Rebalancing Act: How Global Policy Shifts Are Rewriting the Rules of Capital and Trade

When the Balances Stop Balancing

In the global economy, nothing ever balances itself — it must be balanced. And the tool we use to understand that process is the financial balances identity:

(Private Sector Balance) + (Government Balance) + (Current Account Balance) = 0

This deceptively simple equation reminds us that the financial positions of households, businesses, governments, and the rest of the world are always interlinked — one sector’s deficit must be matched by a surplus elsewhere. But when policies distort trade and capital flows, they don’t eliminate this identity. They just shift the burden of adjustment — often suddenly and painfully — to another part of the system.

We’re now entering such a phase. As we explored in a previous piece (see the bond market and productivity), the global economy is confronting overlapping questions about how — and where — capital will be absorbed. That blog argued that it’s not simply a question of whether savings adjust (they must), but rather what mix of prices, policies, and expectations will force that adjustment — particularly as governments and firms simultaneously reach for the same pool of private capital to fund deficits and an AI-driven capex surge.

These concerns sit at the heart of what this next piece explores. Around the world, governments are pulling financial levers in conflicting directions. The United States is simultaneously contemplating financial transaction taxes, introducing punitive investment measures, and expanding fiscal deficits. Europe is loosening its purse strings in the name of strategic autonomy, while fast-tracking plans for a Savings and Investment Union that would re-anchor more capital within its borders. And China, still deeply mercantilist, is doubling down on export-led growth, capital controls, and state-directed investment — while keeping domestic consumption artificially suppressed.

Overlaying all this is a sharp resurgence in protectionist trade policy, with the United States now imposing tariffs across a wide swathe of imports. These frictions are not just policy noise — they are tearing at the global capital recycling mechanisms that once allowed persistent imbalances to be absorbed without systemic rupture.

As we wrote last time, markets may be pricing in an AI-led productivity renaissance — but if that narrative falters or is undercut by misaligned financial flows, the repricing could be swift and severe. And here’s the real concern: the fragile scaffolding that once allowed the world to function with these imbalances is now being dismantled — leaving a system where capital is needed in one place, unwanted in another, and increasingly blocked from flowing freely.

The United States Closes the Financial Tap

Suppose the US implements a tax on financial transactions or introduces new restrictions on foreign portfolio investment. This would mark a sharp reversal from decades of financial openness, fundamentally challenging the US model of attracting global capital to fund persistent fiscal and current account deficits.

Recent policy proposals, including those under the so-called "Big Beautiful Budget" clause and Section 899 of the Internal Revenue Code, point to a new willingness to weaponize financial channels. Section 899 allows for punitive taxation—so-called "revenge taxes"—on investors from countries deemed to have imposed discriminatory measures against the US. These steps create uncertainty for foreign capital and increase the risk premium on US assets.

If capital inflows shrink, the identity demands that either: • The current account deficit shrinks (via export gains or import compression), • The government deficit shrinks (unlikely given current policy), or • The private sector saves more than it invests.

This would strain the US economy. The dollar would likely weaken. Treasuries might lose some of their safe haven appeal, especially if yields rise to compensate for reduced foreign demand. Liquidity premia would widen. The US could no longer rely on the rest of the world to finance its deficits cheaply and reliably.

US Fiscal Expansion Without Financing

Now consider a parallel development: a renewed US fiscal expansion driven by tax cuts and defence spending. The federal deficit widens further. But with capital inflows potentially constrained, the private sector—households and corporations—must absorb the gap.

This creates a contradiction. Expansionary fiscal policy often tends to reduce household saving (more income, more consumption) and encourages firms to invest. But the financial balances identity demands the opposite: that the private sector save more to offset government dissaving and a flat or shrinking current account.

If private savings don’t rise, interest rates must. The result: pressure on equity and bond markets, and a risk that the US enters a cycle of high borrowing costs just as its productive potential hinges on long-term investment.

The Capital Hunger of the AI Revolution

This imbalance becomes more acute when considering the capital demands of emerging technologies. AI is no longer just software — it requires hyperscale data centres, GPU clusters, semiconductor fabs, grid-scale power delivery, and secure digital infrastructure. This is physical, capital-intensive investment.

In theory AI could reignite productivity growth, offering a partial antidote to years of stagnation in output per worker. But in practice, the realization of these productivity gains is conditional on massive and sustained upfront investment. Generative AI, large language models, and the broader automation ecosystem depend on an extensive physical foundation: hyperscale data centres, cutting-edge semiconductor supply chains, and redundant, high-capacity electricity networks. Crucially, these infrastructures are not energy neutral. Training advanced AI models consumes vast quantities of electricity — often exceeding the daily consumption of thousands of households — while running inference at scale requires constant cooling and power reliability.

With foreign capital inflows constrained and fiscal resources increasingly tied up in politically motivated programs like tax cuts or defence spending, there is little room for public sector leadership in financing this transition. That means the burden of investment must fall on domestic private savings — households and firms already under pressure to offset public dissaving. This creates a dual bind: the very sectors tasked with funding the AI boom are also expected to increase their net saving to keep the macro-financial system stable. The result is a tension between technological ambition and macroeconomic reality, one that risks stalling transformative progress just as its potential begins to emerge.

So while households are asked to save more to offset public dissaving, they must also help fund the most capital-hungry industrial transition since electrification. The likely result: rising real interest rates, investment bottlenecks, or deferral of transformative technologies due to macro-financial mismatches.

Europe Loosens Up: A Regional Realignment

Europe, too, is shifting. Defence spending is potentially rising. Green industrial policy is taking root. For decades, the EU was a surplus exporter of savings — often into US Treasuries. But looser fiscal policy could reduce that surplus, keeping more capital within the eurozone.

Moreover, the EU is accelerating plans to build a more integrated capital market—through a revived push for a Savings and Investment Union. This aims to mobilize domestic savings, harmonize regulation, and create deeper, more liquid financial markets within Europe. If successful, it would further reduce Europe’s reliance on exporting capital abroad and increase its capacity to fund its own transition priorities.

From a global perspective, this compounds the US problem: less foreign saving chasing US assets, less downward pressure on the euro, and a reorientation of global capital flows away from Washington.

Tariffs and the Collapse of Global Absorption Mechanisms

Tariffs, especially those imposed by the US on China and other trade partners, reduce global trade flows. This also constrains global capital flows — since a country’s current account is the mirror image of its capital account.

If the US current account deficit shrinks because of weaker trade, it cannot continue importing capital from abroad. And if the US simultaneously refuses to cut its fiscal deficit, the burden again falls on the private sector. Less trade = less capital recycling = more strain on domestic finance.

China’s Surplus in a Fracturing World

China’s model remains mercantilist. It runs a persistent current account surplus, maintains capital controls, and funnels domestic saving into state-directed investment. But if the rest of the world closes its capital accounts or erects trade barriers, China's surplus must shrink.

In recent months, China has moved to stabilize its property sector, rein in local government debt, and redirect stimulus toward advanced manufacturing and technological self-sufficiency. These policies are designed to shore up domestic growth while maintaining high levels of investment. Yet they continue to suppress consumption — the very adjustment China needs to avoid further imbalances.

Without a shift to consumption-led growth, China risks generating excess saving with nowhere to go. That saving then depresses global returns, fuels overcapacity, and worsens geopolitical tensions as China seeks new markets and influence.

When Global Adjustment Becomes a Zero-Sum Game

The financial balances identity will always hold — but how it holds matters. Right now, the world's three economic giants — the US, China, and the EU — are each pursuing policies that rely on other regions absorbing the adjustment burden. But there is no longer a clear absorber of last resort.

If capital can't flow in, and governments won't reduce deficits, the private sector must fill the gap. That means: • Households saving more, consuming less • Companies scaling back investment or diverting funds away from productivity-enhancing projects • Higher real interest rates to equilibrate mismatches

This becomes even more dangerous in an era of AI, where the need for long-term investment is high, but the willingness and capacity to fund it is undercut by misaligned global balances.

In short: the global economy isn’t running out of capital. It’s running out of places where capital can go freely, efficiently, and productively.

Investment Implications

For asset allocators, the unravelling of global capital and trade mechanisms implies a more volatile and uneven investment landscape. The relative predictability of global capital flows — with US assets serving as the primary absorber of foreign savings — can no longer be taken for granted.

For equity managers, the likely rise in real interest rates and reduced liquidity conditions will pressure valuations, particularly for capital-intensive growth sectors reliant on cheap financing. AI, while a long-term productivity tailwind, faces a capital bottleneck that may delay the realization of returns. Focus may shift toward firms with robust balance sheets, localized supply chains, and access to stable domestic financing.

Bond investors face a dual threat: rising supply from fiscal expansion and waning foreign demand. Duration risk is now more sensitive to policy credibility and geopolitical sentiment than to conventional inflation-fighting expectations. US Treasuries may no longer serve as the unchallenged safe haven of choice.

For traders, these developments open up opportunities in FX volatility, relative rate plays, and country-specific risk premia. The dollar faces growing asymmetrical downside risk. With foreign capital inflows disincentivized, fiscal deficits widening, and the private sector strained, the dollar may become a key adjustment valve. While short-term bouts of strength are possible, particularly in risk-off episodes, the structural trajectory is tilted toward depreciation — a shift that could fuel broader volatility across rates, equities, and emerging markets. Volatility in EMs could spike as global surpluses dry up.

In a world of fractured flows and constrained absorption capacity, capital will become more selective — and so must those who manage it.