Time and Pressure
Geology is the study of time and pressure. That’s all it takes, really, pressure, and time. Stephen King (Shawshank Redemption)
The global economy, led by China, is headed for a major decline and no amount of positive thinking will change this fact. Plenty of investors have come to this conclusion but constant intervention has been reversing the impact of investor sell decisions for a year.
Artificial intelligence represents the last-ditch effort to reverse this slow, inexorable decline but it was rushed into existence without a true need, apart from saving the world. Instead of saving the global economy, it’s going to make the decline much worse than necessary as the capital invested will be written down, in many cases to zero value. The financial model that undergirds AI makes no sense whatsoever.
AI will have good company. Green energy and climate change will also play a part. Western Europe, China, Canada, and parts of the US will be hit hard by past investments into supposedly clean energy. These investments are locked into energy cost structures for the foreseeable future, especially Germany where all their nuclear power plants were shut down over dubious fears.
While the US will remain the strongest of all, the horrible economic policy decisions, of both parties, will force us into a period of retrenchment. The asset market inflation that created a positive economic experience for many will be replaced by asset deflation going forward for the simple reason that much of our asset base won’t have economic value in the retrenchment.
We know how this will end. It will be a liquidity crisis. These crises occur when counter parties stop trusting each other because both know there is garbage in the banking system but not necessarily who has it. Parties with excess liquid assets are loathe to invest those assets in parties that need liquidity. When this happens, the banking system grinds to a halt.
Timing is the only question because intervention has broken historical financial feedback loops. Instead of experiencing negative results due to bad investment decisions, bad investors have been getting bailed out by mysterious “short squeezes” and miracle funding of corrupted credit at the eleventh hour. Expect this to continue until bad debt becomes too much to ignore.
Financial authorities have done a magnificent job of keeping Black Swans at bay but this time, those nasty birds are flocking just over the horizon and they are going to hit at one time in 2026. The worst will be China, the place where the CCP has effectively destroyed the economy and almost literally, salted the earth as thoroughly as Scipio in Carthage.
China
Really don’t mind if you sit this one out. My words but a whisper – your deafness a SHOUT. I may make you feel but I can’t make you think – Ian Anderson (Jethro Tull)
If you follow China closely, you’ll quickly realize that China imitates everything that is seen as successful. Xi Jinping calls the Chinese system “Socialism with Chinese characteristics,” but it’s Western economic policies with Chinese control mechanisms. It’s the CCP wanting economic progress on their terms. Rather than understand the factors that determine success, the CCP steals, imitates, and throws money at the problem.
China’s urban middle class is contracting the same way it’s happening in the West, only faster – crushed by mortgages, child care, and healthcare. But China never built the vast wealth that was created in the West, they only tried to copy the consumer-based economy that was created along with that wealth. China’s housing market is in a violent contraction with no floor in sight, it’s real birth-rate is likely below 1.0, less than half the replacement rate of 2.1 and Chinese hospitals are closing at a rapid rate. On average, 7 hospitals are closing each day. Private hospitals are closing while public hospitals are merging. Doctors and nurses are paid intermittently.
This is significant because it clearly shows us that Chinese Communist Party officials never understood wealth creation, only how to copy the results. In fact, neither Marxism nor socialism creates wealth. These two economic doctrines aim to re-distribute wealth after it has been created. Now China is out of money.
US Treasury Secretary Scott Bessent agrees with our assertion that China is experiencing an economic depression but don’t look for it in official data. Instead, you’ve got to look for the bits of information that inadvertently makes it out of China.
Tea prices are down 50% y-o-y. Shanghai-Pudong airport laid-off 8,000 as international flights are just over half of 2019’s number. According to the Ministry of Education, 74% of primary schools have closed since 2000. According to the Ministry of Housing, from 2000 to 2023, the number of rural villages declined from 3.63 million to 2.34 million. China’s white liquor (baijiu) production has fallen from 13 million tons in 2016 to 3 million tons in 2025. Nothing has replaced it.
It’s become impossible to hide the bad data. Fixed asset investment, the driver of China’s economy over the past 30 years, fell 15% y-o-y in October. October’s fiscal deficit was 45% in October. Chinese government at all levels is out of money.
A bank analyst out of Hong Kong published a piece showing how China’s top 6 banks are cashflow negative and only survive by rising deposits from customers and from the People’s Bank of China. The PBOC has created a program called “Outright Reverse Repurchase Agreement” which allows them to inject money into banks without officially expanding their balance sheet because the banks supposedly return that cash every 3-6 months. It’s a farce since the PBOC is rolling over new contracts on each maturity, allowing the cumulative number to rise to nearly $1 trillion by October.
On the fiscal front, the CCP instituted a new Social Security policy in September that is now mandatory. They have also gotten far more vigilant in enforcing VAT’s, or value-added taxes. Thanks to AI, they can now track every on-line transaction resulting in widescale bankruptcy. Local governments are still arresting business leaders from outside their regions to extract fictitious fees and penalties. Regional and local governments have instituted widescale salary cuts of 25% to 40%
Baidu lost $1.59 billion in 3Q2025 on a 7% decline in revenues. Not only did they lose money, they started laying off software engineers. Does this signal success in AI?
BIDU is the Google of China – the gold-standard stock, bluest of blue-chips. It’s supposed to be one of China’s biggest beneficiaries of AI but they can’t succeed because Chinese consumers are being squeezed at every turn.
Young men and women in China practice “tang-ping” or “lying flat” where they do just enough to survive but no more. The middle class is being systematically destroyed by taxes, fees, housing losses, and banking losses from wealth products that promised above-average returns over banks.
We are witnessing the destruction of the Chinese economy in real-time, obscured by continued dependence on economic and market data. I used the above quote for this section because it came from the song “Thick as a Brick” and it describes the continued reliance on economic and market data even though that data is entirely manipulated.
China is in a state of collapse. It’s not coming, it’s here. I only touched upon a few variables that reflect the collapse; there is so much more I can write on the topic. I’ve got notebooks full of examples as well as my theories on the impact of the fallout. The short answer is that it’s going to result in a deflationary impetus through the global economy followed by supply chain discord worse than 2021.
It's not truly a Black Swan because the information is out there but it will have the same effect because China represents cognitive dissonance in most people. They simply cannot accept that China is in an advanced state of decline.
The CCP is an evil entity but they maintain stability. I suspect their time is up and that the eastern coastal cities are going to break away before long. Given that much of the global supply chain continues to move through China, things are about to get interesting.
But let’s not forget, China learned from the West. China imitated the excesses in our consumer economy. They patterned their banking system and intervention policies from those first adopted in Japan, Europe, and the US.
The collapse of their housing market is an omen for what we can expect before long in the West, perhaps not to the same extent, but certainly the direction. The only difference is that the US has an exit ramp from these policies while China faces economic oblivion.
Europe
Even philosophers will praise war as ennobling mankind, forgetting the Greek who said: “War is bad in that it begets more evil than it kills” – Immanuel Kant
I have studied the Second World War extensively since high school. To this day, my mind cannot fully embrace the magnitude of the suffering that enveloped Europe. I’ve spent little time on the First World War because it was largely a war of attrition, fought over relatively small advances where everyone lost except British bankers.
With so much death and destruction on European soil, it seems unfathomable to me that Germany, France, and the UK want to test this path once again. All three are preparing for war with Russia, even as their populations express reluctance to take up arms.
The economies of all three are in varying states of decline. The UK has been in decline since 1946 when their empire started dropping off one-by-one. Today, the UK economy is effectively supported by financial services and some science-based industries. Their former glory was built on extracting resources from its far-flung empire, without which, the typical Brit is slowly becoming poor.
France held on to its empire far longer than Britain, maintaining influence in the African Sahel region of Mali, Burkina Faso, Niger and Chad until 2022. Without it, they have lost their access to cheap minerals, the basis of French wealth.
Germany lost its industrial juggernaut the day Putin’s tanks rolled into Ukraine, resulting in a massive increase in natural gas and oil costs. German companies can no longer compete with nations that enjoy lower input costs. This is especially true since Germany shut-down their nuclear electric capacity for climate change. In effect, their politicians committed national economic suicide; Germany is no longer competitive.
The political leadership of all three nations are in serious trouble with the electorate. Starting with Keir Starmer of the UK, he’s one of the least popular prime ministers to ever grace 10 Downing Street. His Labour party is one election away from a severe loss of power. The Tories, Britain’s so-called conservative party, has already collapsed in the polls. Together, they represent more than 100 years of failed policies and they are on the verge of being replaced by relatively new political parties.
Like Starmer, Emmanuelle Macron of France is hugely unpopular after 8 years of disastrous immigration policies and attempts to rein in France’s unique social services. The French people have long embraced a system where taxes are high at 45% of GDP, allowing for social services – pensions, health, family/unemployment benefits – to remain high at 30% of GDP. It’s uniquely French and it’s what the French people want.
Macron’s mistake was in allowing unfettered immigration into France where these immigrants receive welfare at 2.5X that of indigenous French people. Now they can’t afford to maintain this sacred contract with the French people, resulting in the formation of 3 powerful groups – the left, center, and right. Both the left and right want to maintain traditional French economics while Macron’s party at the center wants to eliminate this social contract.
Friedrich Merz ascended to Chancellor after winning election in 2024, promising to not accelerate military/government spending. The first thing he did after winning the election, but before assuming office, was to push a bill through the old German parliament that aggressively expanded military spending. Now, he’s extremely unpopular, having destroyed the trust of those who voted for him.
These three numbskulls, who represent the three biggest economies in Europe, are so desperate to maintain power that they are willing to go to war with Russia, a nuclear power. The fact that the UK and France want to put “boots on the ground” in Ukraine tells me all I need to know about the economic prospects of France and Britain.
Nobody in his right mind wants Germany to mobilize for war but desperate people do dangerous things. France has a budget deficit of 5.8% of GDP while the UK’s deficit is 5.2%. Germany is watching its industrial behemoths like Siemens, Bosch, and Volkswagen cut domestic operations for lower costs abroad. All three countries are on the edge of economic depression.
The people of all three nations are angry which is why Starmer and Macron won’t be in power much longer. A sharp decline in all three economies in 2026, along with massive bank losses, is another Black Swan hovering just out of view.
Japan
Anyone who isn’t confused really doesn’t understand the situation – Edward R. Murrow
The Japanese yen carry trade is one of the structural supports of the US stock market. The two charts below clearly reflect this dynamic as strength in the Japanese yen correlates to weakness in the S&P500.
The problem is that interest rates are starting to rise in Japan as years of easy money combined with a low birth-rate and high energy prices are pushing prices higher. Labor costs are rising as a smaller cohort of workers replace the retiring Baby Boomers that built Japan into an economic behemoth. I think it’s clear that the yen funding the bull market in stocks won’t be sustained much longer.
The Bank of Japan is expected to raise interest rates to 0.75% late next week even though it appears the Japanese economy is close to contraction. I think it’s safe to say that Japan has pushed 0% interest rates as far as they can and now they will be forced to let them rise.
Who is going to provide the funding for the risk trade going forward? What will happen if the Japanese yen starts to move higher versus the US dollar? The above correlation suggests a rise in the yen should result in a decline in the S&P500.
Furthermore, the sharp move higher in the value of Japan’s 10-year Treasury bond is concerning since the Japanese government has effectively monetized Japanese bonds. How can it move up this quickly?
Japan has been in and out of deflation since the early 1990’s but like the US, Covid reignited inflationary pressures. I’m not sold on the thesis of Japan facing secular inflation because a stronger value of the yen will bring consumer inflation down and higher interest rates should cause a rally in the yen. This is where the confusion is at its greatest because the yen carry trade requires the yen to remain weak versus the dollar yet higher interest rates will inevitably support a bid in the yen versus the dollar.
Japan’s new Prime Minister Sanae Takaichi is impressive; Japan finally has a decisive leader to unite the nation behind a consistent strategy. Ultimately, I view Japan as one of the long-term winners once the global economy is separated from the yoke of the global banking system. I expect the separation will be a function of a global deflationary economic depression that has already started in China.
USA
Always make your team around you feel like you are succeeding, even though you know, way down deep, it’s a long shot. You have to be a fighter and the leader and the one who instills energy and hope in others – Jon Huntsman, Sr
I think it’s a long shot for the US economy to avoid a sharp downturn in 2026. I’m enthusiastic about the long-term prospects of re-balancing the economy away from financialization and excess consumption because true economic strength relies on competitive advantage, not stock prices. The problem is the transition.
The US economy is highly levered to asset appreciation, so much so that young people face heavy barriers to asset acquisition – costs are too high. It’s a model that requires low interest rates and economic stability to work; neither can be sustained long term.
The table is set for a liquidity crisis in the US that can happen at any moment. The problem isn’t the banks, it’s the “shadow banks” such as KKR, Blue Owl, and Blackstone. In response to changing banking laws following the “Great Financial Crisis of 2008,” the industry elevated these firms to take the place of risky lending from the banks.
Instead of changing the risky behavior that caused the 2008 crash, risk was moved to these new entities which follow less strenuous accounting standards for illiquid and distressed assets than banks. Today, these firms and the funds administered by these firms are chock full of the investment sins of the past 15 years – including AI data centers.
Debt Blow Off Top?
The Covid years marked the beginning of the end for the financialization cycle. The amount of money governments needed to spend to maintain economic stability reignited inflation. It wasn’t just the US, it was Canada, Europe, and Japan. In China, Covid spending was vastly more than the rest of the world and forced down to the local level, effectively bankrupting local and regional governments.
In the US, the Federal Reserve reluctantly raised interest rates and were vilified for allowing inflation to return but the US Congress was responsible. The chart below shows the rate of change on debt growth at two inflection points – 2008 and 2020. Since 2008 and especially since 2020, Congress has been spending in destructive fashion without any element of prudence.
Presently, the US budget deficit is greater than 6% of GDP, more than 2X a reasonable figure and wholly unsustainable.
Everything jumped in price – food, energy, housing, services, and discretionary items. Auto maintenance costs spiked thanks to a short-sighted effort to fill cars with expensive electronic devices. The average price of a new car eclipsed $50,000. When combined with the added maintenance costs, new automobiles are unaffordable, despite increasing the average duration of new car loans to 5.75 years.
Prices are higher across the whole economic spectrum thanks to government handouts. We can see the chart below that shows how these payments are wildly elevated. Payments made to illegal immigrants will decline but will likely be replaced by people losing their jobs.
The change from 5 years ago is roughly $2 trillion plus the added one-time payouts in response to Covid. Transfer payments represent almost 27% of consumer spending in 2025, up from 20% in 2019. This jump in transfer payments is the main culprit of higher inflation in the US.
In the short run, our economy needs to maintain these payouts – most people don’t have an alternative and won’t have options to change until our economy transforms. This suggests that US federal debt growth is unlikely to decline over the next few years.
This is why the US is a tough call for 2026. Government spending has a palliative effect on the economy. The problem is that we’ve already seen cracks in the private credit market, normally the playground of informed investors such as insurance companies. Today, this garbage can be found in funds sold to individual investors such as the Blue Owl OBDC II and $OBDC funds, among others.
Commercial real estate is also starting to crack as corporate downsizing reduces office space and closed retailers reduce cash flow at malls and strip malls. Zombie companies with excess cheap debt from past years may not survive the need to re-finance at higher current rates.
I don’t know how this is going to play out in 2026 but I want to stay as far away from these potential Black Swans as possible. In particular, private equity looks poised to start hemorrhaging investors before much longer.
AI – Arrogance Improbable
Probable impossibilities are to be preferred to improbable possibilities – Aristotle
AI was rushed to market before being commercially viable. It’s well-documented that LLM’s are inaccurate and close to the limit of accuracy. They are good for some things but not good enough to justify the hundreds of billions of dollars invested in them.
This critique has been around for years yet the arrogant heads of the world’s leading tech companies have plowed capital into these models anyway. In doing so, they have become both capital-intensive and commoditized. Today, we have ChatGPT, Gemini, LlaMa, Azure, Grok and others. They all piled onto the same boat which means nobody will be able to charge premium prices for their proprietary models.
It's not just inaccurate LLM’s, the data center profitability model is a disaster thanks to the success of Nvidia. Nvidia’s chips are so expensive and so short-lived that it’s nearly impossible for data centers to achieve profitability, let alone return of capital.
OpenAI is burning through tens of billions of dollars while shadow banks and investment banks scramble to find funding sources or off-load losing bets. AI has all the ingredients for a liquidity crisis. Ultimately, it may require a government bailout to settle accounts.
The world seems to have bet the ranch on AI but instead of progress, we’ll probably get another Black Swan that hits in 2026.
Conclusion
With ‘Black Swan,’ the ballerina saga flips its tiara and goes on a hallucinatory bender, a scary acid trip where transfiguration and disfiguration meet – James Wolcott
I’ve never watched the film but that quote is a classic and oddly matches my view of the global economy since 2008. It’s been a “hallucinatory bender,” with economic growth manufactured from increasing debt, not from productivity. It’s a classic model that has destroyed many successful economies going back to the ancient Greeks.
The system is perpetuated by destroying anyone who bets against it in the capital markets as well as destroying those who support prudence in capital spending decisions. The winners have been those who were willing to use financial leverage to scale up quickly; slow and steady loses the race. Betting against the system has been the equivalent of being a bug colliding with a windshield.
Both financial and operating leverage makes competitors susceptible to shocks. Financial authorities have proven that they can deftly counter any systemic threats for 15 years but those threats hit one at a time. What’s going to happen when faced with a series of threats at one time?
They cleared the cupboards in response to Covid, leaving the world with elevated prices and crippling debt. The cupboards are bare even as multiple Black Swans are flocking just over the horizon.
In the long run, intervention in the markets and the economy results in misallocation of capital and fragile organizations. Economic winter is coming and we’re stuck wearing summer clothes thanks to faulty weather reports.
If you’re interested in learning more, visit us at https://geovestadvisors.com/ and contact Paul Hurley.
Philip M. Byrne, CFA