The Euro was created with monetary union first, assuming political and fiscal union would follow; they haven't. Now, with nationalist governments rising across Europe, the project's core conflict is exposed. A shared currency managed by inwardly-focused national interests is a fundamentally unstable structure.
When drivers of an "economic miracle"—typically demographics and productivity—inevitably slow, governments often turn to debt to maintain high growth rates. This happened in post-WWII Italy and is happening now in China. It's a dangerous attempt to paper over a structural slowdown, leading to debt sustainability problems.
If the Fed cuts rates too aggressively during a productivity boom, the bond market will likely sell off long-duration bonds. This "bear steepening" would raise long-term yields that influence mortgages and corporate borrowing, tightening financial conditions and counteracting the Fed's intended easing.
While AI growth seems organic, low interest rates encourage even healthy companies to take on excessive debt. This is happening now, with some AI-related firms seeing decreasing free cash flow as leverage increases. The private credit market is already showing signs of nervousness about this trend.
The knee-jerk reaction to a geopolitical shock is often a bond market rally (flight to safety). However, if the shock impacts supply (e.g., oil), the market can quickly reverse. It pivots from pricing geopolitical risk to pricing the risk of persistent inflation, forcing yields higher in anticipation of rate hikes.
Despite talk of de-dollarization, the US remains the only market offering superior returns due to its productivity advantage. Recent ex-US outperformance was a short-term anomaly based on perceived geopolitical risks in the US, not a fundamental shift. When seeking returns, capital must ultimately flow to the US.
The US has experienced four major tech-driven productivity booms in 40 years (PCs, .com, mobile, AI), while Europe has consistently missed these waves. The core reason for US dominance isn't just the technology itself, but its superior ecosystem of human capital—universities, patents, and R&D—that fuels these revolutions.
Technological revolutions like AI boost productivity, which increases the neutral interest rate (r-star). Central banks that cut policy rates below this new, higher r-star risk creating asset bubbles and inflation, a mistake former Fed Chair Greenspan made during the dot-com boom, according to economist Paul Samuelson.