, the US economy would have grown very slowly in the first half of this year.  Indeed, business investment in information processing equipment accounted for 46% of US GDP growth in the first half of 2025. If investment in software is added, then these two categories were responsible for more than 90% of GDP growth in the first half of the year.

By almost any measure other than AI, the US economy and the US equity market are not especially impressive. One exception, however, has been the surprising strength of US consumer spending. Yet to some extent, that too reflects the impact of AI. After all, the wealthiest 10% of US households own most of the equities while the highest-earning 10% are responsible for roughly half of consumer spending. Thus, one can argue that, in the absence of the surge in equities, consumer spending growth would have been less impressive.

Meanwhile, US labor force growth has been extremely slow, largely due to the significant reduction in immigration. Yet sustained, strong economic growth suggests that the economy is being driven, in part, by gains in labor productivity. Moreover, we know that in recent years, a disproportionate share of labor productivity growth was due to the tech industry. In fact, productivity grew much faster on the West Coast than in the rest of the country, largely due to the concentration of the tech industry there.

Going forward, a couple of questions emerge. First, will the massive investment in AI generate positive returns in the near term? If not, could there be an equity market correction? Second, is the current rise in productivity due to the investment in AI? The answer is that the evidence suggests not. Rather, it likely reflects investment in other technologies, especially in the services sector, which faces labor shortages. That shortage is leading companies to seek labor-saving or labor-augmenting technologies

Japanese politics drive a new economic direction

• In Japan, Sanae Takaichi was elected leader of the Liberal Democratic Party (LDP), much to the surprise of predictions markets, which had anticipated victory for Shinjiro Koizumi. Takaichi is the first woman to lead the LDP, and will almost certainly be the next Prime Minister—also a first.

Thus, the Takaichi Age is beginning. Ms. Takaichi compares herself to Margaret Thatcher. Like Thatcher, she is a fan of the libertarian economist Friedrich von Hayek and believes in free markets and limited regulation. Yet, she was also a devotee of the late Japanese Prime Minister, Shinzo Abe. His policy, known as “Abenomics,” involved three pillars: fiscal stimulus, monetary expansion, and structural reforms. Many observers expect her to revive Abenomics while attempting to liberalize the Japanese economy in the mode of Thatcher.

The selection of Takaichi led to a sharp decline in the value of the yen, a rise in long-term bond yields, and a big increase in Japanese equity prices. Many investors expect Takaichi to pursue fiscal stimulus, which implies higher bond yields and, potentially, higher inflation. Moreover, there is an expectation that she may put pressure on the Bank of Japan (BOJ) not to pursue further increases in interest rates. The expectation of higher inflation and lower policy interest rates contributed to the decline in the value of the yen. Plus, the expectation that the economy could grow faster contributed to the rise in equity prices.

As for equity prices, there was a sharp rise for pharmaceutical companies, auto companies, and semiconductor manufacturers. There was an especially sharp rise for companies in defense-related industries, given that Takaichi is expected to pursue increases in defense spending. Bank stocks, however, fell on the expectation that interest rates are less likely to rise.

Polls indicate that the primary concern of Japanese voters is inflation, which remains historically high. Yet the selection of Takaichi does not signal a likely effort to quell inflation. Rather, given the unpopularity of the LDP, it is possible that the parliament members, who chose Takaichi, want to create a sense of excitement to boost support, especially if she chooses to call a new election. On the other hand, some critics suggest that Takaichi is too conservative for Japan’s current mood. In fact, the LDP’s junior partner, Komeito, is likely to exit the government as it disagrees with Takaichi’s hardline policies on defense.

As mentioned above, the selection of Sanae Takaichi as leader of Japan’s LDP, and her likely ascent to the role of prime minister, has led to a sharp rise in long-term Japanese government bond yields. That, in turn, reflects an expectation that, under Takaichi, Japan’s government could implement a more aggressive program of fiscal stimulus.  That means more selling of government bonds and, consequently, higher bond yields.

There is concern that the increase in the supply of Japanese long-dated bonds could put upward pressure on bond yields in other countries. That is because the rise in Japanese yields might lure Japanese investors to bring money back to Japan from foreign domains. On the other hand, the Japanese yen depreciated following news of Takaichi’s victory. That reflected an expectation that the BOJ will likely follow an easier monetary policy than previously anticipated.

Gold price surge tells us something about the economy

• The price of an ounce of gold hit a record high of US$4,037—up more than 54% since November 2024. Why? One reason is that China’s central bank has been buying gold at a rapid pace. This likely reflects an effort to diversify away from exposure to the US dollar. Indeed, since early this year, there has been evidence that global investors, both in the private sector and public sector, have been reducing exposure to the dollar.

There has long been an unhealthy obsession with gold. The late economist John Maynard Keynes called gold a “barbarous relic.” Gold is essentially a speculative asset, and swings in gold prices often reflect speculative influences rather than underlying supply and demand patterns. Yet gold prices can sometimes be useful indicators of issues beyond the market for gold.

Historically, increases in the price of gold often indicate growing expectations of inflation. Gold has been considered a hedge against inflation. In the United States, at least, there has been a sharp rise in consumer expectations of inflation and a more modest rise in investor expectations. Sometimes increases in the price of gold reflect lower interest rates, meaning that the opportunity cost of holding gold has declined.  Indeed, in the United States, there is an expectation that short-term rates will fall further.

Yet it seems likely that, in this case, the sharp rise in the price of gold reflects more than just expectations of inflation and lower interest rates. Indeed, the rise in gold prices has lately correlated with the decline in the value of the dollar. This is despite the surge in US equity prices, which has partly been driven by an influx of foreign money. Yet we know that foreign investors in US equities have hedged to protect themselves from dollar depreciation.

The latest on trade

• When the United States and the European Union reached a trade deal in July, there was hope that this would set the stage for a new period of stability and predictability, thereby enabling companies to confidently make supply chain investments accordingly. Yet the United States is now talking about undermining the deal because of concerns about the EU law on climate.

Specifically, the US government has asked the European Union to exclude non-EU companies from the requirement that they provide “climate transition plans.” In addition, the United States is asking the European Union to exclude US companies from a requirement to identify environmental or social costs in their supply chains.  Also, the United States has complained about the European Union’s carbon border tax, which is set to begin next year. These demands are consistent with the US government’s current stance against regulations meant to compel companies to engage in a transition to clean energy.

The United States says that the EU regulations, which were enacted last year, create “serious and unwarranted regulatory overreach,” which “imposes significant economic and regulatory burdens on US companies.” In addition, it said that the regulations mean that “extraterritorial reach, onerous supply chain due diligence obligations, climate transition plan requirements, and civil-liability provisions will adversely impact the ability of US businesses to compete in the EU market.”

It is not clear what the US will do if its demands are not met. The United States is not offering anything in exchange for the EU meeting its demands. Observers worry that US demands could lead to the undermining of the existing trade deal that was agreed upon in July. Uncertainty about the stability of the deal could have adverse effects on supply chain investment.

• The World Trade Organization (WTO) says that the impact on global trade from US tariffs will come later than previously anticipated because of stockpiling of goods in 2025 in anticipation of tariffs. The full impact will mean a sharp deceleration in goods trade. An economist for the WTO said that “the tariffs have a significant effect. It’s just the timing that has changed.”

On the other hand, the impact of the US tariffs has been softened because other countries have not retaliated. Early in this episode of trade tension, there was a significant expectation that other countries would retaliate against US tariffs, thereby having a further negative impact on trade flows. This has not happened. US trading partners have accepted that the United States will keep high tariffs regardless of what they do. Moreover, they have learned that the best way to avoid even more onerous tariffs is to promise to import more goods from the United States as well as to invest more in the United States. These promises are mostly gentleman’s agreements for which there is no enforcement mechanism.

Meanwhile, the director-general of the WTO said that “the outlook for next year is bleaker, and I am concerned. Just because we see resilience in the system doesn’t mean we are home free, because there is so much uncertainty in the system.” She suggested that trade will decline sharply in 2026, when the full impact of the tariffs likely will be felt. This, in turn, will have a negative impact on global economic activity.

The WTO also said that, although the tariffs have only targeted merchandise trade, they will have a negative impact on services trade—especially transportation and tourism. On the other hand, the WTO noted that, so far this year, the tariffs have led to a diversion of trade, which has entailed increased trade between emerging countries, many of which are attempting to reduce exposure to the United States.

• China imposed new restrictions on rare earth minerals, and not only restrictions on exports. Rather, it imposed restrictions on third parties that export magnets that have even small amounts of Chinese-produced rare earth minerals. This is similar to the Foreign Direct Product rule used by the US government to restrict usage of key technologies. In response to the new Chinese rules, the United States announced it will impose a 100% tariff on imports from China. This, in turn, led to a sharp decline in US equity prices after a prolonged bull market. President Trump said that “We import massive amounts from China and maybe we’ll have to stop doing that.”

Despite these words, the president said that the 100% tariff would not go into effect until Nov. 1, 2025. This means that there remains time to negotiate a trade agreement. Meanwhile, Trump is scheduled to meet with China’s president soon.  There is now uncertainty as to whether the meeting will take place.

Week of October 6, 2025

• US government shutdown and its implications
• Signs of financial stress for US households
• Potential impact of US plans for H1B visas
• US port fees and their potential impact
• Eurozone inflation and ECB policy

US government shutdown and its implications

• As the US government’s new fiscal year began on October 1, large swaths of the US government shut down. That is because the Congress did not pass a bill to fund the government. And that is because passage requires a supermajority in the Senate, which means that the Republican-controlled Senate cannot pass it alone. As such, Democrats are withholding support unless certain demands are met. Let me address the potential economic impact.

The reality is that a shutdown of the government does not necessarily have a substantial economic impact. That is because many government functions continue to take place. A big part of what the Federal government does involves expenditures that are not budgeted each year and are immune to a shutdown. These include payments of benefits such as Social Security, Medicare, Medicaid, and other entitlement programs. In addition, interest payments on the debt continue to be made. Moreover, the military, intelligence, security, and law enforcement functions continue to operate, although many employees of these agencies do not get paid during a shutdown even though they are required to work.

The principal impact of a shutdown is the closure of non-essential agencies and the temporary dismissal of their employees. The Congressional Budget Office estimates that a shutdown will involve furloughing about 750,000 employees of the government. Although they will be given back-pay when they ultimately return to work, the temporary loss of income has an impact on consumer spending and on the ability of these people to pay their bills, including servicing debts. The longer the shutdown lasts, the greater the impact—although even a month-long shutdown will not likely have a significant impact on the longer-term trajectory of the US economy.

One important function of the government is to release economic data that can be used by policymakers, including the Federal Reserve, in its deliberations. Data will not be released during a shutdown. Moreover, it has already been announced that the September employment data will not be released as scheduled. Absent good data, the Fed might find it more difficult to discern the state of the economy when it meets at the end of this month. That could mean indecision about whether to cut interest rates again.

On the other hand, the Fed generates some of its own data, including industrial production as well as qualitative data on the economy gleaned from its periodic surveys of business and financial leaders. Plus, the Fed can utilize access to private sector data.

The shutdown has so far not influenced financial markets, and it is not likely to happen. The shutdown has nothing to do with the ability of the government to service its debts, which is an issue that can influence asset prices. That issue arises when the Congress comes close to failing to raise the debt ceiling. That issue is no longer on the table following passage of the One Big Beautiful Act, which kicked the issue down the road. However, the high frequency of government shutdowns in recent decades likely erodes investor confidence that the Congress will ever address underlying structural imbalances in its fiscal stance.

• Although the US government did not release a report on September employment data last week, there is private sector data on employment. ADP, a payroll processing company, provides a monthly estimate of private sector employment that is often, but not always, a good predictor of the government numbers. ADP recently reported that, in September, private sector employment was down 32,000 from the previous month. ADP’s chief economist commented that “despite the strong economic growth we saw in the second quarter, this month’s release further validates what we’ve been seeing in the labor market, that US employers have been cautious with hiring.”

Notably, ADP reported that employment increased by 33,000 at large companies (those with 500 or more employees) but fell more sharply at small- to medium-sized companies. ADP also reported that employment declined in most industries with the exceptions of mining, information, and education/health care. The latter saw an increase of 33,000 jobs. In addition, ADP reported that all the job losses in September took place in the Midwest while job growth took place in the other regions.

Finally, ADP reported that, for job stayers, annual pay rose 4.5% from a year earlier, significantly higher than the rate of inflation. This reflects tightness in the job market despite no job growth. And that, in turn, likely reflects the impact of a restrictive immigration policy. That is, as demand for labor recedes, the supply of labor is receding commensurately due to lower immigration and deportations.

Signs of financial stress for US households

• At a time when US consumer spending is growing at a healthy pace, and faster than the growth of household income, it is notable that the number of households facing financial stress has grown substantially. Specifically, a large number of households are facing trouble servicing their automotive loans. Automotive lending is the second largest source of consumer credit after home mortgages. By the middle of this year, Americans had nearly US$1.7 trillion in automotive debt. This is roughly 9% of total consumer debt, including mortgages.

The share of automotive loans that are 90 or more days delinquent hit 5% in the second quarter of this year. That is only slightly below the historic high of 5.3% in 2010. In poorer parts of the United States, the delinquency rate was much higher (10% in Mississippi and 8.4% in Louisiana). Not surprisingly, younger borrowers have higher delinquency rates. And, of course, the delinquency rate on sub-prime loans has increased sharply, far faster than the rate on all loans. Specifically, the share of sub-prime automotive loans that are 60 or more days delinquent is 10% (the highest since 2008) while the share for all automotive loans is only 2%. This fact is creating anxiety in financial markets.

Recently a major sub-prime automotive lender filed for bankruptcy. While it is reported that there were specific reasons for this implosion, many investors are becoming more concerned about the state of the sub-prime market, with some worrying that there might be hidden problems among the participants in this market. This is especially true given that a large automotive parts supplier recently filed for bankruptcy as well.

Sub-prime borrowers (those with modest incomes and poor credit histories) are the most vulnerable given their weak financial cushions. When delinquencies among sub-prime borrowers rise significantly, it is often a sign of larger troubles to come with respect to household finance. If true, it could foretell systemic problems in the market for consumer finance. Indeed, the delinquency rate on credit card debt (the third biggest type of consumer debt) has risen sharply in the past two years.

Meanwhile, much of the debt held by lending institutions gets bundled and sold as securitized debt. As defaults rise, the value of the securities falls. As institutions that hold these securities mark the value to market on their balance sheets, they could be compelled to liquidate other assets to cover their losses, thereby leading to a general decline in asset values. Plus, an increased perception of hidden risk could stifle credit market activity and lead to higher risk spreads.  

Potential impact of US plans for H1B visas

• The recent decision by the US administration to impose a US$100,000 fee on new H1B visas has set off a debate about the potential impact. H1B visas are issued by the US government to companies that need highly skilled workers. Often, such skills are in short supply in the United States. The government currently issues 85,000 such visas per year. The new fee will mean a significant cost for companies, many of which might decide to offshore some processes rather than bring workers to the United States.

Although the new decision will have implications for employment trends at technology, consulting, and financial services companies, a larger impact could emerge. According to a study published by the University of Chicago, H1B visa holders contributed significantly to productivity growth in the United States. Specifically, the study found that, in the period 1990 to 2010, H1B visa holders contributed between 30% and 50% of all productivity growth in the US economy. Moreover, according to a report from the Peterson Institute, H1B visa holders are not simply employees. They are important factors of production, playing a key role in innovating in such industries as information technology, engineering, bioscience, and financial services.

Moreover, evidence suggests that, in the past, when there were changes in the number of visas issued, it had an impact on productivity growth. Specifically, the number of visas was boosted significantly in 1998 and then reduced significantly in 2004. Notably, this coincided with acceleration and then deceleration of productivity. Plus, as the Peterson Institute notes, “H1B visas cause dynamism and opportunity for natives. They cause more patenting of new inventions, ideas that create new products and even new industries. They cause entrepreneurs to found more (and more successful) high-growth startup firms. The resulting productivity growth causes more higher-paying jobs for native workers, both with and without a college education, across all sectors.”

Finally, a study published by the American Economic Association found that, in the long run, the most effective policy lever to boost productivity growth is “increasing the supply of human capital (for example, relaxing immigration rules or expanding university STEM admissions).” As such, the new decision could be one of the most impactful policy moves of this administration.

US port fees and their potential impact

• Aside from tariffs, an important trade restriction implemented by the US administration is a docking fee at US ports charged to ships that are either owned or operated by Chinese companies or were built in China. This fee is set to begin on October 14. The United States is imposing the fee due to what it sees as “unfair” competition from state-subsidized shipping in China. It is also meant to revive US shipbuilding. Given that the fee is only applied to Chinese shipping, companies and builders in other Asian countries such as Japan and South Korea see an opportunity to boost their market share.

Meanwhile, China dominates the shipping industry. It is reported that 29% of container ships on the water were made in China and 70% of ships on order will be made in China. The fees are set to be very steep and could either lead to sizable increases in the prices paid for shipping services or diminished profits for shipping companies. As such, some shipping companies have been rotating Chinese-built ships out of US-bound shipping lanes, attempting to minimize the impact of the fees. US exporters have complained that the fees could reduce their competitiveness as they apply to any Chinese ship that visits a US port, whether bringing goods to or taking goods from the United States. And US retailers, which purchase goods from Asia, are concerned about the potential impact on their costs.

China’s government has responded to the US plan, saying it will implement countermeasures against US ships. The government said that “these countermeasures include, but are not limited to, charging special fees on their vessels when calling at Chinese ports, prohibiting or restricting these vessels’ port access in China, and barring or restricting their organizations or individuals from accessing China-related maritime data or operating in international shipping and related services to and from Chinese ports.”

There remains uncertainty as to whether the United States will go ahead and implement the fees, given that the United States and China are in the midst of negotiations about permanent trading relations. It is possible that the fees will be postponed.

Eurozone inflation and ECB policy

• Inflation in the 20-member Eurozone accelerated slightly in September. The European Union (EU) reports that, in September, consumer prices rose 2.2% from a year earlier. This was up from 2% in August and was the highest rate of inflation since April 2025. On the other hand, when volatile food and energy prices are excluded, core prices rose 2.3%, the same as in each of the previous four months. Thus, underlying inflation appears to be steady.

The main reason that headline inflation accelerated is that the decline in energy prices abated. Otherwise, inflation appears to be stable. Prices of services were up 3.2% in September from a year earlier, roughly unchanged for the past five months. Meanwhile, prices of non-energy industrial goods rose 0.8%, unchanged for the past three months.

For the European Central Bank (ECB), the stability of underlying inflation at a relatively low level would appear to support its choice to keep the policy rate unchanged. Moreover, the rise in the value of the euro in the past year helps to suppress inflation by reducing import prices. ECB President Lagarde said, however, that the choice to keep rates unchanged is not “fixed.” Rather, “we are well placed to respond if the risks to inflation shift, or if new shocks emerge that threaten our [medium-term inflation] target.” She added that “we cannot pre-commit to any future rate path, whether one of action or inaction. We must remain agile, and ready to respond to the data as they come in.” Although the ECB has a single mandate to minimize inflation, the ECB undoubtedly keeps an eye on the health of the economy and the stability of the financial system.

Week of September 29, 2025

• The US announces new tariffs
• US economic growth more resilient than expected

The US announces new tariffs

• Trade disruption continued as President Trump announced, through social media, a series of new tariffs. In addition, there are reports of potential other trade restrictions. Here is what we know:

The president said he will impose a 100% tariff on “any branded or patented Pharmaceutical Product, unless a company IS BUILDING their pharmaceutical manufacturing plant in America.” He added that there will be “no tariff on these pharmaceutical products if construction has started.” This evidently does not apply to generic pharmaceuticals which account for about 90% of the pharma products imported into the United States. The lion’s share of these come from India.

Many branded pharma products, however, come from Europe. Several European pharma companies already have production facilities in the United States or are currently investing in such facilities. This will potentially enable them to avoid the new tariffs. Still, it is not clear if the exemption applies to all products made by a European pharma company investing in the United States, or just to those products that a company plans to manufacture in the United States. It is reported that companies are engaging with the United States government to obtain clarity.

Another issue is whether the trade agreement recently reached between the United States and the European Union (EU) supersedes the latest announcement on pharma products.  The deal says that all imports from the European Union will face a 15% tariff. A spokesman for the European Union said that “this clear all-inclusive 15% tariff ceiling for EU exports represents an insurance policy that no higher tariffs will emerge for European economic operators.” Still, it remains unclear if the US administration intends the new tariff on pharma products to be added to the 15% tariff. As for the United Kingdom, a government spokesman said that the announcement is “concerning.” In response to the announcement, shares in Europe-based pharma companies fell.

Shares of pharma companies in Australia, Japan, South Korea, and India fell in response to the latest announcement. The Japanese government said that it expects the trade deal between the United States and Japan, which calls for a 15% US tariff on imports from Japan, will supersede the announcement about tariffs on pharma products. Yet this was not made clear in the US announcement.

The impact of the new policy on drug prices in the United States could be muted by two facts: first, most imported drugs are generic rather than branded and, as such, are not subject to the tariff. Second, many non-US pharma companies already engage in manufacturing in the United States or are actively investing. This will mean that either some or all of their exports to the United States will be exempted. The problem now is that the devil is often in the details and not many details were provided. Thus, uncertainty remains.

In addition to the tariffs on pharma products, the president announced that there will be new tariffs on some furniture products as well as heavy trucks. Specifically, he said that there will be a 25% tariff on heavy trucks. This is meant to protect US-based truck manufacturers from “unfair outside competition.” As with pharma products, it remains unclear if this 25% tariff will be superseded by the 15% tariff on imports from the European Union and Japan. Trump also said there will be a 50% tariff on imports of kitchen cabinets and bathroom vanities as well as a 30% tariff on upholstered furniture.

These new tariffs will potentially boost the effective average tariff rate of the United States which lately has been estimated at 19.6%. The tariffs will likely boost inflation, especially for durable goods.

Meanwhile, it is reported that the US administration is considering a plan meant to boost domestic manufacturing of semiconductors and reduce US dependence on overseas supplies. Recall that this was the goal of the CHIPS Act that was passed during the Biden Administration and involved substantial subsidies to companies that build chip fabrication plants in the United States.

US economic growth more resilient than expected

• Real GDP in the United States grew faster in the second quarter than previously estimated, according to the third and final revised estimate of GDP from the government. How can we explain the evident resilience of the US economy, especially at a time of very slow job growth?

First, the government reports that, in the second quarter, real GDP grew at an annualized rate of 3.8% from the previous quarter. This is up from an initial estimate of 3.0% and a second estimate of 3.3%. This was due to a significant upward revision of growth in consumer spending, a slower decline in real business investment, and a bigger decline in imports (which has a positive impact on GDP growth).

In part, the strong growth resulted from a sharp decline in imports. Real (inflation-adjusted) imports of merchandise were down at an annual rate of 35.0% from the previous quarter. When the impact of trade and government spending are excluded, real GDP increased at an annual rate of 2.9%. When the government released its first estimate of GDP, this measure was up only 1.2%. That measure of underlying growth appeared to signal a weak economy. Now, with the revision, it appears that underlying growth was quite strong in the second quarter.

The main difference between the first and last estimates is the impact of the consumer, both through consumer spending and imports. The strength of consumer spending is somewhat surprising given the weak growth of employment that took place in the second quarter. However, real disposable personal income (household income after taxes and after inflation) increased at an annual rate of 3.1%, the fastest growth since the first quarter of 2024. This reflected strong wage gains in a tight labor market.

Also, it could be the case that households are spending rapidly in anticipation of higher prices due to tariffs later this year or next year. If true, that could set the stage for a slowdown in consumer spending growth once inflation starts to accelerate significantly. Moreover, an increase in inflation in the coming year will not only be due to tariffs. It will likely reflect the restrictive immigration policy leading to a labor shortage that drives up prices, as well as a surge in the cost of electricity due to the rapid rollout of data centers.

In any event, the evident strength of the economy might give pause to the Federal Reserve as it contemplates continuing its decision to ease monetary policy by cutting interest rates. After all, the Fed evidently chose to start easing because, although it expects a temporary boost to inflation, it worried that the economy is in danger of a sharp slowdown. With today’s revision, it will be harder to make that case. As such, there could be some spirited debates within the confines of the Fed over the future course of monetary policy. Indeed, the President of the Federal Reserve Bank of Chicago, Austen Goolsbee, said that “I’m uncomfortable with overly frontloading a lot of rate cuts on the presumption that [inflation] will probably just be transitory and go away.” The assumption of transitory inflation is based on the view that a weak economy is expected to prevent a wage-price spiral that could lead to sustained higher inflation.  Yet Goolsbee said that “we’ve still got a mostly steady and solid jobs market.” That, in turn, could help to sustain higher inflation.

• The US government reported that, in August, for the fifth consecutive month, the US personal savings rate declined from the previous month, thereby enabling household spending to rise faster than income. Indeed, this has contributed to the continued strong growth of the economy despite a marked slowdown in job creation. Meanwhile, the Federal Reserve’s favored measure of inflation indicated some acceleration, with prices of durable goods rising at the fastest pace since December 2022. This likely reflected the burgeoning impact of tariffs. Let’s look at the details:

In August, the personal savings rate (savings as a share of disposable income) fell to 4.6%, the lowest level since December 2024 and the second lowest level since December 2022. As such, although real disposable income only grew 0.1% from July to August, real personal consumption expenditures were up 0.4% from July to August. This included a stunning 0.9% real (inflation-adjusted) increase in spending on durable goods, a 0.5% increase for non-durables, and a 0.2% increase for services.

Why was consumer spending so resilient in August? Here are two possible answers.  First, equity prices have soared, boosting the wealth of relatively upscale households. Second, anticipation of the inflationary impact of tariffs might be causing households to frontload spending.

Meanwhile, the government also reported on the Fed’s favorite measure of inflation: the personal consumption expenditure deflator, or PCE-deflator. The deflator was up 2.7% in August versus a year earlier, the fastest rate of growth since February. When volatile food and energy prices are excluded, the core deflator was up 3.0% in August versus a year earlier. This was the same as in July and the highest since February.

More importantly, the prices of durable goods were up 1.2% in August versus a year earlier, the fastest rate of increase since December 2022 at the tail end of the pandemic. If we exclude the pandemic era supply chain disruption that boosted prices of durable goods, this was the biggest increase in durables prices since 1995. Also, prices of non-durables were up 0.7% while prices of services were up 3.6%. The latter has been steady for many months.

• Consumer sentiment in the United States has fallen again, according to the University of Michigan. Its consumer sentiment index fell 5.3% from August to September and was down 21.6% from a year earlier. This indicator was even lower in April and May when news on tariffs created fears. Excluding those two months, the September reading was the lowest since November 2022.

The decline in sentiment was seen across all ages, incomes, and education cohorts. The only exception was that sentiment improved for households with heavy exposure to equities.