The game has changed ever since Trump was elected and inflation started to pick up. This is a risky proposition because the system is unstable. The only reason why it looks stable today because central banks are doing everything in their power to make it look good. However, this very action is what makes it vulnerable. The international decisions with regards to trade and monetary policy are often described as currency wars. I disagree with this terminology because wars are fought in a battle of strength. Each central bank is actually weak. Each is trying to maintain its own house of cards. It’s not a war; it’s a game of Jenga where each country tries to make a move without causing repercussions that knock the system down.

Every time the Fed raises rates by a quarter point, it is pulling a Jenga piece out of the tower in hopes that it doesn’t fall. The hawkish tone has causes bond yields to rise and the dollar to rise. Bond yields rising increase the interest expense on the U.S. government debt. With the U.S. debt approaching $20 trillion, this could be disastrous depending on how high yields rise. The dollar increasing hurts multinational’s profits and American exports. The Fed is hoping the JCB and ECB taper because it will halt the dollar rally. However, rising interest rates abroad further increase U.S. government bond yields. With many international bonds being manipulated to have negative interest rates, the capital flowed into American bonds because its record low yields were relatively high. By being hawkish, the Fed created this ‘lose, lose’ scenario. It took the penultimate Jenga piece. The next one pulled may knock the tower down.

Speaking of treasury rates increasing, one of the reason why yields have been increasing is because of foreign selling. This foreign selling is being caused by the rising dollar. The expensive dollar is a problem in of itself. The negative consequence of foreign selling of government bonds doesn’t help. As you can see from the chart below, China sold a record $41 billion in American paper in October. It sold $125 billion in the past 4 months. China is not in position where it is the aggressor in this scenario. It is simply trying to keep the Yuan from tumbling further.

This situation is the exact worst case scenario for a Trump administration. He already wants to label China a currency manipulator. The more the dollar rises, the more China sells U.S. government bonds. This will only infuriate Trump more. Trump has the situation backwards when he says China is manipulating its currency lower as China is trying to get it to stabilize. America calling any other country a currency manipulator is ‘the pot calling the kettle black.’ America cannot have a Fed with a $4.5 trillion balance sheet and claim other countries are manipulating their currencies.

With climate change agreements, Trump is correct that America is being asked to do more than developing countries. The logic behind these protocols is that America can afford to reduce emissions, while developing countries need a break to get their people out of poverty before worrying about climate change. If President Trump wants to negotiate less cuts for American carbon dioxide emissions, he has plenty of wiggle room to get that done. With regards to trade with China, Trump is also right. China is not playing fair as it doesn’t allow American corporations like Google (GOOGL) and Facebook (FB) access to their markets. Chinese companies rip off American intellectual property and sell to their consumers. This is another area where Trump will have leeway to negotiate.

Where Trump will not have leeway in negotiating is monetary policy. Chinese SEOs are losing money. Capital is leaving China and its economic growth rate is slowing. The Chinese government needs to do whatever it takes to keep its bubbles from collapsing. I can see Trump getting mad China’s actions if they have repercussions on America, but China is simply trying to keep itself afloat. Some may say that since China is the second largest owner of U.S. debt that it has negotiating power with America. This is not the case because China cannot decide to hold a losing proposition as a negotiating ploy. If the economy was stationary and China was growing its economy faster, this could be done, but in the current environment it cannot. As the dollar rises, China may claim it is selling treasuries because of Trump’s policies, but that would simply be bluster.

Some sceptics of central banks are claiming the chart below, which shows relentless selling pressure of U.S. treasuries by foreign central banks, shows evidence that they are losing trust in America to pay the money back. I don’t think this is the case. While I could see a private individual selling treasuries because of the amount of debt America has, this selling is being caused by the global Jenga game. Central banks are the last institutions to lose trust in a government because they are part of the government themselves. You won’t find someone who is worried about having too much debt at the JCB or the ECB since they all have enormous debts themselves.

Just because the faith has not been lost doesn’t mean this selling is not a problem. Adding to this selling is the possibility of U.S. QE being unwound. While I don’t think the Fed will able to sell the bonds on its balance sheet, when it talks about the possibility of selling the bonds, as it is doing now, this makes private investors also want to sell them. Private investors were front-running the central banks when they were buying bonds, making yields go negative. Now they will try to front-run the bond selling. This will only cause yields to rise further. This threat of rising yields is why I don’t think the Fed will be able to sell them.

Conclusion

As the dollar rises, central banks around the world are selling treasuries. Yields will also be forced higher if the BOJ and the ECB taper their QE. Rising yields will cause U.S. government deficits to skyrocket. The deficit would rise about $600 billion if rates normalize. Imagine how high deficits would rise rates were above their long-term average. Rising rates are also bad for stocks as low rates are the reason investors are giving as to why valuations are so high now.