License to Kill
A country like America is in debt not because of a deficit but because of the countless unnecessary wars it has engaged in. That debt is going to tie Trump's hands.
In mathematics, some operations move you from one paradigm to another. These functions exist to describe things that happen in the world. For instance, Direct Current follows a step function. It has two states: off or on. There is no intermediate state, unlike an alternating current.
The Trump Presidency seems to be a step function—a step down.
A week ago, I wrote about the dollar and deficit being two sides of the same coin. Trump went after trade and found out very quickly how fragile the dollar is. In international relationships, a currency does not get hit by a sell-off on the dollar, but on the instrument used to hold the dollar - the bond.
The US Treasury bonds are the most preferred way for countries to hold dollars because they provide a return on the asset held.
When America buys stuff from China, they pay China in US dollars. China could ask for it to be converted to Yuan and transferred to China but China will need US dollars to buy petroleum. Hence they leave that money parked in a NOSTRO account at the US Federal Bank. That money often is far greater than what China needs and hence they end up investing that money in US Treasury Bonds to get some returns on it rather than sit there depreciating. This is the source of the infinite cash that seems to be available to the US for the debt that they issue.
When you antagonise those who hold your debt, they no longer have any reason to hold on to it.
The USA spent a trillion dollars to kill ONE man who was sitting in an ally’s territory.
If China has to write off $1 trillion to permanently and completely decimate the American currency hegemony, do you think they will flinch? Is it really too big a price to pay?
It is a pawn sitting there to be sacrificed if it can deliver the goods!
Ultimately…
Money is imaginary. It is our imagination that gives it value! There is nothing real about it. It is not like the resources that we dig out of the ground or the food that we grow and eat.
If a country were to face 10,000% inflation, the money would not be worth the paper it is printed on.
The US has 8 trillion dollars in debt owed by foreign nations. The rest of its debts are owed to Americans.
Source: US Treasury
The market fluctuates with the mood of the participants. The bonds pay a constant yield no matter what is happening in the world. At least so long as the country is liquid and not bankrupt.
The US bond is seen as a safe asset since the country is not expected to default on its bonds. Therefore, an inverse relationship exists between the market and the bond yield. When the markets rise, demand for the bond goes down, and yield rises. When the markets fall, demand for the bonds goes up, and the yield falls.
This gives the US unique powers. It can foment war, cause uncertainty and benefit from it. I am sure this was part of the Trump calculus.
There is a shared fiction that the USD is a great store of value. Everyone agrees with this fiction because they are paid in that currency. This also allows the US to engage in quantitative easing and print currency several times each year to finance itself. They call it the debt ceiling, and politicians use it as a means of engaging in one-upmanship every year.
But - In the absence of a deficit, who needs the dollar? The demand for the dollar will fall. If our books are even and I don’t have extra dollars to pay for other stuff, I would insist on paying with my own currency rather than borrowing dollars to buy petrol or any other thing.
The fiction will begin to unravel.
But when a quarter of your debt is held by foreign countries you seek to antagonise, they drop your debt on the market.
They are making a deal, to screw you!
The Cause
Source: CNBC
China and Japan started selling the US bonds, causing the yield to balloon. For the first time in a long time, the markets were falling, and so was the demand for the US bond, and yields were rising.
The Effect
Source: Google Finance
Fun Fact - In the next 18 months, the US has to refinance another $8 trillion of debt, and all of that debt would then have to be issued at a higher interest rate! Do the math, half a per cent on $8 trillion, that is $40 billion more in interest payments. On a 10-year bond, it implies an increase of $400 billion in interest payments.
All of the “savings” that the Trump administration has accomplished through the myriad firings would amount to nothing compared to the rise in interest.
Pump the Brakes
So, you had Trump suddenly put the brakes on the whole tariff plan last week. The falling demand for the bonds was not anticipated. It puts the US in a very sticky position. Further, if this increase goes unchecked, it can spiral out of control, not to mention it would be in the interest of a country like China to let it spiral by providing some more impetus to the market.
So while Trump was willing to let the markets gyrate by 1000s of points, a 10% move on the bond yield took the wind out of his sails.
On the one hand, you can argue that he is using tariffs as a negotiating tactic and pushing allies and foes alike to see how far he can go. But on the other hand, he is also testing the strength of the very foundations of the US economy. Allies and foes alike can kick at that foundation and see how sturdy it really is!
This has the potential to go extremely awry for the US.
Bond has the license to kill, whether at MI6 or in the market.