Yields on U.S. bonds are expected to continue to rise over the next few years in what some describe as a slow-motion, tai-chi bear market for bonds (alternatively called Chinese water torture).
"The financial markets realize the Fed will keep raising rates," Buntrock says, but every time that rates go up bonds don't necessarily behave by falling to the extent some expect. Moreover, U.S. interest rates have little correlation with foreign bonds, with which dollar-denominated debt must compete in global markets. Indeed, Jim Swanson, chief investment strategist at Massachusetts Financial Services, notes there is little correlation between a weak dollar and the path of interest rates.
Global bonds did not perform well in the late 1990s, but they have enjoyed two good years since late 2002. Buntrock says these cycles can often last six or seven years.
If the dollar is likely to continue to slide, what currencies are likely to rise? So far, the euro has been the big beneficiary, much to the dismay of government officials in Europe who fear their strong currency is only serving to stunt the growth of their already anemic economies. From a low exchange rate of 83 cents, the euro has climbed to $1.33, and one could argue it has already overshot fair value. "It's almost the rule that currencies overshoot," Buntrock says. "Asian currencies, including Japan, have more appreciation potential."
In fact, if the United States looks dubious thanks to its addiction to debt-financed growth, Europe's fundamentals don't give it the look of a better long-term investment. With 10% structural unemployment, labor-market rigidities, colossal social entitlement expectations and unrealistic pension obligations, Europe's problems would appear to be as severe as America's, even though its citizens are bigger savers. "Every estimate of European growth is being cut back." Buntrock says, adding that European bankers would like nothing more than to see the dollar fall.
Even though the Chinese yuan is pegged to the dollar, leaving China's economy in a neutral posture regarding the U.S. currency's direction, Asia's awakening giant and the rest of the region also have an interest in avoiding a doomsday scenario. For a nightmare scenario to unfold, China and Japan would have to make a conscious decision that they no longer wanted to hold devaluing U.S. securities and start dumping them aggressively. That would force the Fed to raise interest rates and push up yields, which could trigger an economic slowdown or recession in the United States.
In all likelihood, housing prices and financial asset values would decline dramatically. Under such circumstances, "they [Japan and China] could buy properties here very cheap, but it would come at a tremendous cost to their own economies," Buntrock says.
A major U.S. recession would slam-dunk Asian export-driven economies and send unemployment in the region through the roof. "Everyone is worried about big changes in [Asia's] central bank reserves," Buntrock says. "But historically, central banks are very slow-moving creatures. They are among the most conservative institutions in the world."
So that's not likely to happen. Still, something has to give. Tiny advanced nations like The Netherlands can run current account deficits for 300 years without destabilizing the global economy, but when the players are giants like America, China and Japan, these imbalances can't run forever.
And some of the current imbalances are feeding on each other. For instance, Swanson of MFS notes that when Japan and China keep buying U.S. Treasuries they keep interest rates artificially low, fueling the U.S. housing boom and the consumption binge.