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

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

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.

After all, it is the liquidity of US Treasury bonds that makes them the world s leading reserve asset.

Markets are now signaling that US Treasury bonds are much more valuable assets than they were a month ago.

Evidence that the inmates were running the asylum would almost certainly precipitate the wholesale liquidation of US Treasury bonds by foreign investors.

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

China may point to the mountain of US Treasury bonds that it has bought up, thereby helping to sustain America s budget deficit.

Chinese power today comes not from its ability to match America s blue water navy, but from its holdings in US Treasury bonds.

The downgrade could, moreover, force the US Treasury to raise the interest rate on new bonds, in which case China would stand to gain.

Above a certain limit, China s stockpiles of US treasury bonds imply welfare losses, not to mention the capital losses that the country almost certainly will suffer.

It naturally raises the question why aren t people moving their money from TIPS (and US Treasury bonds and other safe assets) to stocks (and other relatively risky assets)?

It has no choice the seven year notes are the shortest duration Treasury bonds that now pay interest.

Emerging market countries could also invest in euros, if only they were offered such liquid assets as US Treasury bonds therein lies the current debate over the proposed creation of eurobonds.

Back then, China bought US Treasury bonds to keep the currency from rising and eroding the competitiveness of Chinese exporters. As a result, it accumulated an astounding 4 trillion of foreign reserves.

So a marginal investor was willing to pay more than 15 more cash and more than 30 more equities for US Treasury bonds at the end of the month than at the beginning.

Finally, the yield curve did not steepen sharply for the United States federal funds rates at zero I expected, but 30 Year US Treasury bonds at a nominal rate of 2.7 I did not.

Essentially, by buying long term Treasury bonds from private investors portfolios, the Fed hopes that these investors will rebalance their portfolios.

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

But it is exposed to other risks, especially if it confines its investments to that slice of the asset pool, US Treasury and high grade corporate bonds, that American politicians are comfortable having foreigners own.

The low interest rate on long term Treasury bonds has also boosted demand for other long term assets that promise higher yields, including equities, farm land, high yield corporate bonds, gold, and real estate.

The current small difference between the real interest rate on such bonds (2.1 for 30 year bonds) and the nominal interest rate on conventional 30 year Treasury bonds (now 4.6 ) implies that the market expects only about 2.5 inflation over the next three decades.

The very low interest rate on long term United States Treasury bonds is a clear example of the current mispricing of financial assets.

Needless to say, these surpluses reflect a gross misallocation of resources. Above a certain limit, China s stockpiles of US treasury bonds imply welfare losses, not to mention the capital losses that the country almost certainly will suffer.

Commercial institutions like banks also bought billions of dollars of bonds and other treasury paper, holding more than 24 billion at the war s end.

China s official foreign reserves are increasing at a rate of about 1 billion per business day, almost all of which is used to buy US Treasury bonds and other international assets that carry a minimal rate of return.

Inflation in the US or Europe would reduce the purchasing value of the dollar bonds or euro bonds.

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

Quantitative easing is scheduled to end in June 2011, and the Fed is not expected to continue its massive purchases of Treasury bonds after that.

That is an extraordinary gap in the returns that you can reasonably expect. It naturally raises the question why aren t people moving their money from TIPS (and US Treasury bonds and other safe assets) to stocks (and other relatively risky assets)?

That may sound extreme, but some scholars, such as the 2004 Nobel Prize winner Ed Prescott, have shown that, historically, holding a large diversified portfolio of stocks long enough is generally a far better investment than ultra safe US Treasury bonds.

Some contend that large fiscal deficits do not matter if the US can exploit its central position under the dollar standard that is, if it finances its deficits by selling Treasury bonds to foreign central banks at near zero interest rates.

In the US, the interest rate on government bonds now rises from 1.80 at five years to 2.86 for 10 year bonds and 3.70 for 30 year bonds.

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.

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.

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

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

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

Let's break their bonds apart, and cast their cords from us.

This could happen for two reasons. First, investors, recognizing that the dollar is overvalued and that they are likely to suffer large losses when it returns to its fundamental value, could start selling their Treasury bonds, corporate bonds, and mortgage backed securities.

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.

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.

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