US trade tariffs: What if China and Canada retaliate by withdrawing investment?

While the United States has kickstarted what could turn into a global trade war, its current economic situation is akin to that of a volcano that can erupt at any moment. Because if the countries that the US is initially targeting — China and Canada in particular — decide to retaliate by withdrawing their investment in American treasury bills (T-bills), the US economy may end in major trouble.

According to Nukta Research, foreign ownership of US T-bills has reached $7.6 trillion, where these foreign-held treasuries have a weighted average maturity of 6.3 years and the vast majority or 97% are in the form of long-term treasuries.

The latest data reveals that China holds around $816 billion worth of US treasury bills while Canada has around $336 billion. Other countries in the top five list are Japan with $1,136 billion, United Kingdom with $679 billion, and Luxembourg with $370 billion.

Countries had already figured out even before Donald Trump won the election that following his appointment as president, harsh measures would be imposed, which would shake the economic landscape.

Japanese investors sold a record $61.9 billion of US government securities in the three months ended Sept. 30, data from the US Department of the Treasury revealed. Meanwhile, Chinese investors offloaded $51.3 billion during the same period, the second biggest sum on record.

The return on treasuries peaked at a 2.5-year high in mid-September before the Republican Party gained control of both Congress and the White House. The securities have since dropped almost 4% from that level on concern Trump's low-tax, high tariff policies will stoke inflation.

According to the US debt data, total debt as of Feb. 4 accounted for nearly $36.435 trillion while debt per head as per the population stood around $107,100 per person and nearly $323,046 per taxpayer.

What would happen if T-bills investment is withdrawn?

Higher cost of borrowing

If there is a mass sell-off in T-bills, it would drive the market down and push yields, leading to a higher interest rate regime.

The US government relies on low borrowing costs to finance its massive debt and a rise in the yields would make them costlier, which would strain government finances and potentially lead to a "shut down".

The higher interest payments would also force the US government to spend more on interest payments instead of public programs.

Stock markets in crisis

Rising bond yields make equities less attractive, as investors shift money from stocks to higher-yielding bonds. Market panic could trigger a sell-off in the S&P 500, Dow Jones, and Nasdaq, leading to a major correction or even a financial crisis.

The Federal Reserve could intervene to buy back treasuries to stabilize the market, raise interest rates more slowly or even cut them to prevent an economic slowdown.

Acceleration in de-dollarization

The U.S. is still the world’s largest economy and the dollar remains the world’s primary reserve currency.

However, a large-scale sell-off by China and Canada could accelerate global de-dollarization efforts, making countries more wary of relying on U.S. debt. This means countries may start using currencies other than the dollar for trade.

Lower growth

If the tariffs remain, they will trim 0.36 percentage points from U.S. GDP growth over the next 12 months, according to RSM’s modeling.

"Even though Canada and Mexico have promised retaliation, we anticipate that the disputes with those two nations will be resolved in the near term, though the standoff with China will last longer. If there is no resolution, the impact on the U.S. economy will be significant," according to an analyst at a leading brokerage in London.

"Growth will slow notably from the 2.9% average over the past three years as inflation and interest rates rise. The yield on the 10-year treasury, currently around 4.5%, could climb to a range between 4.75% and 5%. At stake is about $1.323 trillion in trade imports that come from China, Mexico and Canada, accounting for 43% of U.S. imports and 5% of the $27 trillion U.S. gross domestic product."

The new import taxes will increase the average tariff rate from its current level of 3% to 10.7% based on contemporary trade pattern, he added. "Should the trade skirmishes escalate to include the European Union and turn into an all-out trade war, expect U.S. economic growth to ease back to 2% as the tariffs drag down growth and employment, stoke inflation and widen the current account deficit, all amid higher interest rates. A recession, though, is unlikely this year," the analyst stated.