“Bonds should come with a warning label”

– Warren Buffett.

The bond market is on far shakier ground than many investors realize. There is strong evidence that action; or inaction, on the part of President Donald J. Trump might trigger a bond meltdown.

The danger is the vast amount of US government debt (mostly treasury bonds) held by banks and national governments. Commercial banks in the United States hold $2.4 trillion (€2.26 trillion) worth of government debt and agency securities, CNBC reported. The People’s Republic of China held $1.05 trillion (€990 billion) in Treasury bonds in November 2015.

Even some private institutions own enough US government debt to create real problems. Citigroup (NYSE: C); one of the much maligned monster banks that dominate American finance, held $111 billion (€104.57 billion) worth of such securities in third quarter 2016.

The Danger of a Bond Sell off is Greater than You Think

The greatest risk is that Trump would take some action to anger decision makers in China or at large bank. Those individuals would retaliate by simply picking up the phone and telling somebody to sell all the U.S. government debt.

That would create instant panic and massive sell off in the bond market. There are also some Trump promises that might trigger such move.

Donald’s promise to impose a 45% tariff on Chinese made products entering the United States is certainly one of these. So would an effort to break up the monster banks by reinstating the long defunct Glass-Steagall Act.

Glass-Steagall was a Depression era law that barred consumer banks from owning investment banks. Its’ restoration would threaten the basic business model of monster banks; such as Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Citigroup, Wells Fargo (NYSE: WFC) and Goldman Sachs (NYSE: GS). The companies combine investment and consumer banking and make vast amounts of money through the process.

Four monster banks; Bank of America, Chase, Wells Fargo and Citigroup, held $185 billion in U.S. government debt in third quarter 2016 according to CNBC. That gives them a vast amount of leverage over President Trump.

The Benefits of a Bond Sell Off

These institutions have another great reason to sell off treasuries. They can use the cash raised by such a sale to buy back their stock, some of which is trading at very low prices right now. Bank of America was trading at $24.52 (€23.10) a share on February 17, 2017, for example. That would raise stock prices and give them capital or leverage for further acquisitions.

The Chinese would also benefit from the pile of cash they would raise from a bond sell off. They might use the proceeds to buy stock in American corporations or to reinvest in their own industry and infrastructure. The money can also be used to boost the Chinese stock market and the value of companies like Alibaba which are partially financed by the Chinese government.

A Disruptive Bitcoin Investment the Chinese might make

Another investment the People’s Bank of China (PBOC) might make with the proceeds of a treasury sale is in bitcoin. Buying up large amounts of bitcoin would be a better means of influencing the cryptocurrency’s price than regulating or banning it.

Recent PBOC efforts to discourage bitcoin use have failed, during the week of February 13 the digital currency recovered almost of the value it lost in January. A bitcoin was trading at $1,063.63 (€1,002.05) on February 19, 2017, close to the January 4 price of $1,069.40 (€1,007.49).

China is the world’s largest bitcoin market; and the volume of trading in the currency is a serious embarrassment to the PBOC. An intriguing possibility is that economists at the central bank might think bitcoin can be used an economic weapon; that would give China an advantage in competition with other nations. Using bitcoin would enable China’s intelligence agencies to make large untraceable payments to US citizens, including Trump’s political opponents.

Controlling a large chunk of Bitcoin would give the PBOC a vast amount of potential buying power. Such a deal might make the PBOC a lot of money by greatly boosting bitcoin’s price. Just imagine how the markets will react when word that a major government is buying up bitcoin gets out?

Not Just Trump

Nor is it just Trump bond investors have to worry about. There are other erratic world leaders; such as India’s Prime Minister Narenda Modi, who destroyed the value of his nation’s currency with demonetization.

There is also the possibility of the collapse of governments or nations. What happens to the British gilt, if Scotland pulled out of the United Kingdom over Brexit? Then there’s Eurobonds, what happens to them if the European Union falls apart?

Such catastrophic events might kill off the government bond market by totally destroying its stability. Stability is the only real selling point government bonds have left, in today’s market which offers a vast choice of investments.

Is it the End of the Bond Market?

A meltdown would do incalculable damage to a bond market that is already in very sorry shape. Many investors already shun government bonds because they can make more money with other kinds of securities; such as junk bonds or corporate paper, thanks to the low returns on some government bonds.

The only selling point government bonds have is their supposed safety. If that evaporates there will be a stampede away from the bond market. This presents problems because governments finance their activities with bonds. Most modern models of government finance are based on the central bank’s ability to issue debt. Governments would be forced to raise interest rates, raise taxes, implement new taxes or issue new kinds of securities.

This would certainly create problems for Trump who has promised vast increases in infrastructure spending; that would presumably be financed with government debt. He’s also promised increases in military spending and some large projects; the cost of the Mexican border wall has been estimated at $40 billion (€37.65 billion).

To make matters worse, Trump has also promised tax cuts particularly for wealthy and upper middle class Americans. How is that supposed to be paid for if the government cannot sell its debt?

The dangers in bond market are far greater than you might think. Investors might be well advised to stay away from government bonds for the foreseeable future.