This week, Kevin Warsh begins his term as the US central bank's new chair. He was chosen by Trump for his belief in AI as a driver of lowering costs across the economy, which would open the possibility of cutting the short-term interest rate. However, there are several reasons why US interest rates – both short-term (set by the central bank, which raises them when inflation is too high) and long-term (set by the bond market, which raises them when inflation expectations are elevated or too much debt is being issued) – are likely to remain high and may go even higher.
First, there has been a global regime change in the past five years: interest rates have stopped declining for the first time in decades. There are several structural reasons for this – from massive government spending to international conflicts, all of which raise inflation and consequently interest rates – and such structural changes are unlikely to reverse without a clear cause, such as a meaningful reduction in debt or a resolution of major conflicts, neither of which seems likely anytime soon.
Second, the global shift towards higher interest rates is generating new mechanisms that reinforce the trend. Japan, for instance, may increasingly sell US assets to protect the value of its currency. If Japanese investors were to sell US government bonds at sufficient scale, it would add further upward pressure on US interest rates. A similar dynamic has emerged as a possibility from the troubled Gulf states – suggesting this is a structural feature of the new global economy, not something specific to Japan.
Third, the US economy has been running close to overheating for several years and still is, which calls for higher interest rates, not lower ones. US employment has been near maximum levels for 55 consecutive months, while the central bank has missed its inflation target for 63 months.
Fourth, while AI – Warsh's rationale for lowering interest rates – may create disinflation over the long term, its near-term effects have been more inflationary: demand for the metals, energy and chips needed to build data centers has driven up the costs of all three.
Last week, a new OECD report on industrial subsidies was picked up across western media, highlighting the finding that Chinese companies receive 3 to 8 times more government support than their western counterparts. However, a careful reading of the OECD report shows this figure is misleading – and that framing China's rise as mainly enabled by government subsidies will lead to the wrong response.
First, the OECD shows that higher subsidies for Chinese companies are entirely dependent on below-market borrowing – in other words, relatively low interest rates on loans from Chinese banks to Chinese companies. When it comes to direct grants and income-tax concessions, western governments subsidize their companies at comparable levels as China. This matters because China's below-market borrowing is, as experts like Michael Pettis have shown, a structural feature of its political-economic system: in China, capital is channeled to companies through state banks at below-market rates to keep the economy dependent on investment-led growth, effectively paid for by Chinese households, who receive artificially low returns on their savings. This is not a targeted subsidy program, but something far more deeply embedded in how the Chinese Communist Party chooses to develop the country - and therefore not something that will be overcome through responses like import tariffs or western subsidies.
Second, and this is what deserves closer attention, the OECD data shows significant variation between industries. The automotive industry is worth examining, because it is the sector that both the US and the EU have targeted with import tariffs, explicitly justified by claims of unfair Chinese subsidies. Research by the Rhodium Group shows that only 5% of the cost advantage of Chinese cars is based on government subsidies. The remaining 95% reflects genuine competitive strengths: the vertical integration of Chinese manufacturers – who produce their own batteries and other components or source them domestically, unlike western firms that rely on complex global supply chains – and higher levels of investment in research and development, supported by lower labor costs and a longer planning horizon.
The implication is that framing the rise of Chinese companies as primarily a subsidy story leads to the wrong response. For instance, since the EU raised import tariffs on Chinese cars in October 2024, the market share of Chinese cars in Europe has continued to grow, while some European manufacturers that produce their cars in China lost market share, as they found themselves penalized by their own governments' tariffs. Rather than focusing on penalizing China for its industrial model, western governments would be wise to address their own competitiveness – and to maintain access to world-class Chinese products in the meantime.
During the last week, the European Union took significant steps on three of the most important political issues on the continent: the asylum system, the capital markets union, and China. Together, they reveal a Europe in which a renewed sense of unity is driving progress in some areas, while deep divisions persist in others - and both forces are equally likely to shape Europe’s future.
Asylum. The EU is moving forward with legislation to establish return hubs in non-EU countries for asylum seekers who have been denied entry and must be returned to their country of origin. Currently, more than 70% of those ordered to leave never actually do so. This could become the most significant asylum legislation in decades and reflects a new degree of political unity on the topic.
Capital markets union. The six largest EU economies have agreed on first principles for a capital markets union that would gradually replace national investment regimes with a single European framework. The plan is widely seen as capable of significantly improving conditions for doing business across Europe and attracting greater flows of global capital. The countries involved are pressing for urgency and want an actionable plan by the end of the year.
China. As a new trade conflict between the EU and China shows signs of escalating, Spain - known for its China-friendly approach, including welcoming Chinese investment in solar, batteries and electric vehicles - pulled back from a French-led initiative to develop European tools to restrict Chinese imports. Spain's minister for economy and trade stated that Europe should focus on engaging with Chinese authorities and remain open to Chinese investment, rather than pursuing legislation that further damages the trade relationship.
A Singaporean think-tank has found that 66% of Singaporean opinion leaders would side with China over the United States if forced to choose - a striking figure for one of Washington's closest partners in the region.
Europeans should resist filing this under "Asian story." Singapore (and ASEAN more broadly) sit in Europe's predicament: the US is their most important security partner and China is their most important trade partner – and they would rather not choose at all.
As news emerges of escalation in the trade conflict between Europe and China, it may seem naive to point to the opportunity of them working more closely together. However, we should not be surprised if that is exactly what happens in the coming years. Europe and China share a fundamental goal in the transition to clean energy, and to complete it, they need each other.
The transition to clean energy is a shared goal for Europe and China, albeit for different reasons. In China, clean energy is central to the country's economic reform plan, in which the economy transitions away from investing in real estate and infrastructure and towards high-tech manufacturing, including clean energy technologies. In Europe, besides climate targets, successive global crises have made its energy system expensive and vulnerable to disruption, necessitating a transition towards clean, local energy sources.
What is sometimes underappreciated is that, because of this shared goal, clean energy has already become a key driver of economic growth for both (see chart). In China, clean energy industries account for 25% of GDP growth; in Europe, more than 30%. In the US, the figure is just over 5%.
Most importantly, to complete the transition to clean energy, Europe and China need each other. Europe cannot achieve energy security without affordable Chinese technologies, and China cannot sustain its export model without reaching agreement with advanced economies like Europe on the rules for market access.
The key question is how exactly Europe and China will be able to cooperate amid conflict – driven mainly by Europe's concerns about overreliance on Chinese products – especially at a time when tensions are still escalating. The answer lies in the current energy crisis. Europe will increasingly discover that the greatest value from clean energy lies not in manufacturing these technologies (solar panels, wind turbines, heat pumps) but in deploying and integrating them with the local energy system, as this is what unlocks the potential of the broader economy. The Netherlands is a case in point: its congested electricity grid is already preventing new business formation even outside industrial production.
The main bottleneck for cooperation between Europe and China is therefore not economic competition but strategic security: Europe does not want to become overly reliant on a single country for its energy needs again. This will drive European policy towards a logic of diversification – as seen this week in the area of chemicals – rather than punishment (like the US approach of import tariffs on Chinese goods). This European approach could, like the Western quota policies on Japanese imports in the 1980s, provide the basis for diplomatic agreement.
Last month, Stanford University published research that contradicts the dominant narrative on US-China artificial intelligence (AI) competition. According to millions of human voters, the performance gap between the top US and top Chinese AI models has effectively closed (see chart).
Most importantly, Chinese firms are generating frontier AI capability at a fraction of the costs of US firms. According to Stanford, a 23-to-1 spending gap between US and Chinese private firms is producing a 2.7% performance gap. This has direct implications for US-based AI companies whose valuations rest on the assumption of a structural advantage. It also suggests the DeepSeek shock of January 2025 – when the launch of a single Chinese model briefly erased a trillion dollars from US tech stocks – was not an anomaly, but the first sign of a convergence that had been underway for several years and has continued since.
A key question in the coming years will be how Western investors can profit from China's AI capabilities. On April 27, the Chinese government cancelled Meta's $2 billion acquisition of Manus, a Singapore-based AI startup founded by Chinese engineers. Beijing is signaling that frontier AI capability is now treated as strategic territory in the same category as rare earths and semiconductors – and is therefore closing the offshore "Singapore-washing" route that Chinese tech firms have used for years to reach Western investors.
Since COVID, western societies have grown deeply dependent on government financial support during times of global crisis. The COVID response from 2020 onwards was unprecedented: the US launched the largest infrastructure investment packages in its history, while EU countries agreed for the first time to issue joint debt. The energy support packages that followed the war in Ukraine in 2022 were also significant, reaching up to 5% of GDP in some European countries. In 2026, however, as the economic impact of the war in Iran threatens to become severe, the capacity for a similar response is largely gone.
The main reason is the worsening state of government finances. Since COVID, the yields investors demand on government debt are substantially higher than six years ago. In simple terms, governments can no longer afford large-scale financial support without triggering a further rise in the yields on their debt. And rising yields, for countries already carrying high debt-to-GDP ratios, risk setting off a vicious cycle: higher borrowing costs force spending cuts, which slow growth, which worsens the debt burden, which pushes yields even higher - and so on.
A key implication is that western governments, without the ability to soften the blow of a global crisis, are losing control over the way economic pain will drive change. The early signs are already visible. In the US, the adoption of renewable energy is accelerating despite the Trump administration's efforts to protect fossil fuels, because businesses and households are discovering that renewable technology – including the Chinese-made products the administration has sought to block – offers greater price stability than oil and gas. In Europe, calls for a more stable relationship with China are growing for the same reason.
In the coming years, alternative protein (plant- and cell-based protein as a substitute for animal-based food) is likely to follow the same pattern as renewable energy technology over the past twenty years: driven by Chinese innovation, the cost falls so far that the case for transition shifts from a divisive moral ideal into a shared economic necessity.
Twenty years ago, the Chinese government made renewable energy technology a top priority for the first time in its 11th Five Year Plan (2006–2010). Today, China is the global leader in solar panels, batteries and electric vehicles. Over that period, several global crises that drove up the price of energy (the war in Ukraine, the war in the Middle East) turned renewable energy into a shared economic necessity: a more reliable energy supply at a lower cost. Something similar is now likely to happen in food, whose global prices are high and rising because of the war in the Middle East.
In its 15th Five Year Plan (2026–2030), the Chinese government has made alternative protein a top priority. China is already the world's largest funder of agricultural R&D, spending twice as much as the United States. The city of Shanghai has made the industrial scaling of alternative protein a key strategic objective. In November 2025, one Chinese company opened a factory the size of 75 football fields capable of producing alternative protein at 50% of the cost of animal-based protein - and with 95% lower carbon emissions.
A significant signal of financial stress in the Gulf has emerged: according to the Wall Street Journal, the governor of the UAE's central bank has opened talks with the United States about a currency swap arrangement. The stability of the UAE's currency, the dirham, depends on its peg to the US dollar, which is maintained through large dollar reserves accumulated via the UAE's trade and financial networks. Those reserves are now under pressure from two directions: maritime trade disruption and capital flight – particularly in real estate, where luxury property discounts of over 50% are being reported. Together, these forces threaten a structural decline in dollar income. This is the mechanism that triggered the 1997 Asian financial crisis: when dollar reserves backing a pegged currency erode faster than they can be replenished, a currency crisis becomes self-fulfilling.
The Gulf states are therefore in urgent need of regional stability – but looking at both the US and Iran, that appears unlikely. The US is caught between three bad options: tacitly admitting defeat and watching the Iranian regime it tried to destroy consolidate into a regional power with global influence through its control of the Strait of Hormuz; muddling through while the global economy absorbs severe shocks across multiple supply chains; or risking the consequences of further military escalation. Meanwhile, according to reporting by The New Yorker, those who now govern Iran are considerably more hardline than is widely assumed – and less inclined than their predecessors to accept a diplomatic settlement favorable to the US and Israel.
All of this carries a long-term risk for the US in its rivalry with China. In their talks with Washington, UAE officials explicitly warned that the Chinese renminbi is a serious alternative to the US dollar. This warning is credible because the Gulf states have already been building the infrastructure for such a shift. The mBridge project – a digital currency platform backed by the central banks of China, Saudi Arabia and the UAE – processed $56 billion in transactions in 2025, a 2,500-fold increase from 2022. Although mBridge operates at the level of financial transactions rather than central bank reserve holdings, this is how the dollar's network effects would weaken first in a long-term shift.
As the Hormuz crisis continues, we would be wise to remember a lesson from the COVID crisis: local shortages of specific resources can cascade into larger global problems that are difficult to predict. Global attention is currently focused on energy (rising oil and gas prices), food (higher fertilizer costs) and helium (critical for computer chip production), but a closer look reveals at least three additional supply chain disruptions that could spiral into something larger.
First, shortages of naphtha — refined from oil and used in the production of plastics, chips and cars — have triggered an industrial state of emergency across Asia. Both Japan and South Korea are attempting to calm markets, but supply chains are already being disrupted. In Japan, the prime minister intervened to quell online rumors of an imminent shortage after several plastic producers announced production cuts affecting sectors as diverse as food and healthcare. South Korea has banned naphtha exports to protect domestic medical procedures and has reluctantly begun sourcing the material from Russia.
Second, Australia — heavily dependent on diesel — faces rising prices and emerging shortages that threaten to shut down both farming and mining operations. As an emergency measure, several tankers carrying diesel have been sent from the US, a journey that takes up to three months, underscoring the severity of the situation. This matters globally: Australia is one of the world's largest producers of minerals like iron ore, lithium and nickel.
Third, Europe is on course to run out of kerosene within three weeks. While an aviation disruption may appear less urgent than food or mining, it would indirectly affect a wide range of businesses and economies through the collapse of tourism.
Each of these shortages may seem secondary to the broader disruption of energy, food and chip production. But together they threaten industries as diverse as healthcare, mining and tourism — and could push the global economy into territory that is difficult to predict.
