The twin ‘factories’ spurring global growth are both at risk
Sustainability of the AI-driven investment boom and China’s export machine are uncertain
Mohamed El-Erian
The global economy and markets last year repeatedly defied trade wars, warnings of slow growth and multiple negative shocks from geopolitical upheaval to attacks on the independence of the US Federal Reserve.
The tumultuous start to this year is a sign that such challenges are far from receding.
And this year, investors will have to digest the rising risks to important enablers of growth in 2025.
Last year the global economy and markets were helped by two high-pressure “factories” operating at full throttle, delivering positive outcomes that surprised even the most seasoned analysts.
The first engine, the US capital market factory, has proven to be a marvel of financial engineering and cost effectiveness, supporting the promise of a genuine productivity surge that could help the country grow its way out of its debt burden.
Despite the complexities of a shifting monetary policy regime, it has shown an unprecedented ability to fund a transformational “AI super-cycle”, along with mergers and acquisitions and the usual corporate and household needs.
The ample fuel for innovation allowed firms to grow and scale up at a cost that would have seemed unusually low just a few years ago.
The second engine, the Chinese export factory, has helped the country decouple from the huge American market without crippling its trade and growth.
A highly adaptive manufacturing juggernaut delivered a record $1.2tn trade surplus despite a 20 per cent drop in shipments to the US.
This enabled the maintenance of 5 per cent growth despite a recovering property sector and cautious consumer base, buying the government time for structural reforms aimed at rebooting domestic engines of growth.
Along the way, China made huge advances in areas such as electric vehicles, green energy and telecommunications.
Yet these turbocharged factories are also generating significant risks.
The sheer volume of debt involved raises the spectre of financial bubbles, especially if the AI-driven productivity miracle fails to monetise as expected.
The potential for a painful deleveraging process that hurts growth and financial stability is hard to ignore, particularly when US bonds and the dollar sell-off together as they have this week.
Contagion from an increasingly fragile Japanese bond market also threatens the stability of US financial markets.
Meanwhile, China might find it harder to find markets for its export machine, not only because of tariffs and restrictions in selling goods to the US.
Its factories are already testing other countries’ willingness to absorb redirected shipments, especially in Europe and other parts Asia.
This is all part of the larger phenomenon of a broader array of potential scenarios for 2026.
As much as we would like to, we should not be comforted by a simple “bell curve” of outcomes with “thin tails” and a dominant probability of continued steady growth and record asset prices.
Instead, this no more than 50 per cent central scenario, relatively low compared with the usual Bell distribution, comes with two equally probable “fat tail” possibilities.
The favourable tail is a stronger global economy that benefits earlier than most expect from the productivity surge powered by US AI and Chinese green tech.
This would solidify a 1990s-like period of sustainably higher growth, declining debt burdens and better distribution of wealth.
The other tail is more reminiscent of the era of 1970s-type stagflation marked by global protectionism, disruptive bond and currency markets and financial deleveraging.
To navigate well this delicate cost-benefit equation, investors would be well advised to follow what Belinda Hill, my Gramercy Funds’ colleague, calls “stay calm, carry on, and mind the fat tails”.
This cautions against heavy reliance on a passive buy-the-index approach that many have got comfortable with in the past few years.
What’s needed is a more tactical bottom-up approach that pays extra attention to resilience and contingency plans.
Investors also need to be agile and consider the pace of AI adoption rather than just focusing on the companies delivering foundational models.
They will need to seek out what is likely to be a much smaller set of AI-related winners.
Debt investors, particularly, should be conservative in assessing balance sheet strength and capital structure seniority.
Overall, investors should not rely on what worked well last year.
They need to adapt to the eroding power of the two big macro engines that supported markets and economies through what has now become systemic uncertainty and volatility.
The writer is the Rene M Kern professor of practice at Wharton School, chief economic adviser at Allianz and chair of Gramercy Funds Management
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