Although the US is home to the single largest bond market, the size of the global bond market has exploded over the past three decades, with non-US bonds making up more than half of the $67 trillion global pie.

Investors can now pick up emerging market sovereign debt, corporate bonds from South America or global inflation-protected bonds almost as easily as they can buy a US Treasury bond. As a result, we can find ample opportunities outside of our own markets.

That’s fortunate for investors, because the US Federal Reserve has maintained an effective zero percent interest rate policy and is embarked on its third round of quantitative easing (QE3). Thanks to the Fed’s machinations, if you purchase a new 10-year Treasury bond today you’ll receive a yield of just 1.64 percent—an all-time low—while a 30-year Treasury yields just 2.83 percent.

Those paltry yields on US sovereign debt come despite the fact that our country is running a stunning deficit with total outstanding government debt of just over $16 trillion. At the same time, the Fed has seen the assets on its balance sheet balloon from about $900 billion before the financial crisis to almost $3 trillion today (see graph, below).



Our overall debt-to-gross domestic product ratio currently stands at 101.5 percent. I’m not passing judgment on the fiscal and monetary policies that have led to our nation’s indebtedness; politicians on both sides of the aisle and economists of all persuasions have contributed to this situation. But the simple fact is that most other countries find their bond markets punished when fundamentals have deteriorated to these levels.

Prior to the Great Crash of 2008–2009, global confidence in the US dollar was steadily eroding. The graph below shows the US Dollar Index which tracks the value of the dollar against a basket of global currencies. After peaking at 120 in early 2002, the index value had plunged to 72 by mid-2008, as the government continued to run a growing deficit despite our country’s economic strength.



However, over the past four years the US has made some gains in fits and starts. As fund guru Bill Gross likes to say, the US has the cleanest “dirty shirt.” Although US dollar fundamentals have actually deteriorated over the past few years, the greenback has maintained its safe haven status, driving the extreme demand we’ve seen for US Treasury bonds, which have been among the best performing asset classes since the start of the crisis. Over the past three years, long-term Treasury bonds have outperformed the S&P 500, despite the bull market in equities.

The Treasury party can’t last forever, though.

Let me be clear: I’m not predicting the outright collapse of the US dollar any time soon. With $10.3 trillion of US currency in circulation as measured by M2—a figure which includes coins and currency and “near money” such as travelers checks and bank deposits—the US dollar is simply too embedded in the global financial system to experience a total loss of confidence.

Moreover, I see little chance of a real versus technical default on US debt, if for no other reason than we always have the power of the printing press to make good on what we owe. That wouldn’t be a popular solution for our debt problem but it would get the job done.

Our problems still pale in comparison to the continuing European debt crisis. For more than three years, every time the European Union (EU) has taken one step forward it seems to take three steps back, making little progress in addressing its huge debt burden.

While the EU has made progress with the introduction of its European Stability Mechanism to help ailing banks, so far its talk of greater regional fiscal unity has basically been just that. So many details remain to be worked out that even the EU itself seems largely pessimistic, cutting its own internal growth forecasts for this year and next as the debt crisis continues to choke off growth.

But the US isn’t immune to similar setbacks. In August 2011, Standard & Poor’s cut the US sovereign credit rating from AAA to AA+ as Congress brawled over whether to raise the nation’s debt ceiling. Although the US borrowing limit has been increased more than 100 times without incident since it was established in the early 1900s, last year both Republicans and Democrats played a political game of chicken over the issue.

While US Treasury prices barely registered a blimp, the value of the dollar took a temporary dive as the markets digested the event. The impasse was ultimately breached when it became clear that neither side was winning the public relations war ahead of this year’s elections.

US Treasury officials say that America will once again bump up against the debt ceiling sometime in late December or early January. With voters on Novmeber 6 essentially maintaining the status quo in Washington, it seems likely that we’ll see a drama similar to 2011 unfold.

In addition, the new Congress will have to contend with the “fiscal cliff,” about $500 billion in automatic tax increases and spending cuts, set to take effect in January. Mandated by the Budget Control Act of 2011, automatic cuts in a number of programs near and dear to Democratic and Republican hearts such as defense and health care spending are on the table.

Few political watchers express confidence that Congress will reach a meaningful compromise on the fiscal cliff and most predict that lawmakers will kick the can down the road—again.

Even if Congress sets partisanship aside when dealing with the fiscal cliff, tackling both entitlement and tax reform in one shot is likely to prove too much to bite off at once, because the two sides are so far apart on both issues.

If Congress doesn’t rise to the occasion the dollar is likely to see another erosion of confidence, especially since there are in fact a number of “clean shirts” in the world. Investors don’t have to settle for a few stains here and there, thanks to the less blemished growth in foreign bond markets.

To find out more about those clean shirts, see this issue’s “Stock Spotlight.”