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: year. Many developed economies are in recession and the consensus expects 2009 to see falling output in America, the euro zone, Britain and Japan.

“Global bond yields are sure to be much higher in five years than they are today, but this does not imply that the market currently is in a bubble,” says Martin Barnes of Bank Credit Analyst, a research group. “The economic backdrop will remain bond-friendly for at least the next six months.” This leaves investors with a dilemma. In the short term, they may like government bonds for the security they offer. Treasury bonds outperformed the S&P 500 index by an incredible 53 percentage points last year. But if yields are heading back to 4-5% (or even higher) by 2011 or 2012, at what point do they sell? The rational investor would want to get out of the asset class before the herd decides to do so. The logical extension of that argument (assuming most investors are rational) is to sell now.

But what if Japan provides the template? Many people thought Japanese bonds were overpriced when yields fell to 1-2% in the late 1990s. They have stayed around that level for the past decade, despite a vast amount of issuance (at $8.7 trillion, according to Bloomberg, the Japanese government-bond market is the biggest in the world). Even the expected $2 trillion of American issuance this year will leave its debt well below Japan’s. The crucial difference, however, is that Japan has been running current-account surpluses, not deficits. The Japanese owe the money to themselves whereas the Americans are in debt to foreigners. Such investors could lose twice over: yields could rise and the dollar could depreciate.

For the moment, the balance is maintained by what Nick Carn of Odey, a hedge-fund group, calls “mutually assured destruction”. If overseas investors seek to sell their bonds, they will not only ruin the American economy but the value of their existing portfolios as well.It is a precarious balance. It may well hold through 2009 and even 2010. But at some point, government bonds will surely suffer a horrendous bear market.