Moreover, the US government provides a very good inflation hedge in the form of Treasury Inflation Protected Securities (TIPS).

That expected inflation rate is consistent with the difference in interest rates between ordinary US government bonds and Treasury Inflation Protected Securities.

For example, the US government should offer more financial instruments like Treasury Inflation Protected Securities (TIPS), thereby allowing China to convert some of its holdings of US government securities into similar but safer assets.

Looking forward, investors can protect themselves against inflation in the US by buying Treasury Inflation Protected Securities (TIPS), which index interest and principal payments to offset the rise in the consumer price level.

The long term nominal and real Treasury rates continue to be absurdly low, so much so that I rub my eyes whenever I see them. And the market inflation forecast the spread between Treasury Inflation Protected Securities and normal Treasuries remains extremely tame.

Because the inflation rate is also about 2 , this implies a negative real interest rate, which is confirmed by the interest rate of 0.6 on ten year Treasury Inflation Protected Securities (TIPS), which adjust interest and principal payments for inflation.

Inflation protected securities are now being sold at negative yields for the first time ever.

BERKELEY The S P stock index now yields a 7 real (inflation adjusted) return. By contrast, the annual real interest rate on the five year United States Treasury Inflation Protected Security (TIPS) is 1.02 .

China and Hong Kong are the largest net purchasers of US Treasury securities.

Frustrated investors would then dump their US Treasury securities. Bond yields would shoot up.

But interest rates on US Treasury securities are very low and are not rising.

(a) A significant number of large pension funds have investments in the following additional asset classes inflation protected securities, high yield bonds and alternative investments (e.g., hedge funds, commodities, forestry and private equities).

They buttress their argument that the deficit is not an immediate problem by pointing to very low interest rates on long term government debt, with a 2 yield on the ten year Treasury bond and a negative real interest rate on Treasury inflation protected bonds (TIPS).

As they absorb their losses on US treasury and agency securities, capital flows toward the US will diminish.

China is worried that its more than 1 trillion investment in US Treasury securities will not hold its value.

But hoarding international reserves, mostly in the form of low yielding short term US Treasury securities, is expensive and inefficient.

What happened next, of course, was that the dollar strengthened sharply, as investors, desperate for liquidity, fled into US Treasury securities.

If interest rates on US Treasury securities were high and rising rapidly as the debt grew, I would agree with this argument.

For several reasons, it should buy US treasury securities. In other words, it should go back to intervening in the foreign exchange market.

The result is, of course, paradoxical private funds that flow into these countries are recycled into US Treasury securities via investment of accumulated reserves.

The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief.

Indeed, the rate on inflation adjusted US Treasury bills (so called TIPS ) is now negative up to 15 years.

Since the end of August, when Fed Chairman Ben Bernanke argued for another round of QE, the dollar has plunged more than 7 against a basket of half a dozen major currencies. Inflation protected securities are now being sold at negative yields for the first time ever.

It found these in the US, mainly in the form Treasury and other government backed securities, in turn pushing other investors into more speculative investments.

Indeed, the interest rate on inflation protected bonds has now become 0.5 , even for a five year maturity!

In 1985, the interest rate on ten year Treasury bonds was 10 , even though inflation had declined to less than 4 .

The better known consequence has been deepening uncertainty about the US dollar, the main global reserve currency, and US Treasury securities, supposedly the world s safest financial asset.

America absorbs Chinese imports, pays China in dollars, and China holds dollars, amassing 2.5 trillion in foreign exchange reserves, much of it held in US Treasury securities.

The Fed bought more than 2 trillion of Treasury bonds and mortgage backed securities, nearly ten times the annual rate of bond purchases during the previous decade.

The Fed is buying Treasury bonds and long term mortgage backed securities at a rate of 85 billion a month, equivalent to an annual rate of 1,020 billion.

The securities are hard to value but the sellers know more about them than the buyer in any auction process the Treasury would end up with the dregs.

When the Fed buys Treasury bonds or other assets like mortgage backed securities, it creates reserves for the commercial banks, which the banks deposit at the Fed itself.

Comparing these interest rates with the yields on government inflation protected bonds shows that the corresponding implied inflation rates are 0.9 for five years, 1.3 for 10 years and 1.7 for 30 years.

Investment pooling has permitted Treasury to limit very short term deposits to approximately 20 to 25 per cent of investments, allowing the remainder to be held in marketable fixed income securities.

If this nightmare comes true, China s packed savings in the form of US government securities (which now amounts to some 900 million in Treasury bills alone) will simply go down the drain.

In the first four months of this year, China added 44.3 billion of US Treasury securities to its reserves, meaning that such debt now accounts for 38 of China s total foreign exchange reserves.

NEW HAVEN Real long term interest rates that is, interest rates on inflation protected bonds have fallen to historic lows in much of the world.

Financial firms sell assets, like Treasury bonds or real estate securities, for cash, and promise to buy those assets back (i.e., to repurchase them or, for short, to do a repo ), typically the following day.

Insecure Securities

But, according to US Treasury data, China s holdings of US government securities totaled 1.16 trillion at the end of 2010, accounting for roughly 60 of the overall increase in foreign official holdings of US government debt.

At the moment, the yield to maturity of the ten year US Treasury bond is 3.76 . Subtract 2.5 for inflation, and you get a benchmark expected real return of 1.26 .

At the moment, the United States Treasury can borrow at a real interest rate of zero for five years and shove the entire five year inflation risk onto the lender.

To be sure, investors would have then lost on their bet on Argentina s growth, but they would still have been protected against inflation, even if their bonds had not been denominated in dollars (because Argentina s nominal GDP would have moved up with inflation).

(iv) Treasury

Securing Synthetic Securities