The bond bulls are back in the ascendancy. At one point this week, yields on 10-year government bonds in the US and Germany both traded below 4 per cent.
Such low yields suggest that investors are no longer worried about a resurgence in inflation. Indeed, they are more concerned about a slowdown in the global economy.
For some commentators, this will be confirmation of their belief that the global economy is in the icy grip of deflationary trends that resemble those affecting Japan in the 1990s.
For others, bond bulls have been deceived by a temporary "soft patch" in the US economy and will quickly have to retreat in the face of renewed evidence of stronger growth. Indeed, US 10-year bond yields moved back above 4 per cent later in the week as second quarter output numbers were revised upwards.
We can try to put this debate in context by taking, appropriately enough, the long view.
Yields of 4 per cent look pretty low by recent standards (there was a brief nadir of 3.1 per cent for US yields last year).
But in the light of the 20th century they do not look extraordinary.
US yields averaged less than 4 per cent in 34 of the years between 1926 and 1962, according to the Barclays Capital Equity-Gilt study. Only when inflation took off in the 1960s and 1970s were yields forced higher.
Thus, with inflation apparently conquered, it may not be surprising that yields are returning to levels regularly seen in the first half of the 20th century.
This, however, raises the question whether inflation really has been defeated. Until the 1930s, many countries were linked to the gold standard, which imposed severe constraints on inflationary pressures. Furthermore, governments generally attempted to balance budgets and did not indulge in Keynesian-style demand management. Nowadays, there are few restraints on the creation of credit and governments regularly run budget deficits.
The build-up of debt that has resulted from these trends presents the world's monetary authorities with a dilemma.
If the economy veers into recession, such debt may become a crushing burden. The problem is that the nominal value of debts is fixed, but the value of assets used as collateral to back those debts - and the income needed to service them - is not. The danger is widespread default and depression.
Central banks are keen to avoid those dangers; hence, the ultra-low interest rates maintained by the US Federal Reserve in recent years. Some critics argue that, because central banks will always attempt to head off a debt crisis by adding liquidity, inflation is inevitable in the long run. It is a more painless way of eliminating debt than depression.
Not so, say other analysts. Central banks will prove as powerless as the Bank of Japan in resisting the deflationary forces, among them the growing power of China and the impact of technology, that are affecting the world. As the inevitability of deflation becomes clear, bond yields will drift down below 2 per cent.
The debate is complicated at the moment by the interaction of the Treasury bond market, the US current account deficit and Asian central banks' foreign exchange policies. The wide US current account deficit is being financed not by direct investment in factories or by portfolio purchases of equities, but by central bank purchases of bonds. As the deficit rises, therefore, there is a need for central banks to make more purchases, and this is holding down bond yields.
So it is possible that US yields are being held artificially low. And, as Tim Bond of Barclays Capital points out, the mere existence of low yields helps to stimulate the US economy by allowing homeowners to refinance their mortgages at cheaper rates. The US Federal Reserve probably does not want this stimulus and may try to talk yields higher.
On the other hand, leading indicators for the US economy have been trending down, as have corporate profits forecasts. Dresdner Kleinwort Wasserstein says that, over the past month, US earnings optimism suffered its biggest fall in 20 years.
Andrew Smithers of the consultancy Smithers & Co argues that "below-trend growth needs a boost from fiscal or monetary policy if it is to reverse". But he points out that, in both areas, policy is being tightened. The Organisation for Economic Co-Operation and Development forecasts that the US's cyclically adjusted budget deficit will drop from 4.6 per cent of gross domestic product in 2004 to 3.9 per cent in 2005. Meanwhile, the Fed has pushed up interest rates three times since June.
The economy could still pick up if corporate investment grows sharply, if the savings rate falls again, if the rest of the world grows rapidly or if taxes are cut further. But Smithers thinks none of these possibilities is likely.
Clearly, a number of investors agree with Smithers' analysis, otherwise yields would not be where they are. In the short term, however, such yields leave little margin for error. Bond markets could be volatile in the next few months with any strong economic numbers prompting a sell-off.
But it still makes sense to own some bonds because it seems likely that growth will disappoint next year - and as a hedge against the grim scenario the deflationists are fond of describing.
At the same time, one should not discount, in the long term, the possibility that the inflationists might be proved right. So a holding in index-linked bonds should also be part of any cautious portfolio.
A real yield of 2 per cent may not seem very appealing. But any return that is positive in real terms will look very attractive if inflation picks up again.
Hedging against both possibilities might seem like dithering. But it is a mistake to be too dogmatic when constructing a portfolio. Bond investors have been caught out twice in the past 50 years, once by the arrival of inflation and then by its disappearance. It will take flexible thinking to ensure they won't get fooled again.