President Trump actually thinks it was his tough policy that had forced North Korea to finally talk to South Korea. Although the North just wanted to talk about the Winter Olympic 2018 with the South and nothing else, including its nuclear programme, Trump praised himself and took the credit anyway. Perhaps thinking his tough policy works, Trump is about to pull another stunt.

Now, Canada believes Donald Trump will most likely withdraw from decades-old NAFTA. After an extremely bullish stock market last year (2017), the U.S. president is more than determine to raise interest rates this year. Now, there are talks that there could be more than 3 rate hikes this year. But the U.S. stocks and bonds don’t like it and have since plunged.

After NAFTA, his next potential target is none other than China. But Beijing is ready to take on Trump, should the U.S. president decides to unilaterally impose tariffs or other trade restrictions on China under the justification of protecting U.S. industries. Adding to bond investors’ jittery, the Chinese could deliver a blow and end of a 3-decade bull market.

According to Bloomberg, China is thinking about slowing – or even stopping entirely – the purchases of  U.S. Treasuries. China is presently the world’s biggest owner of foreign-exchange reserves – US$3.1 trillion. It’s unknown why Beijing plans to do so. The Chinese officials just mentioned that  U.S. government bonds are becoming less attractive relative to other asset.

However, it’s not hard to understand the real story behind such plan. It has everything to do with a trade war, one that Trump administration is ready to declare on the Chinese. Obviously, the strategy to stop buying U.S. debts could hurt the U.S. financial markets, no matter how much analysts and economists try to rubbish the impact on America.

In August 2017, after 8 months of fighting cash outflows, China reclaimed its top position as the world’s top owner of U.S. Treasuries – essentially I.O.U. debt paper. Japan had held the top spot since October 2016. Both China and Japan own more than a third of all foreign ownership of U.S. Treasuries, which totalled US$14.5 trillion – the world’s largest debt paper.

Essentially, China is holding 21% of U.S. total debt paper. Without the Chinese, somebody needs to absorb the U.S. sovereign debt to not only feed the Americans’ spending but also to support the U.S. dollar. That’s why when the news broke that Beijing is toying with the idea of stopping the purchase, the worried market sends the dollar to the bottom while treasury prices fell.

Strategists at Jefferies said – “If China stops buying Treasuries, the market could suffer. Treasury financing needs are going to rise significantly in 2018 and beyond relative to recent history.”  Michael Shaoul, chairman and CEO of Marketfield Asset Management, said – “I think the Chinese will contribute to the removal of liquidity from the U.S. bond market. That’s not helpful to a bond market.”

Coincidently, Trump administration is preparing to boost its supply of debt. As the Federal Reserve reduces its balance sheet and as fiscal deficits look set to widen, the U.S. needs to borrow more money. The U.S. is scheduled to reopen US$20 billion of 10-year debt on Wednesday, followed by US$12 billion of 30-year bonds on Thursday.

It seems the Chinese deliberately wanted to test the water and see the impact of news that they may stop supporting the U.S. debt market. However, some investors said China cannot possibly threaten the U.S. financial markets, considering the Chinese’s net purchases of Treasuries have already slowed “significantly.” But China hasn’t even unleashed its true weapon.

A more damaging weapon, of course, is when China actually starts selling their existing arsenal of U.S. Treasuries I.O.U. papers to disrupt the bond markets. And China has planeloads of such debt papers in an event of a full-blown trade war with the U.S. Already, bond investors and traders are bracing for what they feared could be the end of a three-decade bull market.

The latest move by Beijing, however, could be a chess game strategy to prevent President Trump from recklessly declaring a trade war on China. The Chinese could be sending a message to Washington that if the U.S. tries to punish Beijing, they could always diversity elsewhere such as the European Union – the world’s second largest economy.

Its worth to mention that in 2016, China was the world’s largest economy for the second year in a row – producing US$21.3 trillion in economic output. The European Union was in second place, generating US$19.2 trillion. The United States fell to third place, producing only US$18.6 trillion. But is E.U. comparable to the U.S. for China to continue make money?

The 2016 E.U. trade deficit with China remains unbalanced at almost €175 billion Euros (US$209 billion; £155 billion). In comparison, the U.S. trade deficit with China was US$347 billion in 2016. Sure, the Chinese may earn US$138 billion less but when push comes to shove, they probably can live with a trade war with the U.S. But can the Yankees live with high inflation due to more expensive goods?

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