News in Charts: Global imbalances

Tariffs now define Washington’s trade stance. The effective rate on US imports was surging well above its long-term trend, even before the Liberation Day announcement that, according to Fathom, catapulted it to around 33%. Like any tax, tariffs bolster federal revenue and lift consumer prices, prompting less spending and more savings, something that could marginally raise the national saving rate.

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They do not, however, change the core arithmetic: domestic demand still exceeds domestic output, so the US continues to fund its spending with foreign capital. The net external liability position has drifted towards one quarter of annual global GDP, financed by the same overseas investors that the tariffs are meant to deter.

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Those investors reside chiefly in the surplus economies of the chart above. Germany’s external asset surplus sits at close to 3% of world GDP, and China’s is closer to 5%. Their excess savings recycles into US assets, propping up the dollar and suppressing Treasury yields. Durable rebalancing therefore demands adjustment on both sides: the debtor must consume less or save more, while the creditors must spend more at home. Or, the creditor must pay the debtor in the form of tariffs — something that seems to be the preferred option for the current US administration.

Europe, led by Germany, has finally begun to move in a trajectory that could potentially help the US close its external liability position. Berlin has suspended its constitutional debt brake, exempted defence spending of up to 1.5 % of GDP from EU fiscal limits and pledged €100 billion for infrastructure. With the lowest debt‑to‑GDP ratio in the G7 and, on average, a balanced budget since the turn of the century, Germany can afford to loosen up; Bund yields have barely budged.

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This, in turn, is already shaping equity markets: the forward P/E gap between US and euro‑area indices has narrowed from about 14 points in 2022 to 10, the first meaningful compression in four years. Valuation convergence reflects more than mathematics. Higher real rates push up the US equity‑risk premium as earnings momentum cools, while renewed European fiscal support brightens the outlook for cyclicals — especially defence. Since the 2024 US election, European defence shares have rerated sharply; multi-year procurement plans and political sponsorship have lowered the discount rate on their cash flows.

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China stands on the other side of the ledger. Together with Hong Kong, it commands the world’s largest positive net external asset position, built on persistent trade surpluses. US tariffs aim to erode that surplus, yet Beijing’s options are limited. Absorbing duties is untenable — average profit margins in tariff‑exposed manufacturing hover at near to 4%, and well below those of other countries. Moreover, permanent subsidies would strain the public purse. A more likely mix is targeted support and gradual renminbi depreciation. Absent of a decisive pivot to household consumption, China will continue exporting both savings and mild deflation to the rest of the world.

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Dollar dynamics remain pivotal. Fathom’s valuation metrics still place the greenback at about 20 per cent above fair value, and April’s concurrent dollar slide and gold surge has underscored its sensitivity to policy shocks. Reserve managers are diversifying at the margin, yet the currency remains the linchpin of global liquidity.

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Key issues to watch for this summer and beyond are clear. First, can US tariffs on their own raise national saving quickly enough to narrow the external gap and current account deficit without reigniting inflation? Second, will Germany’s fiscal pivot be large and sustained enough to anchor a broader European recovery? Third, will China accept slower, domestic-consumer-led growth, or risk missteps by heavily subsidising exporters? Fourth, how far can the dollar’s premium decline before markets demand higher US yields? And finally — arguably overriding all the above — will the US strike trade deals with other major economies, as it did with China, to restore confidence in the global trade framework? And if so, will those deals prove effective?

These questions frame the analysis in Fathom’s Global Outlook – Summer 2025: A puerile obsession? In a world where trade policy is increasingly unpredictable, it is no surprise that asset returns are volatile. How investors can allocate efficiently in such an environment is the motivation behind our new allocation tool, also presented in Fathom’s Global Outlook.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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