Three recent reports (see links below) have suggested that US consumers and businesses pay most of the tariffs imposed by the second Trump administration. The percentage varies from around 86% to 96%. US customs revenue surged by approximately $200 billion in 2025, but this was a tax paid almost entirely by US consumers and businesses. Foreign suppliers largely maintained their (pre-tariff) prices. They took a hit in terms of reduced volumes rather than reduced pre-tariff prices.
The incidence of a tariff between consumers, domestic importers and overseas producers will depend on price elasticities of demand and supply. The following diagram shows a product where the importing country is large enough to have a degree of market power, which will normally be the case with the USA. The greater its buying power, the flatter will be its demand curve, showing that the foreign supplier will have little influence on the price. With no tariff, the equilibrium price paid by importers will be at point a, where demand equals supply. Q1 would be imported at a price of P1.
Imposition of a tariff will shift the supply curve upwards by the amount of the tariff. The new equilibrium price paid by importers will be at point b, where the new supply curve crosses the demand curve. Importers thus now pay a post-tariff price of P2: an effective rise in price of P2 minus P1. Foreign exporters receive P3, which is what they are paid by importers after the tariff has been paid.
The consumer price will be above P2 as that includes a mark-up by US businesses on top of the price they pay to import the product. Importers may bear some of the increase in price and not pass the full amount onto consumers, depending on competition and their ability to absorb cost increases.
President Trump argued that there would be very little rise in price from the tariffs and that overseas suppliers would bear the brunt of the tariffs. Indeed, recently he has argued that this must be the case as US inflation has been falling. In response, critics maintain that the rate of inflation would have fallen more without the tariffs and that current prices would be lower than they are. Also, if US importing firms or retailers bear some of the increased cost, even though this helps to dampen the price rise, their lower profits could damage investment and employment.
The Reports
The first report is from the New York Fed (one of the regional branches of the Federal Reserve Bank). It examines the effect of tariffs imposed in 2025, over three periods: (i) January to August, (ii) September to October, and (iii) November. In the first period, 94% of the tariffs were paid by US importers and 6% by foreign exports; in the second period, the figures were 92% and 8% and in the third period, 86% and 14%.
The second report is The Budget and Economic Outlook: 2026 to 2036 from the Congressional Budget Office. Box 2-1 notes that, as of November 2025, ‘the effective tariff rate was about 13 percentage points higher than the roughly 2 percent rate on imports in 2024’. Its analysis suggests that 95% of the tariffs will be borne by importers. Of these higher import prices, 30% will be borne by US businesses, largely through reduced profit margins, and 70% by consumers through higher prices. This will also allow many businesses which produce goods that compete with foreign imports to ‘increase their prices because of the decline in competition from abroad and the increased demand for tariff-free domestic goods’.
The third report is from the Kiel Insitut. In its Policy Brief, Americaʼs Own Goal: Who Pays the Tariffs?, it finds that US importers and consumers bear 96% of the cost of the 2025 tariffs, with foreign exporters absorbing only about 4%. It bases it findings on shipment-level data covering over 25 million transactions valued at nearly $4 trillion. This also shows that exports to the USA declined as foreign exporters preferred to reduce volumes rather than absorbing the tariffs.
The tariffs raised some $200 billion in 2025, around 3.8% of Federal tax receipts. But, as we have seen, this was paid largely by US consumers and business. It goes some way to offsetting the annual cut in tax revenues of around $450 to $520 billion per year from the tax cuts, largely to the better off, in Trump’s ‘One Big Beautiful Bill’.
Reports
Aricles
- NY Fed report says Americans pay for almost all of Trump’s tariffs
Reuters, Michael S. Derby (12/2/25)
- A year in, it’s official: Americans, not foreigners, are paying for Trump’s tariffs
CNN, Allison Morrow (12/2/26)
- Costs from Trump’s tariffs paid mainly by US firms and consumers, NY Fed says
BBC News, Kali Hays (13/2/26)
- Consumers and businesses paid nearly 90% of Trump tariffs in 2025, new analysis found
CBS News, Megan Cerullo (12/2/26)
- New Studies Challenge Who Really Pays for Tariffs
Investopedia, Diccon Hyatt (12/2/26)
- Trump Tariffs: Tracking the Economic Impact of the Trump Trade War
Tax Foundation, Erica York and Alex Durante (6/2/26)
- Who Is Paying the Trump Tariffs?
Paul Krugman (15/2/26)
Questions
- Summarise the findings of the three reports (but just Box 2-1 of the Congressional Budget Office one).
- Assess the argument that protectionism leads to inefficiency in the protected industries.
- Under what circumstances would exporters to the USA absorb a high percentage of tariff increases? Consider questions of elasticity.
- Can tariffs ever be justified on efficiency grounds?
- Can tariffs be justified as a bargaining ploy? Can they be used as a means of achieving freer and fairer trade?
- Read the blog, President Reagan on tariffs and summarise President Reagan’s arguments. Are they still relevant today?
- Consider the arguments for and against the EU raising tariffs on US goods.
The gold market has become one of the most talked-about commodity markets in 2025, with prices reaching record highs. This is largely due to increased demand from investors, who see gold as a ‘safe haven’ during times of economic and political uncertainty. Central banks are also buying more gold as a way to reduce their reliance on currencies like the US dollar. With many analysts predicting prices could reach over $4000 per ounce in the next year, the gold market is showcasing how supply and demand, confidence, and global events can all influence a commodity market.
The commodities market is where basic agricultural products, raw materials and metals, such as gold, are bought and sold, often in large quantities and across global exchanges. Commodities are typically traded either in their physical form (like gold bars) at current market prices (spot prices) or through financial contracts, where investors buy or sell in futures markets. These are where a price is agreed today to buy or sell on a specific future date.
As with other commodities, the price of gold is determined by supply and demand. Demand for gold typically rises during times of economic uncertainty as investors want a safer store of value. This results in an increase in its price. Supply and demand, and hence price, also respond to other factors, including interest rates, currency movements, economic growth and growth prospects, and geopolitical events.
Record high prices
This year, the gold market has seen a remarkable rally, with the price of gold hitting a record high. Demand for the precious metal has resulted in spot prices surging over 35% to date (see the chart: click here for a PowerPoint). Rising prices earlier this year have been attributed to the US President, Donald Trump, announcing wide-ranging tariffs which have upset global trade. On 2 September, the spot gold price hit $3508.50 per ounce, continuing its upwards trend.
The price has also been lifted by expectations that the Federal Reserve (the US central bank) will cut its key interest rate, making gold an even more attractive prospect for investors. If the Federal Reserve cuts interest rates, the price of gold usually increases. This is because gold does not pay any interest or yield, so when interest rates are high, investors can earn better returns from alternatives, such as savings accounts or bonds. However, when interest rates fall, those returns become less attractive, making gold relatively more appealing.
Lower interest rates also tend to weaken the US dollar, which makes gold cheaper for foreign buyers, increasing global demand. Since gold is priced in dollars, a weaker dollar usually leads to higher gold prices.
Additionally, interest rate cuts are often a response to economic problems or uncertainty. As gold is viewed as a safer asset for investors during times of economic uncertainty, investors will typically increase their demand.
Unlike the market for currencies or shares, gold doesn’t rely on the performance of a government or company. This makes it attractive when people are worried about things like inflation, recession, war or stock market crashes. Gold is thus seen as a ‘safe haven’.
Gold and the Federal Reserve
The rise in the price of gold by more than a third this year can be linked to the US election last year, according to the director of research at BullionVault (see the BBC article below). Attitudes of the Trump administration towards the Federal Reserve have created concerns among investors. Fears that the US administration could erode the independence of the world’s most important central bank have fuelled the latest flows into the metal, which is traditionally viewed as a hedge against inflation.
According to the BBC article, Derren Nathan from Hargreaves Lansdown claims that it is Trump’s ‘attempts to undermine the independence of the Federal Reserve Bank’ that were ‘driving renewed interest in safe haven assets, including gold’. Investors are concerned that a politicised Fed would be more inclined to cut interest rates than would otherwise be the case, sending long-term inflation expectations higher.
This could lead to fears that future interest rates would then be pushed higher. This would increase the yields on longer-term government bonds by pushing down their price, as investors demand higher compensation for the increased risk of higher future interest rates reducing the value of their fixed-rate investments. This would force the US Treasury to pay higher interest on new bonds, making it more expensive to service US government debt.
Expected price rises for 2026
As we saw above, it is predicted that the price of gold will rise to $4000 per ounce next year. However, if the market sees investors move away from dollar assets, such as US Treasuries, the price increases would be even higher. Daan Struyven, co-head of global commodities research at Goldman Sachs explains ‘If 1 per cent of the privately owned US Treasury market were to flow to gold, the gold price would rise to nearly $5000 per troy ounce’ (see Financial Times article below).
If the Federal Reserve does come under political pressure, it could affect the stability of the US economy and beyond. When gold prices rise sharply, demand usually falls in countries like China and India, which are the world’s largest buyers of gold jewellery. However, in 2025, this trend has changed. Instead of reducing their gold purchases, people in these countries have started buying investment gold, such as bars and coins, showing a shift in consumer behaviour from jewellery to investment assets.
At the same time, global events are also influencing the gold market. Suki Cooper, a metals analyst at Standard Chartered, said that events like Russia’s invasion of Ukraine have added to political uncertainty, which tends to increase demand for gold as a safe-haven asset. She also highlighted how changes in international trade policies have disrupted supply chains and contributed to higher inflation, both of which have made gold more attractive to investors. Additionally, a weaker US dollar earlier in the year made gold cheaper for buyers using other currencies, which boosted global demand even further.
Conclusion
Although the gold market is expected to remain strong over the next six months, some uncertainty remains. Many analysts predict that gold prices will stay high or even increase further, especially if interest rates in the US are cut as expected. Continued global instability, is also likely to keep demand for gold as a safe haven high. At the same time, if inflation stays elevated or trade disruptions continue, more investors may turn to gold to protect their wealth.
However, if economic conditions stabilise or interest rates rise again, gold demand could fall slightly, leading to a potential dip in prices. Overall, the outlook for gold remains positive, but sensitive to changes in global economic and political events.
Articles
- Gold price hits record high as investors seek safety
BBC News, Faarea Masud (2/9/25)
- Safe-haven gold rally gains further momentum after soft US data
Reuters, Sherin Elizabeth Varghese and Ashitha Shivaprasad (3/9/25)
- Gold vaults $3,000 in rush for safety from market, political worry
Reuters, Sherin Elizabeth Varghese and Anmol Choubey (14/3/25)
The foundation of gold’s rally to historic highs started back in 2022CNBC, Suki Cooper (17/3/25)
- Gold could hit nearly $5,000 if Trump undermines Fed, says Goldman Sachs
Financial Times, Emily Herbert (4/9/25)
- London’s bullion market set to trial digital gold
City AM, Maisie Grice (3/8/25)
- Gold price hits record high as investors seek safe haven
The Guardian, Julia Kollewe (2/9/25)
Data
Questions
- What factors influence the price of a commodity such as gold on the global market?
- Use a demand and supply diagram to illustrate what has been happening to the gold price in recent months.
- Find out what has been happening to silver prices. Are the explanations for the price changes the same as for gold?
- Why might investors choose to buy gold during times of economic or political uncertainty?
- How will changes in interest rates affect both the demand for and the price of gold?
- What are the possible consequences of rising gold prices for countries like India and China, where there is a traditionally high demand for gold jewellery?
- How do global events impact commodity markets? Use gold as an example in your answer.
A common practice of international investors is to take part in the so-called ‘carry trade’. This involves taking advantage of nominal interest rate differences between countries. For example, assume that interest rates are low in Japan and high in the USA. It is thus profitable to borrow yen in Japan at the low interest rate, exchange it into US dollars and deposit the money at the higher interest rate available in the USA. If there is no change in the exchange rate between the dollar and the yen, the investor makes a profit equal to the difference in the interest rates.
Rather than depositing the money in a US bank account, an alternative is to purchase US bonds or other assets in the USA, where the return is again higher than that in Japan.
If, however, interest-rate differentials narrow, there is the possibility of the carry trade ‘unwinding’. Not only may the carry trade prove unprofitable (or less so), but investors may withdraw their deposits and pay back the loans. This, as we shall, can have adverse consequences on exchange rates.
The problem of an unwinding of the carry trade is not new. It worsened the underlying problems of the financial crisis in 2008. The question today is whether history is about to repeat itself with a new round of unwinding of the carry trade threatening economic growth and recovery around the world.
We start by looking at what happened in 2008.
The carry trade and the 2008 financial crisis
Prior to the financial crisis of 2008, current account deficit countries, such as the UK, USA and Australia, typically had relatively high interest rates, while current account surplus countries such as Japan and Switzerland had relatively low ones. Figure 1 shows central bank interest rates from 2005 to the current day (click here for a PowerPoint).
The carry trade saw investors borrowing money in Japan and Switzerland, exchanging it on the foreign exchange market, with the currency then deposited in the UK, USA and Australia. Hundreds of billions worth of dollars were involved in this carry trade.
If, however, the higher interest rates in the UK and other deficit countries were simply to compensate investors for the risk of currency depreciation, then there would be no excessive inflow of finance. The benefit of the higher interest rate would be offset by a depreciating currency. But the carry trade had the effect of making deficit currencies appreciate, thereby further boosting the carry trade by speculation of further exchange rate rises.
Thus the currencies of deficit countries appreciated, making their goods less competitive and worsening their current account deficit. Between 1996 and 2006, the average current account deficits as a percentage of GDP for Australia, the USA and the UK were close to 4½, 4 and 2, respectively. Between January 1996 and December 2006, the broad-based real exchange rate index of the Australian dollar appreciated by 17%, of the US dollar by 4% and of sterling by some 23%.
Currencies of surplus countries depreciated, making their goods more competitive and further boosting their current account surpluses. For example, between 2004 and 2006 the average current account surpluses as a percentage of GDP for Japan and Switzerland were 3½ and 13, respectively. Their short-term interest rates averaged a mere 0.1% and 1.0% respectively (compared with 3.4%, 4.7% and 5.7% for the USA, the UK and Australia). Yet between January 2004 and December 2006, the real exchange rate index of the yen depreciated by 21%, while that of the Swiss franc depreciated by 6%.
With the credit crunch of 2007/8, the carry trade unwound. Much of the money deposited in the USA had been in highly risky assets, such as sub-prime mortgages. Investors scrambled to sell their assets in the USA, UK and the EU. Loans from Japan and Switzerland were repaid and these countries, seen as ‘safe havens’, attracted deposits. The currencies of deficit countries, such as the UK and USA, began to depreciate and those of surplus countries, such as Japan and Switzerland, began to appreciate. Between September 2007 and September 2008, the real exchange rate indices of the US dollar and sterling depreciated by 2% and 13% respectively; the yen and the Swiss franc appreciated by 3% and 2¾%.
This represented a ‘double whammy’ for Japanese exporters. Not only did its currency appreciate, making its exports more expensive in dollars, euros, pounds, etc., but the global recession saw consumers around the world buying less. As a result, the Japanese economy suffered the worst recession of the G7 economies.
The carry trade in recent months
Since 2016, there has been a re-emergence of the carry trade as the Fed began raising interest rates while the Bank of Japan kept rates at the ultra low level of –0.1% (see Figure 1). The process slowed down when the USA lowered interest rates in 2020 in response to the pandemic and fears of recession. But when the USA, the EU and the UK began raising rates at the beginning of 2022 in response to global inflationary pressures, while Japan kept its main rate at –0.1%, so the carry trade resumed in earnest. Cross-border loans originating in Japan (not all of it from the carry trade) had risen to ¥157tn ($1tn) by March 2024 – a rise of 21% from 2021.
The process boosted US stock markets and contributed to the dollar appreciating against the yen (see Figure 2: click here for a PowerPoint).
Although this depreciation of the yen helped Japanese exports, it also led to rising prices. Japanese inflation rose steadily throughout 2022. In the 12 months to January 2022 the inflation rate was 0.5% (having been negative from October 2020 to August 2021). By January 2023, the annual rate had risen to 4.3% – a rate not seen since 1981. The Bank of Japan was cautious about raising interest rates to suppress this inflation, however, for fear of damaging growth and causing the exchange rate to appreciate and thereby damaging exports. Indeed, quarterly economic growth fell from 1.3% in 2023 Q1 to –1.0% in 2023 Q3.
But then, with growth rebounding and the yen depreciating further, in March 2024 the Bank of Japan decided to raise its key rate from –0.1% to 0.1%. This initially had the effect of stabilising the exchange rate. But then with the yen depreciating further and inflation rising from 2.5% to 2.8% in May and staying at this level in June, the Bank of Japan increased the key rate again at the end of July – this time to 0.25% – and there were expectations that there would be another rise before the end of the year.
At the same time, there were expectations that the Fed would soon lower its main rate (the Federal Funds Rate) from its level of 5.33%. The ECB and the Bank of England had already begun lowering their main rates in response to lower inflation. The carry trade rapidly unwound. Investors sold US, EU and UK assets and began repaying yen loans.
The result was a rapid appreciation of the yen as Figure 3 shows (click here for a PowerPoint). Between 31 July (the date the Bank of Japan raised interest rates the second time) and 5 August, the dollar depreciated against the yen from ¥150.4 to ¥142.7. In other words, the value of 100 yen appreciated from $0.66 to $0.70 – an appreciation of the yen of 6.1%.
Fears about the unwinding of the carry trade led to falls in stock markets around the world. Not only were investors selling shares to pay back the loans, but fears of the continuing process put further downward pressure on shares. From 31 July to 5 August, the US S&P 500 fell by 6.1% and the tech-heavy Nasdaq by 8.0%.
As far as the Tokyo stock market was concerned, the appreciation of the yen sparked fears that the large Japanese export sector would be damaged. Investors rushed to sell shares. Between 31 July and 5 August, the Nikkei 225 (the main Japanese stock market index) fell by 19.5% – its biggest short-term fall ever (see Figure 4: click here for a PowerPoint).
Although the yen has since depreciated slightly (a rise in the yen/dollar rate) and stock markets have recovered somewhat, expectations of many investors are that the unwinding of the yen carry trade has some way to go. This could result in a further appreciation of the yen from current levels of around ¥100 = $0.67 to around $0.86 in a couple of years’ time.
There are also fears about the carry trade in the Chinese currency, the yuan. Some $500 billion of foreign currency holdings have been acquired with yuan since 2022. As with the Japanese carry trade, this has been encouraged by low Chinese interest rates and a depreciating yuan. Not only are Chinese companies investing abroad, but foreign companies operating in China have been using their yuan earnings from their Chinese operations to invest abroad rather than in China. The Chinese carry trade, however, has been restricted by the limited convertibility of the yuan. If the Chinese carry trade begins to unwind when the Chinese economy begins to recover and interest rates begin to rise, the effect will probably be more limited than with the yen.
Articles
- A popular trading strategy just blew up in investors’ faces
CNN, Allison Morrow (7/8/24)
- The big ‘carry trade’ unwind is far from over, strategists warn
CNBC, Sam Meredith (13/8/24)
- Unwinding of yen ‘carry trade’ still threatens markets, say analysts
Financial Times, Leo Lewis and David Keohane (7/8/24)
- The yen carry trade sell-off marks a step change in the business cycle
Financial Times, John Plender (10/8/24)
- Forbes Money Markets Global Markets React To The Japanese Yen Carry Trade Unwind
Forbes, Frank Holmes (12/8/24)
- 7 unwinding carry trades that crashed the markets
Alt21 (26/1/23)
- A carry crash also kicked off the global financial crisis 17 years ago — here’s why it’s unlikely to get as bad this time
The Conversation, Charles Read (9/8/24)
- What is the Chinese yuan carry trade and how is it different from the yen’s?
Reuters, Winni Zhou and Summer Zhen (13/8/24)
- Carry Trade That Blew Up Markets Is Attracting Hedge Funds Again
Yahoo Finance/Bloomberg, David Finnerty and Ruth Carson (16/8/24)
- Currency Carry Trades 101
Investopedia, Kathy Lien (9/8/24)
- Carry Trades Torpedoed The Market. They’re Still Everywhere.
Finimize, Stéphane Renevier (13/8/24)
Questions
- What factors drive the currency carry trade?
- Is the carry trade a form of arbitrage?
- Find out and explain what has happened to the Japanese yen since this blog was written.
- Find out and explain some other examples of carry trades.
- Why are expectations so important in determining the extent and timing of the unwinding of carry trades?
Gold has always held an allure and with the price of gold on international markets trending upwards since October 2022 (see Figure 1: click here for a PowerPoint), people seem to be attracted to it once again. The price reached successively higher peaks throughout 2023 before surging to above $2300 per oz in 2024 and peaking at $2425.31 per oz on 20 May 2024.
While gold tends to become attractive during wartime, economic uncertainty and bouts of inflation, all of which have characterised the last few years, the sustained price rise has perplexed market analysts and economists. The rally had been expected to peter out over the past 20 months. But, as the price of gold rose to sustained higher levels, with no significant reversals, some analysts have speculated that it is not the typical short-term factors which are driving the increased demand for and price of gold but more fundamental changes in the global economic system.
This blog will first discuss the typical short-term factors which influence gold prices before discussing the potential longer-term forces that may be at work.
Short-term factors
So, what are the typical short-term economic forces which drive the demand for gold?
The most significant are the real rates of interest on financial assets. These rates represent the opportunity cost of holding an asset such as gold which offers no income stream. When the real return from financial assets like debt and equity instruments is low, the demand for and price of gold tends to be high. In contrast, when the real return from such assets is high, the price of gold tends to be lower. An explanation for this is that real rates of return are strongly related to inflation rates and investors perceive gold as a hedge against inflation since its price is positively correlated with a general rise in prices. Higher unexpected inflation reduces the real rate of return of securities like debt and equity whose value is derived from cash flows anticipated in the future. In such circumstances, gold become an attractive alternative investment. As inflationary expectations decline, real returns from financial assets should rise, and the demand for gold should fall.
The relationship between real returns, proxied by the yield on US 10-year TIPS (Treasury inflation-protected securities), and gold prices can be used to examine this explanation. Real returns rose steadily in the aftermath of the COVID-19 pandemic. Yet the price of gold, which rose during the early stages of the pandemic in 2020, has not fallen. Instead, it has remained at elevated levels for much of that time (see Figure 2: click here for a PowerPoint).
There have been short periods when changes in real returns seemed to have a high correlation with changes in gold prices. In late 2022, for example, falling real rates coincided with rising gold prices. The same pattern was repeated between October and December 2023. However, when real returns rose again in the New Year of 2024, in response to stubbornly higher expected inflation and the expectation of ‘higher-for-longer’ interest rates, particularly in the USA, gold prices continued to rise. Indeed, across the 5-year period the correlation coefficient between the two series is actually positive at 0.268, showing little evidence supporting this explanation for the pattern for the gold price.
Real returns in the USA, however, may not be the correct ones to consider when seeking explanations for the pattern of gold’s price. Much of the recent demand is from China. Analysts suggest that Chinese investors are looking for a safe asset to hold as their economy stagnates and real returns from alternatives, like domestic property and equity, have decreased. Further, there are some concerns that the Chinese currency, the renminbi, may be undervalued in response to the sluggish growth. Holding gold is a good hedge against inflation (currency depreciation produces inflationary pressure). Consequently, the Chinese market may be exerting pricing power in relation to real returns in a way not seen before (see the Dempsey and Leng FT article linked below).
However, some analysts suggest that the rise in price is disproportionate to these short-term factors and point to potential long-term structural changes in the global financial order which may produce significant changes in the market for gold.
Long-term factors
Since 2018, there have been bouts of gold purchasing by central banks around the world. In contrast to the 1990s and 2000s, central banks have been net purchasers since 2010. The purchasing fell back during the coronavirus pandemic but has surged again, with over 1000 metric tonnes purchased in both 2022 and 2023 (see Figure 3: click here for a PowerPoint).
Analysts have pointed to similarities between the recent pattern and central bank purchases of gold during the late 1960s and early 1970s (see The Conversation article linked below). Then, central banks sought to diversify themselves from dollar-denominated assets due to concerns about higher inflation in the USA and its impact on the value of the US dollar. Under the Bretton Woods fixed exchange rate system, central banks could redeem dollars for gold from the US Federal Reserve at a fixed rate. The pressure on the USA to redeem the gold led to the collapse of the Bretton Woods fixed exchange rate system.
While the current period of central bank purchases does not appear to be related to expected inflation, some commentators suggest it could signal a regime change in the global financial system as significant as the collapse of Bretton Woods. The rise of Chinese political power and the resurgence of US isolationist tendencies portend an increasingly multipolar geopolitical scene. Such concerns may cause central bankers to diversify away from dollar denominated assets to avoid being caught out by geopolitical tensions. Gold may be perceived as an asset through which investors can hedge that risk better.
Indeed, the rise in demand among Chinese investors may indicate a reluctance to hold US assets due to their risk of seizure during heightened geopolitical tensions between China and the USA. Chinese holdings of US financial assets as a percentage of GDP are back to the level they were when the country joined the World Trade Organisation (WTO) in 2001 (see the Rana Foroohar FT article linked below). Allied to this is an increasing tendency to repatriate gold bullion from centres such as London and New York.
Added to these worries about geopolitical risk are concerns about traditional safe-haven assets – government debt securities. US government budget deficits and debt levels continue to rise. Similar patterns are observed across many developed market economies (DMEs). Analysts are concerned such debts are reaching unsustainable levels (economist.com). The view is that at some point, perhaps soon, a tipping point will be reached where investors recognise this. They will demand higher rates of return on these government debt securities, pushing yields up and prices down (bond yields and prices have a negative relationship).
In expectation of this, investors may be wary of holding such government debt securities and move to hold gold as an alternative safe-haven asset to avoid potential capital losses. However, there has been no sign of this behaviour in bond prices and yields yet.
Finally, there are economists who argue that the increased demand for gold is caused by a different regime-change in the global economy. This is not one driven by geopolitics, but by changing inflationary expectations – from a low-inflation, low-interest-rate environment to a higher-inflation, higher-interest-rate environment.
Some of the anticipation relating to inflation is derived from the persistent fiscal stimulus, evidenced by the higher government debt levels described above, coupled with the long period of monetary stimulus (quantitative easing) in developed market economies during the 2010s.
Further, some economists highlight the substantial capital investment needed for the green transition and reindustrialisation. While the financing for this capital investment may absorb some of the excess money flowing around financial markets, the scale involved will create a great demand for resources, fuelling inflation and raising the cost of capital as borrowers compete for resources.
Finally, the demographic forces from an aging population will also cause inflationary pressures. Rising dependency ratios across many developed market economics will create shortages, particularly of labour. This persistent scarcity of labour will continually drive up wages and prices, fuelling inflation and the demand for gold.
Conclusion
The recent surge in the price of gold has led to great interest by investors, financial market analysts and economists. At first, there was a perception that the price increase was similar to recent history and driven by short-term decreases in the real rate of return from financial assets, which reduced the opportunity cost of holding gold.
However, as the upward trend in the price of gold has persisted and does not seem to be explained by changes in real interest rates, economists have considered other reasons that might signal longer-term significant changes in the global financial system. These relate to changing geopolitical risk derived from an increasingly multipolar environment, concerns about the sustainability of government debt levels and expectations of persistently higher inflation in the world economy.
Only time will tell whether these explanations prove correct. If inflationary pressures subside, particularly in the USA, and if real returns from financial assets rebound, a decrease in the demand for and price of gold will suggest that the previous rise was driven by short-term forces.
If prices don’t fall back, it will only fuel the debate that it is a sign of significant changes in the global financial order.
Articles
- Gold’s weird rally
Financial Times, Robert Armstrong & Ethan Wu (11/12/23)
- A debt crisis at the economy’s edge
Financial Times, Robert Armstrong (15/5/24)
- Good, not great, news on inflation
Financial Times, Robert Armstrong (16/5/24)
- Gold prices are ‘dramatically outperforming’: Macquarie
Investing.com, Senad Karaahmetovic (30/5/24)
- Gold is back — and it has a message for us
Financial Times, Rana Foroohar (15/4/24)
- Countries went on a gold-buying spree before coronavirus took hold – here’s why
The Conversation, Drew Woodhouse (21/5/20)
- Why Gold Keeps Hitting Record Highs
Investopedia, Colin Laidley (9/4/24)
- Why Is the Price of Gold Rising?
Forbes, Wayne Duggan (23/4/24)
- Why gold prices are hitting record highs
TRT World, Kazim Alam (3/4/24)
- Chinese speculators super-charge gold rally
Financial Times, Harry Dempsey and Cheng Leng (23/4/24)
- This gold rally is made in China
Financial Times, Opinion Lex (21/5/24)
Speech
Data
Questions
- Explain the relationship between real returns and inflation for financial securities like debt and equity.
- Why is gold perceived to be an effective hedge against inflation?
- Contrast the factors which influenced the demand for gold in the period which preceded the end of Bretton Woods with those influencing demand now?
- What has happened to the price of gold since this blog was published? Is there any evidence for the profound changes in the global economic order suggested or was it the short-term forces driving demand after all?
According to the IMF, Chinese GDP grew by 5.2% in 2023 and is predicted to grow by 4.6% this year. Such growth rates would be extremely welcome to most developed countries. UK growth in 2023 was a mere 0.5% and is forecast to be only 0.6% in 2024. Advanced economies as a whole only grew by 1.6% in 2023 and are forecast to grow by only 1.5% this year. Also, with the exception of India, the Philippines and Indonesia, which grew by 6.7%, 5.3% and 5.0% respectively in 2023 and are forecast to grow by 6.5%, 6.0% and 5.0% this year, Chinese growth also compares very favourably with other developing countries, which as a weighted average grew by 4.1% last year and are forecast to grow at the same rate this year.
But in the past, Chinese growth was much higher and was a major driver of global growth. Over the period 1980 to 2018, Chinese economic growth averaged 9.5% – more than twice the average rate of developing countries (4.5%) and nearly four times the average rate of advanced countries (2.4%) (see chart – click here for a PowerPoint of the chart).
Not only is Chinese growth now much lower, but it is set to decline further. The IMF forecasts that in 2025, Chinese growth will have fallen to 4.1% – below the forecast developing-country average of 4.2% and well below that of India (6.5%).
Causes of slowing Chinese growth
There are a number of factors that have come together to contribute to falling economic growth rates – growth rates that otherwise would have been expected to be considerably higher as the Chinese economy reopened after severe Covid lockdowns.
Property market
China has experienced a property boom over the past 20 years years as the government has encouraged construction in residential blocks and in factories and offices. The sector has accounted for some 20% of economic activity. But for many years, demand outstripped supply as consumers chose to invest in property, partly because of a lack of attractive alternatives for their considerable savings and partly because property prices were expected to go on rising. This lead to speculation on the part of both buyers and property developers. Consumers rushed to buy property before prices rose further and property developers borrowed considerably to buy land, which local authorities encouraged, as it provided a valuable source of revenue.
But now there is considerable overcapacity in the sector and new building has declined over the past three years. According to the IMF:
Housing starts have fallen by more than 60 per cent relative to pre-pandemic levels, a historically rapid pace only seen in the largest housing busts in cross-country experience in the last three decades. Sales have fallen amid homebuyer concerns that developers lack sufficient financing to complete projects and that prices will decline in the future.
As a result, many property developers have become unviable. At the end of January, the Chinese property giant, Evergrande, was ordered to liquidate by a Hong Kong court, after the judge ruled that the company did not have a workable plan to restructure around $300bn of debt. Over 50 Chinese property developers have defaulted or missed payments since 2020. The liquidation of Evergrande and worries about the viability of other Chinese property developers is likely to send shockwaves around the Chinese property market and more widely around Chinese investment markets.
Overcapacity
Rapid investment over many years has led to a large rise in industrial capacity. This has outstripped demand. The problem could get worse as investment, including state investment, is diverted from the property sector to manufacturing, especially electric vehicles. But with domestic demand dampened, this could lead to increased dumping on international markets – something that could spark trade wars with the USA and other trading partners (see below). Worries about this in China are increasing as the possibility of a second Trump presidency looks more possible. The Chinese authorities are keen to expand aggregate demand to tackle this overcapacity.
Uncertainty
Consumer and investor confidence are low. This is leading to severe deflationary pressures. If consumers face a decline in the value of their property, this wealth effect could further constrain their spending. This will, in turn, dampen industrial investment.
Uncertainty is beginning to affect foreign companies based in China. Many foreign companies are now making a loss in China or are at best breaking even. This could lead to disinvestment and add to deflationary pressures.
The Chinese stock market and policy responses
Lack of confidence in the Chinese economy is reflected in falling share prices. The Shanghai SSE Composite Index (an index of all stocks traded on the Shanghai Stock Exchange) has fallen dramatically in recent months. From a high of 3703 in September 2021, it had fallen to 2702 on 5 Feb 2024 – a fall of 27%. It is now below the level at the beginning of 2010 (see chart: click here for a PowerPoint). On 5 February alone, some 1800 stocks fell by over 10% in Shanghai and Shenzhen. People were sensing a rout and investors expressed their frustration and anger on social media, including the social media account of the US Embassy. The next day, the authorities intervened and bought large quantities of key stocks. China’s sovereign wealth fund announced that it would increase its purchase of shares to support the country’s stock markets. The SSE Composite rose 4.1% on 6 February and the Shenzhen Component Index rose 6.2%.
However, the rally eased as investors waited to see what more fundamental measures the authorities would take to support the stock markets and the economy more generally. Policies are needed to boost the wider economy and encourage a growth in consumer and business confidence.
Interest rates have been cut four times since the beginning of 2022, when the prime loan rate was cut from 3.85% to 3.7%. The last cut was from 3.55% to 3.45% in August 2023. But this has been insufficient to provide the necessary boost to aggregate demand. Further cuts in interest rates are possible and the government has said that it will use proactive fiscal and effective monetary policy in response to the languishing economy. However, government debt is already high, which limits the room for expansionary fiscal policy, and consumers are highly risk averse and have a high propensity to save.
Graduate unemployment
China has seen investment in education as an important means of increasing human capital and growth. But with a slowing economy, there are are more young people graduating each year than there are graduate jobs available. Official data show that for the group aged 16–24, the unemployment rate was 14.9% in December. This compares with an overall urban unemployment rate of 5.1%. Many graduates are forced to take non-graduate jobs and graduate jobs are being offered at reduced salaries. This will have a further dampening effect on aggregate demand.
Demographics
China’s one-child policy, which it pursued from 1980 to 2016, plus improved health and social care leading to greater longevity, has led to an ageing population and a shrinking workforce. This is despite recent increases in unemployment in the 16–24 age group. The greater the ratio of dependants to workers, the greater the brake on growth as taxes and savings are increasingly used to provide various forms of support.
Effects on the rest of the world
China has been a major driver of world economic growth. With a slowing Chinese economy, this will provide less stimulus to growth in other countries. Many multinational companies, including chip makers, cosmetics companies and chemical companies, earn considerable revenue from China. For example, the USA exports over $190 billion of goods and services to China and these support over 1 million jobs in the USA. A slowdown in China will have repercussions for many companies around the world.
There is also the concern that Chinese manufacturers may dump products on world markets at less than average (total) cost to shift stock and keep production up. This could undermine industry in many countries and could initiate a protectionist response. Already Donald Trump is talking about imposing a 10% tariff on most imported goods if he is elected again in November. Such tariffs could be considerably higher on imports from China. If Joe Biden is re-elected, he too may impose tariffs on Chinese goods if they are thought to be unfairly subsidised. US (and possibly EU) tariffs on Chinese goods could lead to a similar response from China, resulting in a trade war – a negative sum game.
Videos
Articles
- IMF Predicts China Economy Slowing Over Next Four Years
Voice of America, Evie Steele (2/2/24)
- China’s Real Estate Sector: Managing the Medium-Term Slowdown
IMF News, Henry Hoyle and Sonali Jain-Chandra (2/2/24)
- China braced for largest human migration on earth amid bleak economic backdrop
ITV News, Debi Edward (4/2/24)
- China’s property giant Evergrande ordered to liquidate as debt talks fail
Aljazeera (29/1/24)
- China’s overcapacity a challenge that is ‘here to stay’, says US chamber
Financial Times, Joe Leahy (1/2/24)
- China needs to learn lessons from 1990s Japan
Financial Times, Gillian Tett (1/2/24)
- The Trump factor is looming over China’s markets
Financial Times, Katie Martin (2/2/24)
- China’s many systemic problems dominate its outlook for 2024
The Guardian, George Magnus (1/1/24)
- China youth unemployment will stay elevated in 2024, but EIU warns economic impact will linger
CNBC, Clement Tan (25/1/24)
- Don’t count on a soft landing for the world economy – turbulence is ahead
The Guardian, Kenneth Rogoff (2/2/24)
- As falling stocks draw criticism in China, censors struggle to keep up
Washington Post, Lily Kuo (6/2/24)
- China’s doom loop: a dramatically smaller (and older) population could create a devastating global slowdown
The Conversation, Jose Caballero (12/2/24)
- China: why the country’s economy has hit a wall – and what it plans to do about it
The Conversation, Hong Bo (19/3/24)
- Confronting inflation and low growth
OECD Economic Outlook Interim Report (September 2023) (see especially Box 1)
Questions
- Why is China experiencing slowing growth and is growth likely to pick up over the next five years?
- How does the situation in China today compare with that in Japan 30 years ago?
- What policies could the Chinese government pursue to stimulate economic growth?
- What policies were enacted towards China during the Trump presidency from 2017 to 2020?
- Would you advise the Chinese central bank to cut interest rates further? Explain.
- Should China introduce generous child support for families, no matter the number of children?
