The long and the short: Part 2

Just after the first part of this note was published, the US and Iran negotiated a fragile ceasefire which appeared to involve the reopening of the Hormuz Strait. Donald Trump and his acolytes attributed this to his threat that “a whole civilisation will die tonight” unless the waterway was reopened. Iran, for its part, insisted it had successfully resisted the military pressure brought to bear on it. Indeed, the Strait remains closed – an Iranian demonstration of how it still holds a lot of the cards.

In truth, there are no real winners. Iran has taken heavy punishment from US and Israeli attacks which have degraded a considerable part of its military capacity and resulted in thousands of civilian casualties. But the US may have lost something even more important – credibility. It cannot claim to have achieved its initial goals of regime change and elimination of the Iranian nuclear programme (despite claims that the programme was ‘obliterated’ in 2025). The Iranian government remains in place even after the assassination of Supreme Leader Khamenei; it retains the ability to launch missiles against its neighbours and it still possesses its stock of enriched uranium. Moreover, Iran has now exerted control over the Strait of Hormuz, a waterway where it once merely harassed shipping but where it now dictates the terms of passage for the 20% of global oil traffic that flows through it.

History suggests that previous episodes of Western involvement in the Middle East have exacerbated rather than improved local security conditions. Recent cases have included the 2001 invasion of Afghanistan and the 2003 invasion of Iraq which precipitated acute sectarian polarisation and a near-disintegration of Iraq’s social fabric. Nothing that has happened in recent weeks suggests that the cycle will be broken this time around. Indeed, events since 7 October 2023 have ratcheted up global tensions in a way not seen since the Yom Kippur war of 1973. Israel’s actions alone have represented a disproportionate use of military force but US strikes against Iran represent an even more consequential strategic miscalculation, with the potential for far‑reaching geopolitical repercussions.

1. US actions will have more adverse geopolitical consequences than previous episodes

The litany of miscalculation and bombast on the part of the US Administration needs no repetition here but it is having profound consequences which could lead to a change in the geopolitical order. Although it made less strident claims during the Vietnam War, the US made a similar geopolitical miscalculation in the 1960s when launching its military power against a supposedly weaker opponent. But it was able to recover from that episode by virtue of being the unchallenged global economic leader. While the war placed fiscal and social strains on the US, the underlying economic engine was so powerful that recovery was almost structurally guaranteed. Along with this economic dominance, the US retained its position as the leader of the western alliance. Today, the size of China’s economy means it is now a near‑peer economic rival, while India and the EU represent sizeable economies that dilute US dominance. Trump’s erratic foreign policy means that erstwhile allies no longer have the same degree of trust in the US, whose leadership of the western alliance has been severely strained.

2.   The western alliance has experienced a profound change

None of this is to say that the US will not remain the strongest western power, both economically and politically. A post‑Trump administration may well re‑anchor US foreign policy in its traditional liberal democratic values, leading to a renewed warmth in transatlantic relations. But as the journalist Lewis Goodall recently noted, the widening gulf between Europe and the US MAGA movement is increasingly about values and “the divide runs deeper than policy, deeper than politics, deeper than any single leader can bridge.”

Trump’s recent threats to pull out of NATO would certainly undermine European security guarantees. But it would also reduce US ability to project its power around the globe. At the same time, efforts to draw European partners into the Middle East war and Trump’s ambitions towards Greenland have reminded Europe that partnership is not the same as dependence, and that it cannot afford to outsource its interests. It now understands the limits of external guarantees and the need to take fuller responsibility for its own security and economic resilience.

This will, of course, have serious military and economic implications for both Europe and the US. In 2023 and 2024, more than half of non-US NATO military spending went to US-owned companies, so the US stands to lose economically if Europe reduces its dependency. But Europe is also heavily dependent on the technology embedded in US-produced military equipment which will not be easy to replace (for a fuller discussion of these issues, see this excellent piece from the Bruegel think tank). The western alliance has served all sides well over the last 80 years. Its demise would not benefit any of its members.

3.   Trump has played into China’s hands

Large parts of the Middle East, particularly the Gulf states, have traditionally adopted a pro-US stance, relying on it for protection from hostile actors. But Iran’s missile attacks on Gulf states which host US military facilities have raised questions about just how much protection the US is able and willing to give. This raises the incentive for them to be more amenable to Chinese overtures as China seeks to expand its sphere of influence.

In East Asia, questions have been raised around China’s ambitions towards Taiwan and how far the US would be prepared to go to defend it. It is notable that Cheng Li-wun, the chair of Taiwan’s Kuomintang (KMT), this week met with Xi Jinping in Beijing, the first such contact in a decade. While there is no suggestion that the People’s Republic is planning a military invasion, Chinese military planners will undoubtedly have taken on board just how quickly the US is prepared to expend resources in pursuit of its goals, and how Iran has been able to absorb the military onslaught against it. Indeed, one of Trump’s biggest blunders has been to expose the limits of military power when confronted by a determined adversary. Deterrence is strongest when overwhelming force is implied, not when it must be used, particularly when it does not actually achieve its goals.

4.   Acceleration of global fragmentation

Historians may look back at the events of March 2026 and conclude that this was the point at which the position of the US at the top of the global geopolitical order became less certain. China has been able to sit on the sidelines and watch the US alienate its allies. One outcome might be a reduction in reliance on the US for security and a greater willingness to explore trade and financial payments infrastructure based on anchors other than the dollar. It is important to emphasise that this will not happen overnight – there will be no sudden rupture – but it could result in a gradual erosion of US dominance as parallel networks gain traction at the margin. This risks a more fragmented global landscape characterised by competing spheres of influence, reduced policy coordination and a diminished capacity to collectively manage cross-border shocks.

5.   Rising tail risks

One cause for concern is that there will be a significant widening in the distribution of risks. A global environment which has been built on a system of deterrence and sharply delineated red lines is increasingly subject to ambiguity. This increases scope for miscalculation by multiple actors operating in close proximity which in turn raises the likelihood of low-probability, high-impact events, ranging from unintended military escalation to a more sustained disruption of critical chokepoints (as we are seeing in the Strait of Hormuz today, but this could equally be a disruption of computer chip supply or some other critical material). In this environment, these risks are not independent: an initial shock could trigger a cascade of responses, amplifying its impact well beyond the original incident. The result is a more unstable equilibrium in which periods of apparent calm mask an underlying increase in systemic vulnerability, and where geopolitical developments are more likely to generate abrupt and non-linear shifts in the global landscape.

Last word

Some, all or none of the above risks could materialise. It may be that the Trump era represents a temporary blip in the global order and that the west will settle on a stable equilibrium once he leaves office. But it would be complacent to assume a return to the old normality. Something has fundamentally changed: the certainties of the old global order have given way to a more volatile and fragmented system, where stability can no longer be assumed and where shocks, whether geopolitical or economic, are likely to be both more frequent and more disruptive. And this is likely to have economic costs as European countries make greater provision for defence spending, diverting resources away from more productive investment and placing additional strain on already stretched public finances. A more fragmented and less predictable global environment will weigh on trade, investment and policy coordination, reinforcing the drag on growth. The cumulative effect is a world economy that is not only more exposed to shocks, but less well equipped to absorb them.

The long and the short: Part 1

As the US-Israeli war against Iran drags into its sixth week, the repercussions will be far-reaching. In the near-term, these are likely to be primarily economic. In the longer-term, the geopolitical ramifications will be more profound as the global order experiences what appears likely to be a permanent rupture. In the first part of a two-part note, I take a look at the economic aspects – drawing on an interactive VAR simulation dashboard to map the transmission of shocks – while the second part (forthcoming) will deal with the geopolitical consequences.

The magnitude of the problem

IEA Executive Director Fatih Birol, recently warned that “we are heading towards a major, major disruption, and the biggest in history.” It is almost certain that market conditions will get worse before they get better. Oil supply in March was partially supported by cargoes that had already passed through the Strait of Hormuz before hostilities escalated, and oil prices are already up 50% compared to pre-hostilities levels. If current estimates are correct that disruptions amount to 12 million barrels per day, this would amount to a 12% cut in global crude supply on an annual basis, compared to reductions of less than 5% in the 1970s. To put that into context, oil prices tripled – both in real and nominal terms – in 1974.

In an ironic twist, the 1970s oil shock was prompted by unconditional US support for Israel during the Yom Kippur war, which angered other Arab States so much that they imposed an oil export embargo. This led to increased tension between the US and several of its European allies who privately criticised the US for its reckless policy actions. US Secretary of State Henry Kissinger later admitted: “I made a mistake. In retrospect it was not the best considered decision we made.” It is unlikely that Donald Trump would ever make such an admission.

That was then. In many ways the world is very different. For one thing, although global oil consumption has doubled since the 1970s, European consumption in terms of barrels per day has remained broadly flat whereas Asian demand has increased fourfold, resulting in a big decline in consumption share for the former and a big rise for the latter (chart above). This is partly a reflection of European deindustrialisation whereby Europe now imports a lot of the manufactured products from Asia that previously would have been produced domestically. This has a double-edged effect: Asia will likely be much harder hit by the recent surge in oil prices than it was in the 1970s, while Europe will still end up importing inflation. Nor is the story these days purely about oil. Natural gas is increasingly used as a form of power generation, with global consumption having increased by 3.5x since the 1970s while European demand is up by 2.5x. So far, natural gas prices have not spiked to the same degree as they did in 2022: The Daily System Average Price (SAP) of Gas in the UK, which is an important determinant of retail prices, is admittedly up by 80% since end-February, but at 4.73p/kWh it is well below levels in excess of 19p/kWh in summer 2022. That said, matters might look different in a few months if energy does not start flowing through the Straits of Hormuz soon.

As it is, the pump price of petrol has risen sharply. US prices are now around $4/gallon, still 20% below the highs of summer 2022, but not a prospect that will endear President Trump to voters ahead of the mid-terms due in November (charts below). Similar trends are evident in the UK with a price around £1.54 per litre still 20% below 2022 highs (though at £5.83 per US gallon, or $7.59 at current exchange rates, UK motorists pay a lot more to fill up their cars). The price of petrol will feed through quickly into inflation. A rough rule of thumb is that every 5p on the fuel price adds 0.1pp to UK inflation, so on the basis of mid-March prices that will add 0.2pp to last month’s inflation rate. Latest data point to another 0.3pp in April. In the absence of energy effects, we could have expected UK April inflation to fall to the BoE’s 2% target rate as a number of base effects drop out of the calculations. On my calculations, that now looks unlikely.

Back in 2022, the huge surge in global prices triggered big increases in domestic energy bills. In the UK, domestic gas prices rose by 130% in 2022 though they are currently 35% below those peaks. In the short-term, consumers will be sheltered by the quarterly fixing of the household energy cap in April which means that any rise in domestic prices will only start to feed through from July. The econometric evidence suggests that it takes around 6 months for the full impact of global prices to feed through to UK consumers, which means we can expect significant increases in household energy bills in the latter part of 2026. On my calculations, the increase is likely to be at least 50% by end-year – and probably higher.

How do policymakers respond?

Even if we assume that the war ends tomorrow, the supply disruptions will take months to unwind, and it could take until end-year before supply is back to normal. But this optimistic scenario is one of the least likely options given the rhetoric out of Washington and Tehran in recent days. To frame the scale of the challenge facing policymakers, I have built an interactive VAR simulation dashboard (here) that allows users to explore how oil shocks and related variables propagate through the US, UK and euro area economies. It is not intended as a forecasting tool, but it provides a clear, model‑based sense of the pressures policymakers – particularly central banks – will have to weigh as they confront the next phase of this crisis[1].

The most obvious question is whether central banks should respond to inflationary shocks by tightening policy. In 2022, central banks responded to higher oil prices by raising interest rates. In one sense they could afford to do this because at the time of the Russian invasion of Ukraine, interest rates were at their effective lower bound. There was, in short, scope to tighten policy. Interest rates today are much closer to neutral. The extent to which rates should rise thus depends upon the extent to which second round effects are likely to impact the economy. In the US, the degree of labour market slack as measured by the unemployment rate is only modestly higher now than in early 2022. But in the UK the unemployment rate currently stands at 5.3% and rising, versus 3.9% and falling in early-2022. The number of  unfilled vacancies in the UK has fallen, suggesting softening demand for labour. All told, the risk of second round effects might be smaller than four years ago. The simulation model suggests that a sustained 50% rise in oil prices will add around one percentage point to UK inflation, and raise the risk of a modest 25bps increase in interest rates (50bps if we use the regime switching option). The ECB would be expected to respond with a 50bps rate hike whereas the Fed may even respond by cutting rates (charts below).

The other question is whether governments will be able to afford to use fiscal means to cushion households against rising energy bills in the way they did in 2022. In the UK, the net cost of support measures was roughly 2% of GDP in fiscal 2022-23. Hopefully the spike in the household energy price cap will be nowhere near as big as four years ago. Even so, a government which has set out its stall to balance the fiscal current account by the end of the decade will have precious little scope to provide any form of support. Indeed, as a senior British lawmaker put it to me recently, there is a question of whether governments should be providing such levels of support at all.

Last word

We can debate the pros and cons of Trump’s war (let us call it for what it is) but the economic consequences are unavoidable. A supply shock of this scale cannot be insulated by monetary policy or fiscal transfers. It will impact on prices and is likely then to affect wages and public finances, testing the political and economic cohesion of the global economy. The uncomfortable reality is that the costs will fall disproportionately on households and regions that had no role in shaping the decisions that triggered the crisis. The extent to which electorates are willing to absorb those costs is one that policymakers can no longer ignore.

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[1] The model includes GDP, CPI, the central bank policy rate and the trade weighted exchange rate (UK and euro zone)/unemployment rate (US). Users can simulate the impact of oil price changes; change the number of periods over which the disruption lasts; the pace of return back to baseline; the forecast horizon and whether they wish to operate in a low or high price regime. Separately, users can simulate the effects of changing endogenous variables with oil prices fixed. Please note that this is a work in progress. See the webpage for more detail.

100 Not Out

To reach the age of 100 is a significant event for anyone. When the centurion in question is the man (formerly) known as Maestro, one of the most significant central bankers of modern times, it is surprising that more was not made of the fact that Alan Greenspan celebrated his 100^th birthday on 6 March. Admittedly he has been out of the limelight for the past two decades, and his reputation was tarnished by the GFC which was widely blamed on his laissez-faire approach in the decade prior to 2008. But his hold over markets during his two decades as Fed Chair was unprecedented and he made a number of policy contributions that remain relevant today.

Such was his stature that during a presidential debate in 2000 when John McCain was asked whether he would reappoint Greenspan if he were elected president, McCain quipped: “Not only would I reappoint him, but if he died we’d prop him up and put sunglasses on him as they did in the movie Weekend at Bernie’s.” Contrast that with the remarks made by President Trump about outgoing Fed Chair Jay Powell to understand the radical shift in the respect shown to those in public office and the institutions they lead.

Assessing the legacy and the key takeaways for today

For someone who sat atop the Fed for so long, and who presided over so many important events in financial history, he obviously got a lot of things right, though we should not gloss over his mistakes. His first test as Chair came on 19 October 1987 – just two months into his tenure – when the market crash which came to be known as Black Monday precipitated the first market rout of the modern globalised era. Greenspan calmed markets with a 30-word statement: “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirms today its readiness to serve as a source of liquidity to support the economic and financial system.” It worked and thus the legend of the Greenspan put was born. The combination of interest rate cuts and repos was subsequently deployed during the Mexican peso crisis of 1994-95, and again in the wake of the 1997 Asian financial crisis which prompted the 1998 collapse of Long-Term Capital Management. Following the bursting of the dot-com bubble in 2001 the Fed was at it again, preventing a major market correction from dragging the economy into a more serious recession.

By the late-1990s, Greenspan was hailed as the Maestro who would always be there to provide support to financial markets. But it bred complacency by creating a climate of moral hazard. The phrase “Don’t Fight the Fed”, coined by the investor Martin Zweig in 1970, became closely associated with the actions of the Fed under Greenspan. Wall Street loved Greenspan for a reason – his policies helped banks generate sizeable profits and made rock stars of those bankers and analysts who were able to ride the wave. But after hubris came nemesis. Greenspan’s light touch was at least partially responsible for the build-up of off-balance sheet debt which was the primary cause of the 2008 market collapse. Working in markets around the turn of the century, I was always cautious of going overboard in praising Greenspan’s achievements. Looking back through some of my old writings, I came across this from August 2002: “It is always wise to be wary of the reputations which the markets create for certain individuals (viz. Mr Greenspan as history may yet pass a different judgement on the conduct of Fed policy during the 1990s boom).”

Greenspan’s tenure coincided with a period of growing economic imbalances. The greatest boom and bust on his watch was the equity boom of the late-1990s and while he vehemently denied that the Fed could have done much to stem the boom, arguing that bubbles are only evident in hindsight, it was obvious to many that the equity market would pop at some point. Greenspan fuelled the flames of the tech bubble by extolling the virtues of new technology and talking up the productivity revolution that they appeared to have triggered.

Yet for all the criticisms, it would be churlish to deny that the actions of the Fed in 1987, 1998 and 2001 to pump liquidity into the US economy prevented a much more serious global downturn than might otherwise have occurred. Nor should Greenspan’s role in advancing the cause of central bank transparency be underplayed. Prior to 1994 the FOMC did not even communicate to markets at what level it set the funds rate – this had to be inferred from market actions by the New York Fed. In addition, the Fed was a leader in publishing the minutes of policy meetings, which considerably improved policy transparency. A return to the pre-1994 world is almost unthinkable today. For all the modern talk of central banks providing forward guidance, it was Greenspan’s Fed which helped write the template, even if his Delphic utterances could be difficult to translate (as he once half-jokingly told Congress in 1987: “If I seem unduly clear to you, you must have misunderstood what I said.”)

While Greenspan’s free market leanings placed too much faith in the ability of financial markets to regulate themselves, we did at least learn much from the mistakes of the Greenspan era. In the rational world of science, in which he placed much faith, that would be regarded as progress. We should also give him credit for not taking received wisdom at face value. His belief that the US economy’s growth rate was faster than implied by the prevailing view of the NAIRU (5% at the time) meant that Greenspan resisted pressure to raise rates aggressively, and the Fed thus allowed the US economic upswing to continue for longer than traditional models suggested was safe. Data subsequently showed that an acceleration in productivity growth suggested he was right – the economy’s speed limit had increased.

An important takeaway for modern day policymakers is that they should pay close attention to the supply side of the economy, particularly the economy’s potential growth rate and the neutral rate (r*). At a time when AI threatens to upend many of our beliefs about the economy’s productive potential, an understanding of the economy’s growth potential is more important than ever. As in the late-1990s, policymakers may again be forced to decide whether apparently unsustainable growth reflects excess demand or a genuine shift in the economy’s productive capacity.

Last word

Greenspan’s tenure as Fed Chair produced a number of paradoxes. The crisis management playbook, which he helped pioneer, remains the template for modern central banking. Yet his hands-off approach to regulation was instrumental in ushering in a period of tighter financial regulation. He communicated frequently with markets, although they did not always understand the message he was trying to convey. He was the most important public official of his day, yet we never really knew his beliefs on many issues until long after he retired. Nonetheless, it is testimony to his importance that his legacy is still debated and that the legacy of the 1990s revolution in central banking continues to echo. Happy 100^th birthday Mr Greenspan.

Deindustrialisation: The rights and wrongs

Marco Rubio’s speech at the Munich Security Conference last weekend was greeted with relief in some quarters for being less bombastic than JD Vance’s aggressive speech in 2025. But in many ways, the underlying message was the same and it did nothing to dissuade the audience that the United States and Europe have fundamentally different geopolitical views and interests. Nonetheless, the speech was interesting and contained some points I agreed with, many that I disagreed with, and one in particular that touched on an economic issue worthy of further thought.

Was deindustrialisation inevitable?

Rubio opined that “Deindustrialization was not inevitable.  It was a conscious policy choice, a decades-long economic undertaking that stripped our nations of their wealth, of their productive capacity, and of their independence.  And the loss of our supply chain sovereignty was not a function of a prosperous and healthy system of global trade.  It was foolish.  It was a foolish but voluntary transformation of our economy that left us dependent on others for our needs and dangerously vulnerable to crisis.”

In my view, the idea that “deindustrialization was not inevitable” is both right and wrong. In order to unpack this, we should recall that the prevailing economic model across the Anglo-Saxon world from the 1980s onwards was heavily influenced by the ideas of Milton Friedman and the Chicago School. They strongly argued that markets allocate resources more efficiently than governments, and that shareholder primacy and capital mobility were normal features of a globalising economy. In order to make this model work, financial markets were deregulated and capital markets became increasingly global in scope. Firms came under strong pressure to relocate production to lower-cost jurisdictions, automate labour-intensive processes and shed capacity that no longer met required rates of return.

Trade barriers were lowered, partly through the completion of the EU single market, but most importantly as a result of China’s accession to the WTO in 2001. And who was the prime advocate of that accession? None other than the United States. However, the result was that in a world of falling trade barriers and increasingly rapid technological change, maintaining high-cost domestic manufacturing often meant either accepting lower profitability or subsidising inefficiency. Detroit’s decline was not wholly due to the inexorable rise of Shiyan – it was aided and abetted by government policy.

But while deindustrialisation was a consequence of governmental decisions, voters also expressed a clear preference for this model. Resources were reallocated towards sectors in which advanced economies enjoyed a comparative advantage – finance, high-value services, technology and knowledge-intensive activities – while production was outsourced to regions which enjoyed lower costs. As a result, consumers benefited from lower-priced goods. After the inflationary turmoil of the 1970s, voters supported policies that prioritised price stability, efficiency and consumer welfare. To that extent, the economic settlement reflected societal preferences as well as political ideology. It was as much a reflection of societal choice as a policy imposed by governments.

We are paying a price

Unfortunately, the gains from a relatively laissez faire policy were unevenly distributed. Indeed, many of us have long argued that the pace at which large parts of the western world deindustrialised, particularly the UK, was always going to create the left-behind communities that politicians now struggle to engage with. Labour was far less mobile than capital, with the result that workers in former industrial regions could not simply retrain overnight or relocate at negligible cost. Skills were industry-specific; social networks were geographically rooted and housing markets were illiquid. What appeared as efficient reallocation in the macro numbers manifested locally as long-term unemployment, wage stagnation, deteriorating public services and social fragmentation.

Although the economic orthodoxy of the time assumed that the operation of market forces would generate new opportunities which would ultimately absorb displaced labour, the duration of the adjustment process was underestimated. In short, while deindustrialisation was perceived as economically rational, it was never economically costless. Perhaps the real problem was the absence of subsequent government engagement. Communities were told that there was nothing that governments could do to prevent the forces of globalisation ripping old industries apart and that they would have to reinvent themselves or face the consequences. Some of the old industries were admittedly unsustainable – coal mining for one – but governments could have done more to cushion the blow for other industries. In the UK, the government blew the windfall gains from oil revenues on tax cuts, rather than building a fund that could have provided support to those communities disadvantaged by the switch from coal to oil.

Thus, while countries such as Norway used resource windfalls to build long-term stabilisation mechanisms, the UK opted for rapid liberalisation with comparatively limited regional industrial policy. A similar position was adopted in the US. Successive governments ignored the fact that while many of the structural forces driving deindustrialisation were powerful and perhaps unavoidable to some degree, they gave little thought as to how society should manage the transition. This, in my view, is why you can debate Rubio’s position from both sides. Deindustrialisation can be seen as a response to the turmoil of the 1970s. We could have struggled on, supporting old industries in a stagnant economy. But the good times of the late-1980s and 1990s would not have happened, and China would have industrialised anyway. Or governments could attempt to fix things – which they did, albeit imperfectly.

Deindustrialisation and parallels with the AI revolution

Advances in AI threaten to unleash even more economic turmoil, for which governments around the world are woefully unprepared. If this popular essay is any guide, the AI models available today are “unrecognizable from what existed even six months ago ... ” and they are coming for your job. This excellent paper by Charles Jones (well worth a read) argues that “AI will likely be the most important technology we have ever developed” and poses the question “What if machines … can perform every task a human can do but more cheaply?” The object here is not to debate what AI can do, nor whether it will replace human labour (we can deal with that issue another time). The more immediate point is that transformative technologies have the power to reshape economies and societies at extraordinary speed. If the risks appear large enough, perhaps we should be trying to pause or even halt the process. But is that remotely feasible? Can you imagine the political backlash from figures such as Rubio if governments were to act in such a way?

The deeper issue is not whether we should stop AI, but whether we could. Once a technology offers clear economic, strategic or military advantages, it acquires a momentum of its own. No major economy can afford to fall behind; no government wishes to explain why it chose restraint while rivals accelerated. In that sense, technological change is not always a policy choice. It can become a structural inevitability. Deindustrialisation in advanced economies forty years ago followed just such a path. It was politically contentious and socially painful, yet in a world of global competition and mobile capital it proved effectively irreversible. AI may represent a similar moment. The real danger lies not in the technology itself but in the illusion that it can be switched off. The task for policymakers is not prevention, but preparation because history suggests that once transformation begins, it rarely asks permission.

Last word

Precisely because the combination of technology and politics is a process rather than a discrete choice, Rubio is wrong to suggest that deindustrialisation was simply a matter of political will. It represented the cumulative consequence of a policy regime that prioritised capital mobility, trade liberalisation and financial integration. It is true that governments could have done more to mitigate the costs, but once advanced economies committed to that path the industrial base adjusted accordingly. At that point, reversal would have required costs and disruptions far greater than those incurred by continuation. What began as a series of policy choices hardened into economic structure.

AI may follow the same trajectory. Early regulatory decisions matter, but once firms – and indeed wider society – reorganise production around algorithmic systems and autonomous capabilities become embedded, restraint becomes extraordinarily costly. The question is not whether policymakers approve of the direction of travel, but whether they are prepared for its consequences. As of now, they are not. It is important to be aware of this because, when future politicians tell us of the mistakes our society made, we should remember that many of the choices made were not ours to take.

2026: TrAIumphalism

If 2025 was the year when artificial intelligence escaped the laboratory and Donald Trump escaped political gravity, 2026 will see the consequences of these events play out further on the global stage. It will be another year dominated by political and policy uncertainty, with cyclical economic considerations likely to take a backseat as policymakers grapple with changing geopolitical circumstances. That said, worries of a bursting of the AI bubble will keep policymakers on their toes, as markets party like it was 1999. However, the crucial difference between today and the dawn of the millennium is that we are no longer basking in the glow of the peace dividend that formed the backdrop to the economic environment of the time. Consumers are anxious; governments are heavily indebted and policy choices are more constrained. Buckle up for another trip around the sun.

Rampant Trumpism

Trade policy dominated the first half of 2025 as President Trump followed through on his threat to use tariffs as a means of extracting concessions from trading partners. By September 2025, the average effective US import tariff rate stood at 10.65%, up from 2.2% in January. Analysis conducted by UPenn Wharton suggests that tariff rate changes generated $124.5 bn in net customs revenue in the first nine months of 2025, while importer shifts in purchasing behaviour reduced potential revenue by only $31.5 bn. In other words, they achieved the goal of revenue generation without derailing the economy, which may embolden Trump to further weaponize trade. But the longer-term effects have yet to feed through. Consumers do not like paying higher prices while the full impacts on growth and inflation have yet to be felt. Bottom line: We can expect to hear more on Trump and tariffs in 2026.

Meanwhile, Jay Powell’s term as Fed Chair will end in May. Concerns that his successor will be more willing to accede to Trump’s demands for looser monetary policy in order to boost growth has the potential to undermine Fed independence. Markets will be keeping a close eye on this issue.

But it is in the realm of geopolitics where Trump will have the biggest influence. In 2024 he promised that “when I’m back in the White House, we will expel the warmongers, the profiteers … and we will restore world peace.” Admittedly, he did enforce a deal in the Middle East in 2025, but this is honoured more in the breach, and he has had no impact on ending the war in Ukraine, despite promising in June 2024 that “I will have that war settled between Putin and Zelenskyy as president-elect before I take office.” Indeed, Trump’s casual disregard for Russian activities close to NATO’s borders (and sometimes inside them) has undermined trust in US willingness to guarantee European security. US military strikes against Iran and Nigeria demonstrate that Trump is not shy about projecting force. But the January 2026 action to overthrow Venezuelan president Maduro, with Trump promising to run the country “until such time as we can do a safe, proper and judicious transition” has raised question marks around whether his foreign policy is ultimately guided by a coherent vision of peace or by transactional calculations that vary from case to case. The result is not disengagement, but an erratic form of activism that has left allies uncertain, adversaries emboldened and global risks harder to price.

As The Economist noted at the end of 2025, the main beneficiary of Trump’s bombast is China. It resisted US tariff pressure, exposing how dependent America and its allies remain on Chinese manufacturing value chains. Moreover, Trump’s strategy has often played into China’s hands. Bilateral tariffs alienated allies rather than building a coordinated response, while attacks on science funding, immigration and foreign researchers will ultimately weaken America’s innovative edge.

The 2026 Midterms may act as a check on Trump’s ambitions. The smart money suggests that the House of Representatives is likely to come under Democratic control following next November’s elections, with the result that a divided Congress will mount some serious opposition to his plans. History is on the Democrats’ side: Only twice in 14 Midterms since 1970 has the House majority aligned with the President’s party. In addition, Trump’s net approval ratings are in negative territory, though admittedly by less than at this point during his first term (although his approval rating has dropped faster, albeit from a higher starting point in 2025). But it would be unwise to fall back on historical patterns to justify betting against him – after all, this is a President who revels in tearing up the rulebook.

AI caramba

Progress in AI will continue to dominate the economic conversation. The most pressing concern for policymakers is the prospect that the AI bubble will burst, dragging down markets in its wake, in much the same way as happened in 2001 following the deflation of the tech bubble. This is a valid concern: Market concentration is high, with the Magnificent 7 accounting for 34% of the S&P500 market cap. Market valuations also look exceptionally toppy, with Robert Shiller’s CAPE measure estimated to have reached 39.4x in December – a value exceeded only in 1999-2000 on data back to 1881. Indeed, the OBR was so concerned about the prospect of spillover effects from a global equity price correction that the November EFO included a scenario in which a 35% decline in equity prices was estimated to produce a 0.6% reduction in UK GDP in 2027-28. It is not only the financial markets which are increasingly AI dependent: In the first half of 2025, business investment in information processing equipment accounted for the bulk of US GDP growth. Any reversal of the AI boom could have significant impacts on the real economy.

While caution is warranted, there are significant differences to the 1999-2000 boom. The current AI cycle is driven by profitable, cash-rich companies which are experiencing robust demand for their products. Admittedly, expectations have outstripped earnings growth as investors engage in a process of price discovery in a wholly new environment, so some wobbles are likely along the way. But there is real demand for the products emerging from the latest AI revolution, backed by an emerging infrastructure. A key trend in 2026 will be the continued shift from experimentation to integration as corporates begin to embed generative AI tools more deeply into core business processes. This will drive productivity gains, although these are likely to be uneven and manifest in ways that are hard to measure in conventional statistics. As with past general-purpose technologies, the biggest effects will come not from flashy applications but from mundane process redesign: faster coding cycles, cheaper discovery processes and increasingly automated customer support functions.

This may add to social tensions as large companies with data, capital and managerial capacity pull further ahead, while smaller firms struggle to keep up. There are increasing concerns that graduate entry level jobs will feel the AI squeeze as white-collar occupations once thought relatively insulated from automation become vulnerable to the application of new technology. The political significance of this phenomenon will increase in 2026, especially as it collides with an already febrile debate about inequality, immigration and cultural change. We see these concerns manifested in the rise of political populism across Europe and the US. 2026 will likely see further declines in the popularity of centrist politicians (Emmanuel Macron and Keir Starmer to name but two) as they struggle to manage the fallout from these competing forces and deliver a return of the feelgood factor that they have long promised their electorates.

Other things to watch

In the absence of any shocks, there are few things to get excited about on the macro front although fiscal policy across the industrialised world remains an area to watch. In the US, Trump’s bias towards tax cuts balanced with (theoretical) spending restraint may start to put some strain on Treasury markets, especially if the new Fed Chair is perceived as soft on inflation. Across the wider world, high debt levels and interest rates which are considerably higher than four years ago will limit government’s room for fiscal manoeuvre. Markets are unlikely to be prepared to fund unlimited borrowing, while voters are not willing to pay higher taxes. This can has been kicked down the road for so long that it is one that most people ignore. We may do so at our peril.

Geopolitically, the world remains unsettled. The risk in 2026 is less of sudden escalation than of chronic instability as conflicts drag on, diplomatic frameworks weaken and international institutions struggle to command authority. For businesses and investors, the defining challenge of 2026 will be navigating a world where technological acceleration coincides with political friction. Scenario planning will become a core managerial skill as businesses will have to adjust rapidly to changing economic and geopolitical currents.

Clearly, 2026 will not be a year of calm. It will be a year in which the forces unleashed in the first half of the decade take firmer shape as we take another step along a road increasingly less framed by the post-1945 settlement. Never was Yogi Berra’s aphorism more apt: “The future ain't what it used to be.”

Relative Claus

It is ten minutes to departure time at the North Pole, and Alfie Smith is annoyed. Not existentially annoyed. Not haunted-by-the-weight-of-global-expectations annoyed. Just irritated. His PlayStation game has been paused mid-mission, and the screen is flashing that passive-aggressive message about inactivity.

“Honestly,” he says in an accent which could place him anywhere from Acton to Zimbabwe, tugging at the red jacket with the mild resentment of someone who did not choose this outfit. “Five more minutes and I’d have cleared the level.”

This, apparently, is Santa Claus.

Not the rotund, bearded figure of myth, but a skinny 21-year-old with messy hair, trainers and the posture of someone who grew up hunched over a console. The beard is clipped on; the suit adds considerable heft; the laugh is optional. The job, he insists, is real.

“People always ask why Santa isn’t old and fat,” Alfie says. “But you try being out of shape in this job. If you think working in an Amazon warehouse is hard on the system, wait until you have to get around the world in about 24 hours, dropping presents as you go.”

Alfie reckons he trains hard to be in shape for his big night, though you would not think so to look at him. He looks more like someone who has trained his thumbs far more diligently than the rest of his body. For 364 days of the year, you would pass him by without a second glance. Which is precisely the point – you can't be Santa for 365 days a year. It is the very definition of a part-time job.

Alfie is vague about what he does for the rest of the year. He volunteers that he works “in computing”, and says it in the way people do when they don’t want to explain the rest. Later, he admits that he is very good at getting into places he is not technically supposed to be. This has proved useful in both his professional life and on Christmas Eve, when an increasing number of households appear to have mistaken “secure” for “Santa-proof”. He won’t be drawn on the issue of cyberattacks on JLR and Marks and Spencer. “Trade secrets mate,” is his only comment.

A young person’s game

The Santa role, it turns out, is not a lifetime appointment. In an inversion of the old slogan, the job is for Christmas, not for life. It’s rotational.

“You can’t have a single individual doing global overnight logistics indefinitely,” Alfie explains. “Fatigue effects, declining marginal stamina, rising injury probability. Dad did it for years, but the system’s changed. Weight is a disadvantage when aerodynamics and roof landings are involved.”

Santa, like many institutions, has modernised. Each Santa serves a fixed term, usually starting in their early twenties when reaction times peak and knees still function. The old image persists, Alfie says, because of branding. And what a brand! Alfie is aware that he is upholding a centuries old tradition. “You definitely don’t want to mess up on the job. After all, look what happened to the Prince formerly known as Andrew. And I’m out there on my own. A misplaced yo-ho-ho and we’re all out of business.”

It is not as if the Santa business has the field all to itself these days. “Amazon are good,” says Alfie, “but they’re not in our league. I mean, if you’re not in, they have to leave a parcel out in the rain or with a neighbour. We deliver to your living room exactly when we say we will.” But he admits Amazon have come a long way in 25 years. There was talk of them dressing their drivers as Santa around the Christmas period “but our lawyers put a stop to copyright infringement,” interjects Fred Smith.

Keeping it in the family

Fred Smith is Alfie’s father and a former Santa himself. He watches from a nearby chair, nursing a mug of something strong and steaming. Fred does look a bit closer to the archetypal Santa figure with his greying hair and carrying a few extra pounds. He took over the round from his father, who in turn took over from his father before him. Family legend has it that the lineage can be traced all the way back to the fourth century Greek Bishop Nicholas, or Old Nick as Fred calls him. The records suggest the line can be traced back to the late Middle Ages, though this depends on how strictly one defines “records”. One ancestor, known only as Old Tom Smith, appears in a fifteenth-century parish ledger as a man who was “frequently abroad at night”, usually carrying a sack, and always returning lighter than he left – unlike his brother William, a noted burglar. Another is mentioned in the margins of a monastic text, accused of “entering the nunnery uninvited, distributing items of unclear origin, and insisting it was for morale”.

By the seventeenth century, the role had become more formalised. A distant ancestor, Edmund Smith, is said to have standardised the red coat “for visibility in poor winter light” and introduced the first sack, after repeatedly losing gifts in snowdrifts. Industrialisation brought challenges. One Victorian Santa Smith struggled with the sudden explosion in toy variety and decided to simplify his job by giving every house an orange and a lump of coal. This did not go down well. Lessons were learned.

The twentieth century was particularly hard on the family. Two world wars disrupted routes, lists and morale. Fred’s grandfather was reportedly forced to deliver presents by bicycle when the reindeer asked for danger money. By the time Fred took over, the job had already begun to modernise. Chimneys were shrinking, expectations were rising, and mince pies had become increasingly experimental. Still, the principle remained the same: turn up, don’t wake anyone, and never, under any circumstances, miss a house.

Fred takes a sip from his mug. “People think Santa’s immortal,” he says. “He isn’t. He just keeps handing the job down.”

He pauses. “Like the crown,” he adds. “But colder.”

Getting around

These days the sleigh is no longer pulled purely by reindeer. Not because the reindeer can’t handle it – they can – but because scale matters.

“Reindeer are great,” Alfie says. “But capacity constraints are a real problem.”

The modern operation uses a hybrid system: reindeer for symbolism and short-haul rooftop work, supplemented by what Alfie describes as “non-disclosed propulsion technology.”

“We don’t like to call it magic anymore,” he adds. “It’s bad for investor confidence.”

The route planning is algorithmic. Time zones are exploited ruthlessly. Sleep is not an option.

“You’re basically arbitraging time,” Alfie explains. “By moving east, you keep buying yourself more night. The whole thing is a window of opportunity, and demand for on-time delivery is perfectly inelastic. Every household wants delivery by morning. No excuses.”

Fred laughs. “In my day, you just went east and hoped for the best.”

Around the world in 24 hours

Alfie’s favourite part of the job is the flying. His least favourite part is the living rooms.

“You see everything,” he says. “The good, the bad, the aggressively beige.”

What makes the job worthwhile, though, is the people you meet – or rather don’t meet if all goes to plan. “People say kids don’t believe anymore,” Alfie says. “They absolutely do. Adults, though? Adults leave the weirdest stuff out. Kale. Gluten-free crackers. One year someone left spirulina.”

He pauses.

“I still ate it. Sunk cost.”

Economically, Alfie says, Christmas is fascinating.

“You see inequality very clearly. Some houses are overflowing. Others are sparse but careful. You learn quickly that value isn’t about quantity.”

He describes one small flat where a single present sat under a tiny tree.

“It was wrapped three times,” he says. “That’s effort. High labour input.”

Fred nods.

“The best gifts are always like that.”

Learning on the job

Last year was Alfie’s first solo effort. Mistakes were made.

“There was a misjudged landing in Manchester,” he admits. “Satellite dish. I took it clean off.”

He grimaces.

“Technically it was infrastructure damage. We had to compensate. Fortunately I had a spare on the sleigh.”

There was also an incident involving a security system in Munich, a drone in California, and what Alfie diplomatically calls “a near-miss with an unidentified anomalous phenomenon.” It turns out he does not believe in little green men. “They’re blue,” he adds quickly.

“But you have to learn on the job smartish,” he says. “The margin for error is thin, and people are always trying to catch you out.”

Fred snorts.

“At least you’ve got GPS – Global Position of Santa. I navigated by instinct and a vague sense of dread.”

Fred’s era, by all accounts, was tougher. No real-time data. No dynamic rerouting. Just a sack, a list and an understanding that failure was not an option.

“And we were heavier,” Fred adds. “Which was a mistake.”

Fred Claus

Fred took on the Santa role in his early-twenties and stayed longer than was healthy.

“Of course the job was a lot harder in my day,” Fred says, “When I did it we ate what we could, when we could. No route optimisation. No GPS. Point the reindeer where we wanted to go and hope we would get round without mishap.” He shakes his head. “Terrible for productivity.”

“There was pride in it,” he says. “But the workload kept rising. More kids, more stuff, more expectations.”

Globalisation, it turns out, was not kind to Santa.

“When supply chains improved, people expected more,” Fred says. “More variety, more precision. Try explaining inventory management to a seven-year-old.”

He gestures toward Alfie.

“This lot have dashboards. KPIs. Recovery protocols.”

Alfie shrugs.

“Still hard. Just differently hard.”

The economics of belief

At its core, Alfie says, Santa’s job is about expectations management.

“The gifts matter,” he says. “But belief is the real public good.”

Belief, he explains in language befitting an economist, is non-rival and non-excludable. Everyone benefits when it exists, and no one household can produce it alone.

“That’s why Santa has to be centralised,” Alfie says. “If it were privatised, you’d get under-provision.”

Fred smiles.

“Never thought I’d hear Santa described as a natural monopoly.”

As departure time approaches, Alfie stands, stretches and checks his watch.

“Right,” he says. “Time to go.”

He pulls on the hat, adjusts the beard, and suddenly looks convincing.

Any last thoughts?

He considers.

“People think Christmas is a season of goodwill,” he says. “But for many, it’s really about effort, timing, efficiency – and showing up when it counts.”

He pauses, then adds:

“And surviving the spirulina.”

The grotto doors open. Cold air rushes in. Reindeer snort impatiently.

Fred claps his son on the shoulder.

“Don’t forget,” he says. “Eat the mince pies. They’re baked into the system.”

Alfie grins.

Then this year’s version of Santa Claus sets off into the night, as he has for generations, though now with better tracking software.

Merry Christmas to you and yours.

The 3Rs: Reeves, Revenues and Resentment

I have said it many times before, but it is worth repeating that the on-the-day take of the UK Budget often misses much of the nuance. This is hardly surprising: we are bombarded with a huge amount of material which takes time to digest, and only once the dust has settled can we give a sober assessment, free from the imperative to say something quickly. But perhaps the most important takeaway is that we – and by we, I mean the electorate as a whole, but particularly politicians and the media – should stop treating a serious area of economic policy as if it were a piece of theatre. Fiscal policy has important implications, both at a microeconomic and macroeconomic level: The decisions taken on Budget day impact on household finances but also affect the nation’s creditworthiness. One might be forgiven for forgetting some of these bigger issues given the faux outrage generated by political opponents and the reaction in parts of the media (this is not a party political point: it is true irrespective of the party in office).

Communication breakdown

As for the framing of the Budget, shambles would be a polite description. Communication ahead of the Budget was characterised by the flotation of various fiscal ideas, as the government released a number of trial balloons, with the Chancellor Rachel Reeves hinting on 4 November that a manifesto-busting hike in income tax rates was on the cards. Just days later, however, the government rolled back on this policy. As the spin doctors got to work to explain the apparent U-turn, we were told that the official forecasts were likely to show a smaller black hole in the fiscal accounts than previously thought and that a rise in income tax rates was unnecessary. Instead a “smorgasbord” of smaller tax increases would be sufficient to ensure that the government could meet its fiscal rules. 

But on 28 November,  two days after the Budget, the narrative changed to suggest that in fact the OBR had informed the Chancellor as early as 31 October that she could still balance the current budget on a five year horizon, even without major tax hikes. Admittedly the margin was too small for comfort and some fiscal adjustment was still necessary, but it appeared to be a far less dramatic problem than we were led to believe.

Not too long ago, the pre-Budget period was characterised by ‘purdah’, with public officials prevented from making any comment on its content on pain of sanction. Once upon a time, monetary policy also used to be conducted in secret in the belief that surprising the market was the most effective means of policy control. The economic literature has since come to the conclusion that clarity and predictability are the corner stones of sound monetary policy. But this is not what we got in the four weeks prior to the Budget, which was characterised by mixed messaging and confusion, none of which helped to shore up fiscal credibility and served only to heighten market volatility. Silence can indeed be golden.

The shambolic communication extended to Budget day itself when the OBR’s main publication was released tothe public before the Chancellor had a chance to inform parliament of her fiscal plans. It is not for me to say whether that was a breach of the law but it was certainly a breach of protocol. Nor do I have any strong views as to what, if any, sanctions should be imposed. But Chris Giles, writing in the FT, noted that: “The OBR’s error is worse than other Budget leaks because the fiscal watchdog exists solely to improve the process and has failed in its main job. The disaster exposes the OBR to future political questions and undermines the case for independent economic institutions … If the OBR cannot organise its document handling, how can we trust it to get the judgment on productivity or the tax richness of GDP forecasts right?” 

Giles did not explicitly call for the OBR’s Chair, Richard Hughes, to be sacked but he certainly hinted that he should be left alone in the study with a pearl-handled revolver. This seems a little harsh given all the anonymous leaks to which we have been subject over the last month.

Was the economics any better?

The answer to that question depends on what we think is the primary objective of the Budget. In my view, those who believe the Chancellor did not do enough to boost growth are missing the point. In the words of the Parliament website, the Budget “is a statement … on the nation’s finances and the Government’s proposals for changes to taxation.” Essentially, the Chancellor has two instruments at her disposal – taxation and spending – to control two quantities (revenues and outlays). Using the tax instrument to target both revenues and growth is asking for trouble. Indeed, the Tinbergen rule states that there must be at least as many independent policy instruments as there are independent policy objectives to achieve them efficiently.

Focusing on the more narrow fiscal questions, however, a lot of awkward questions remain to be answered. Starting with the fiscal rules, the good news is that the OBR’s forecasts suggest they will be met. The Chancellor has a bigger buffer (£22bn) to accommodate any narrowing of the current surplus by 2029-30 (this was a mere £9.9bn in March). However, the OBR only assigns a 59% probability to the chance this will be achieved: While this is the highest in the post-Covid era, it is far from a ringing endorsement (chart above). 

The supplementary target for public sector net financial liabilities (PSNFL) to be falling in 2029-30 is also met in the central forecast, but the probability assigned to this target is just 52%. Indeed, a debt-to-GDP ratio currently close to 90% and set to go higher means that debt servicing costs are highly vulnerable to swings in bond yields. Around 9% of revenues are currently used merely to pay debt interest: At a time when there are so many other competing demands on public finances, this makes debt reduction an imperative (chart below).

A lot has been said and written about the individual fiscal measures and there is little point in rehashing it here (see the IFS analysis for more detailed insight). But a few things are noteworthy: Rachel Reeves did say a year ago that she would not be coming back for more tax revenue following the rise in employer NICs. But she did, and the largest single measure was the extension of a freeze on income tax thresholds from 2028-29 which is set to generate roughly half of the additional tax revenue predicted by 2030-31. Although Reeves did not raise marginal income tax rates, this freeze implies an increase in average income tax rates as earners are pulled into higher tax bands thanks to inflation, hurting the lower paid. There is also a political dimension: A general election must be held no later than summer 2029. In the absence of any recovery in popularity, the government will be going into an election campaign on a platform of higher effective taxes. It is unlikely to be a vote winner and it is a policy which may not survive contact with political reality.

Trying to put it in context

As my colleagues at NIESR noted in the wake of the Budget, it “locks in a high-tax, high-debt steady state in a world of low productivity growth and higher interest rates. Even the historically large tax share of GDP now planned is only just enough to stabilise – not reduce – a debt ratio stuck around 100 per cent of GDP for the foreseeable future … there was a notable lack of economic vision beyond clearing fiscal hurdles. Reforms to the triple lock, council tax, and VAT were pushed into the background while the Chancellor focused – justifiably – on meeting the fiscal rules.”

In other words, the Chancellor – like most of her predecessors – continued to dance around the elephant in the room, goaded on by a rabid commentariat in thrall to the economics of the 1980s. Either voters have to accept that they will have to stump up for the public services they say they want, or they will have to find alternatives. Over the past 40 years, successive governments have told the electorate that consumers are best placed to spend their own money and that they want to put more money back into their pockets. 

This is a laudable objective, but what governments failed to point out is that a smaller state means that voters will have to pay more out of their own money for certain services. More money in voters pockets means less goes to the NHS so if consumers want the same quality of service, they will have to pay more for private health cover. Implicitly, Reeves did drop hints in this direction in her Budget speech. But it is an unpopular message and if a government with a 148 seat majority in parliament is unable or unwilling to make the case, we should not hold our breath that we will be able to have an adult conversation about fiscal trade-offs any time soon.