The obvious candidate for this reserve fund was US Treasury bills.

China is second only to Japan in its holdings of US Treasury bills.

Chinese investments increasingly took the form of official purchases of US Treasury bills.

When China buys US Treasury bills, who depends on whom? Exchange generates interdependence.

Many foreign leaders quickly switched from schadenfreude to fear and to the security of US treasury bills.

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

First, there are limits to how many trillions of dollars China can, and should, put into US Treasury bills.

Better to keep socking away US Treasury bills, even if the return is far lower than on most other investments.

The result is that China and other East Asian countries own a large and growing stock of US Treasury bills.

The only slight difference is that the Fed is buying seven year Treasury notes rather than three month Treasury bills.

Many know that interest rates on three month US Treasury bills became slightly negative in September 2008 for the first time since 1941.

In order to meet his obligations to the option holders if it occurs, he parks the 100 million in one year US Treasury bills yielding 4 .

They obviously still regard US Treasury bills as a safe haven and the dollar as the top international currency, especially given the absence of good alternatives.

During the 1950 s and 1960 s, Europeans amassed a huge stash of US Treasury bills in an effort to maintain fixed exchange rate pegs, much as China has done today.

Advertising and printing bills, electric bills, insurance bills, hotel bills.

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.

Floating exchange rates were supposed to prevent countries from manipulating their currencies, but, by accumulating large quantities of US treasury bills, East Asian countries, especially China, kept their exchange rates artificially low.

After all, higher private consumption implies an end to China s surplus saving and thus to the seemingly open ended recycling of that surplus into dollar based assets such as US Treasury bills.

Having already officially hit the ceiling, the Treasury is moving money around and tapping various pots of unused funds to pay its bills.

After all, why should the central banks of China, Japan, South Korea, and other Asian countries accumulate vast holdings of US Treasury bills if the dollar is likely to lose value in the years ahead?

But for countries that have scope to invest more, particularly those that are holding a surfeit of precious development dollars in idle US Treasury bills, the time may be ripe to reassess the balance of risks.

But 50 bills are 50 bills.

The result is that China and other East Asian countries own a large and growing stock of US Treasury bills. Through financial intermediation, these government securities helped finance the western consumption and speculative boom that collapsed in 2008.

Making matters worse, when China needs to use its savings accumulated over two generations and packed into US Treasury bills to alleviate fiscal constraints, it will find that the value of its foreign exchange reserves has already evaporated.

There was a time when privatization allowing individuals to set up individual savings accounts seemed better than Social Security, which invests in lower yielding Treasury bills.

He parks this 10 million in Treasury bills, too, and sells another 10 million options. This nets him another 1 million, which he uses to cover expenses.

In earlier decades, countries held dollars because they needed to have a highly liquid and widely accepted currency to bridge the financing gap if their imports exceeded their exports. The obvious candidate for this reserve fund was US Treasury bills.

Whenever a crisis erupts, the value of US Treasury bonds gets a boost.

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

So that's two 1 bills. That's two more 1 bills. And then that's two more 1 bills.

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

Drafting bills

So that's two 10 bills and then six 1 bills.

Treasury

Treasury

Wall Street might have survived, and US taxpayers might have been spared even larger bills.

Indeed, China frets over the safety of the US Treasury bonds that it holds.

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

Today, the US Treasury can still borrow unlimited amounts at rock bottom interest rates.

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

Then US Treasury Secretary Hank Paulson sought a bazooka during the 2008 financial crisis.

But the growing risk associated with US Treasury bonds should prompt China to reduce its holdings of US debt.

US budget deficits as far as the eye can see might excite fear of losses on US Treasury bonds.

It would finance the purchases by issuing European Treasury bills joint and several obligations of the member countries and pass on the benefit of cheap financing to the countries concerned.

(What China s recent sell off of US T bills will mean is, for now, anyone s guess.)