Michael Drury and I first met in Singapore at a Global Interdependence Center (GIC) conference. Over the years, our friendship and collegial relationship have grown through our involvement with GIC and its global programming and discussions of economic issues.
Michael’s expertise lies in economics and how the economic outlook translates into financial market activity. He also has extensive knowledge of China’s economy and its international economic relationships, having traveled to China many times.
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Michael has written an excellent missive, dated October 16th, and has graciously given us permission to share it with our readers. We have reproduced the entire piece from McVean Trading & Investments, LLC, where Michael serves as chief economist.
Readers who would like to be added to Michael’s email distribution list for his Sunday missives may contact him at https://www.mcvean.com/michaeldrury.
McVEAN Trading & Investments, LLC
Weekly Economic Update
Michael Drury, Chief Economist
Volume 120, Number 3 | October 16, 2026
This week’s most closely watched data releases were the slightly hotter than expected CPI and the much stronger than expected retail sales, both of which reinforced investors expectations that the Federal Reserve would continue to tighten – but at the December meeting, rather than just ahead of election day. We completely agree – but we found the spike in the less closely watched PPI, and the blowout in the Chinese trade surplus told us much more about the state of the global economy – and where the risks of a slowdown in AI investment truly lie. Meanwhile, concern about an AI bubble bursting was amplified by the troubles at Coreweave, a plunge in the previously high flying South Korean KOSPI, and the 15% sell off in the Philadelphia Semiconductor Index. In the battle between fear and greed, fear has had the upper hand since the start of June, with the S&P500 up less than 1% over four and a half months – after a spectacular run.
We think a rethink on AI investment is the key to 2027 – but it is not in the US financial markets or real economy that the greatest risk lies – as illustrated by this month’s data and market movements. Rather, it is Asia that will be the epicenter of an AI correction — a reversal of their recent boom – hitting equity markets, raising interest rates, exposing their energy dependence, and increasing economic pressure via lower orders and higher costs on economies that have not shown a solid underpinning away from their AI related activities. Yes, the US economy will cool as well, but it will pass along the bulk of the pain to the manufacturing base in Asia, leaving the real recession for the factory floor as has long been the case. Meanwhile, the biggest beneficiary of any AI easing is likely to be the long-suffering US housing market, as both lower rates and more labor and resources at cheaper prices help it cushion the blow from less AI activity.
This month, the Producers’ Price Index jumped up more than twice as much as expected – a 1.3% monthly increase, leaving it 6.3% higher than a year ago. This closely tracked the 1.1% increase in import prices – you know, from the actual producers of manufactured goods – which is up 8.1% from a year ago. Yes, energy is a component, but ex food, energy and trade, PPI is still up 5.0% from a year ago. Foreign suppliers simply cannot keep up with US AI driven demand, so higher price has become the balancing factor. This is causing distortions in the data – and its interpretation.
In September, the Chinese trade surplus (what keeps us up at night) once again exploded higher to $133 billion – for the month! The prime culprit was a 136% annual increase in exports of integrated circuits, to $45 billion. Yet, this $25 billion increase from a year ago was on a 1% rise in volume, and explosion in price. China’s semiconductor exports, up 108% so far this year to $302 billion, are on track to add $200 billion to their annual trade surplus by themselves – almost entirely due to price. That is a substantial part of the US-based AI borrowing spree being directly rerouted to China by purchasers who need China’s lower-end chips to drive their own production of more sophisticated products. Other than semiconductors, China’s trade surplus would be narrowing by about $50 billion (to a mere $1 trillion excluding chips), despite a boom in exports of EVs and electronics, which use a lot commodity-level chips that still face overcapacity in China’s notoriously deflationary factories. However, that shrinkage reflects a decline in real activity, while the chip boom is creating no new jobs – just a windfall for the Party, as it increases it influence around the world.
Wait! Isn’t China recycling these windfall profits into more semiconductor production at breakneck pace? NO! These profits are in foreign currency, and are not lifting Chinese wages or investment. That momentum is being driven by the Party allocating yuan – for which they have their own printing press – to incentivize the activities they desire. Yes, they are favoring technology, and lately slightly more consumer activity, but with so little money printing that they still have less than 1% consumer inflation – but a 5% growth rate in PPI, which they export abroad and raise foreign currency.
So, the US prints money – fueling a 3.7% rise in CPI (and many other inflation measures) – in response to strong credit demand from interest rate insensitive AI firms. A lot of that money finds its way to Asia, where electronics are manufactured, and some goes to China directly, and more indirectly through other trade partners, swelling their trade surplus via price increases with no need for more use of resources (labor or capital). That surplus of non-yuan savings (what’s left after paying up for oil, etc.) buys gold, and other international assets, including loans to other nations – and apparently including US treasuries hidden away in Canada or elsewhere.
While we have been and continue to be very concerned about China’s huge surplus increasing their global clout, part of this missive is to point out that when the US AI credit boom slows, stalls or collapses – China will suffer more than the US. So will Vietnam, South Korea, Taiwan, Thailand, and Malaysia, all of which have economies pumped up on the AI trade. That boom has been so large that they have largely been able to absorb the negative impact of $100 a barrel oil, in economies which are very energy dependent (oh, yeah, the US exports). Unless oil retreats in line with an AI correction — and it does not appear that AI was the primary factor driving energy prices higher – Asia could face a painful double whammy. The US – and especially US equity market – would not be immune, but much of the real economic pain for workers will be transferred into Asia, where non-AI growth has been soft, as seen in their K-shaped consumer activity.
The K-shape has come home to roost in the US as wage growth has cooled somewhat from 3.9% in the year ended September 2025, to 3.1% over the past twelve months. Part of that shrinkage in real wages has been offset by higher hours per week, as hiring has shifted away from medical care and leisure (short hours) to manufacturing, with overtime. However, it is lost on no one that the bottom of the K is feeling the pain – with compensation growth at 4.1% and inflation at 3.7%. A slowing of inflation would reduce the pain, but with compensation at around 4%, any inflation with a 2-handle still suggests under-performance from consumer spending – unless the top of the K is supporting it out of unrealized capital gains or asset sales, driving down the savings rate. All year long affordability has been the clarion call in an election year, and it appears sustained inflation will certainly flip the House — and now maybe the Senate as well.
Perhaps the most surprising economic result recently has been the strength in retail sales over the past three months – particularly in real terms. Perhaps the flat stock market reflects profit taking that is finding its way into spending. However, it is health care, nondurables and food that are lifting spending – not durables, as one would expect from pent up demand. We note that third quarter real retail sales were very strong in 2023 and 2024, after soft second quarters – like this year. In 2025, the pattern was smoother over the mid-year quarters. This sector has been very volatile month to month – and with big revisions. We interpret retail sales as supporting the call for 2% final sales in the third quarter, roughly the sale as in the first half. That is solid, but unspectacular growth – confirming that the AI boom is a big deal in US equity markets, but that much of the real action from production is in Asia, including China. An end to the boom, like when the internet bubble burst in 2000, may be far more significant for the top of the K in the US than the bottom.
Thank you, Michael, for sharing this important discussion with our readers.
Again, readers who would like to be added to Michael’s email distribution list may contact him at https://www.mcvean.com/michaeldrury.
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