China just sent out a warning and it went right over Wall Street's head

• According to reports on Wednesday Chinese officials are thinking of stopping or slowing their purchase of US debt. That news roiled markets.
• The thing is, China would be hurting itself if it ever actually stopped its US bond buying.
• So why did China make this threat? Likely to intimidate the Trump administration ahead of key trade decisions, and emphasize the interconnectedness of the world's two largest economies.

China sent a warning to the US on Wednesday, and the message went right over Wall Street's head.

Here's how it all went down.

For the first time in what has been a roaring new year markets actually fell. US Treasury bonds spiked in the early morning, prompting a bond sell off. Then stocks fell. It was a tiny taste of the calamity analysts have predicted would foretell the end our current nine year bull run in stocks. And perhaps, some say, the 30 year bull market in bonds too.

The initial source of this micro disaster was a warning from Beijing. According to reports Chinese officials are looking at slowing or halting their purchase of US Treasury bonds. China is the largest holder of US Treasury bonds, and Wall Street figured that without its demand the price of bonds could fall - thus the Wednesday's market action.

But that's not the lesson to take from this scenario. Beijing's warning - and it was a warning - was directed more toward Washington than Wall Street. It was a message to the Trump administration as it considers trade action against China, and a proxy for decreased cooperation between countries, not a threat to fundamentally shift credit markets.

How do we know that? Because we know what would happen to China in the event that it really does begin a major US treasury sell off.

A massive sell off of US Treasuries would likely turn around and smack China in the face through its currency.

"Chinese holdings of US treasuries are quite large, but so is the market for these securities. If the Chinese were to engage in a sale of US treasuries sufficiently large to have a significant and enduring negative effect on price (and positive effect on yields), such a sale would also almost certainly have an effect on exchange rates since the Chinese authorities would presumably be selling dollar-denominated US Treasuries in return for their own currency," Professor Lee Branstetter, an economist at Carnegie Mellon told Business Insider via email.

And if China buys its own currency, the yuan, it will go up. That's not ideal for China's domestic economy. If the yuan is too strong it will hurt exports, which are still the brightest spot of the Chinese economy.

"In a nutshell, China cannot 'punish' the US without harming its own interests," Branstetter said. "Given their interest in maintaining economic growth and high employment, the Chinese are unlikely to actually follow through on any threat to dump treasuries."

Now, China could do something less dramatic - say, slow bond buying rather than cut it off completely. In that case, if China doesn't slow or cut off its purchasing enough, then it will just help the Fed's goal of getting interest rates higher, Branstetter also pointed out.

And: "It will modestly raise the price of Trump's larger deficits, but only modestly," he said.

Plus, a modest slow down of buying could also get soaked up by other buyers in the massive global credit market, making China's entire exercise all for naught.

All of this takes us to our original question: What was the point of China's warning in the first place?

The whisper from Washington is that sometime in the next week the Trump administration will announce trade measures against China.

Beijing is likely sending Washington a message about that - about how trust can erode on both sides, and that there are consequences when that happens. This treasury bond threat is a form of preemption, a reminder of the interconnected nature of the US-China relationship and the importance of cooperation between the two countries.

Since Trump was elected, Chinese officials have been quick to bring up this special relationship between the world's number one and two economies in a couple rare US interviews. These officials have been trying to remind the Trump administration that trade and markets are essentially run on trust and cooperation.

Here's what Chinese Foreign Ministry spokesman Lu Kang said in an interview with NBC around this time last year:

"Worldwide, people were interested in his slogan ... 'America First.' My personal opinion, it's fair for President Trump to place the American national interest at the top of his agenda. All the state leaders should put the interest of their people, their public at the top of the agenda. But the problem is that today's world is quite interdependent, countries are quite interconnected. So while trying to pursue the interest in your country you'll have to keep in mind the implications worldwide, and these kind of implications might come back to the policy issues at your own home."

Chinese officials warning about US Treasury bond buying should worry Wall Street, not because of what it means for markets, but because it means Beijing feels it is in a position where it has to make threats. That says a lot about the Chinese government's expectations for the trade decisions that will soon come out of the Trump administration.

For its part, China has always made clear that retaliation is on the table. And it has a lot to work with.

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