The US government should take inflation into account in deciding the return of its Treasury bonds, a former top Chinese official said.

"The US should link the earnings of government bonds with inflation to protect the interests of international investors, including Asian nations," Zeng Peiyan, former Chinese vice-premier, said at the Boao Forum for Asia over the weekend. Zeng now heads the newly established China Center for International Economic Exchanges, a top government think tank.

China's foreign reserves, at US$1.95 trillion, are the world's largest. Seventy percent is held in US dollar-denominated assets such as Treasury bonds.

Zeng said the US Federal Reserve's recent purchase of its Treasury bonds, which effectively prints new money, is likely to turn the budget deficit into inflation. That will lead to the depreciation of the US dollar and cause a major loss in China's foreign exchange reserves.

"The depreciation of the dollar has become an inevitable historical trend," Zheng Xinli, vice-president of China Center for International Economic Exchanges, said at the forum. "Countries with considerable holdings, such as China, India, Japan and South Korea, should join hands to demand that the US make commitments to peg the value of US Treasury bonds to the inflation rates of the US dollar."

Zheng said if the US government promises to do so, it will help reduce the concerns on the losses due to the depreciation of the dollar and allow the US government to continue its borrowing from abroad, which is important for its economic recovery.

"That's a very wise idea," said John Rutledge, former economic advisor to US presidents Ronald Reagan and George H. W. Bush. "Today there is a danger of an American inflation and currency drop. China can essentially trade its treasury bills for indexed treasuries that already exist."

The US Treasury started to issue inflation-indexed bonds in 1997.

The principal of such securities is adjusted to the consumer price index, a common gauge of inflation. While the coupon rate stays constant, it generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation.

China is now the largest foreign holder of US Treasuries and its holdings rose 0.6 percent to US$744.3 billion in February.

Recent figures show China's purchase of US government debt has slowed and is shifting to short-term Treasury bills due to concern over the shaky prospect of the dollar.

Premier Wen Jiabao said in March he is worried about the safety of China's investment in US dollar assets.

Zhou Xiaochuan, the central bank governor, also proposed replacing the dollar with the International Monetary Fund's Special Drawing Rights, a currency basket of the dollar, the Japanese yen, the British sterling and the Euro.

(China Daily April 20, 2009)