This Rally Still Has Plenty of Room to Run

Because the Bank of Japan has faced such strong political position at home to even one modest interest rate increase, the odds of the bank moving to shut down the carry trade are very, very small.

Second, overseas investors and central banks may be souring on U.S. Treasuries, with their relatively low yields, but they're not moving money out of dollar-based assets. Instead, the move is from Treasury notes and bonds into mortgage-backed securities, corporate debt and U.S. equities.

The central banks of China and South Korea have made that shift in policy clear -- well, as clear as central banks ever make anything -- in recent weeks. China's central bank will manage its assets more aggressively, the bank has said, in order to get higher returns. In addition, China's pension funds, banks and insurers will be able to invest abroad, the Beijing government has announced, and will be encouraged to seek out higher returns.

Without those higher returns, there is no chance that China's pension plans will be ready for the country's explosion of old people over the next three decades. (For more on China's demographic and fiscal crisis, see my column "China Wasting Its Huge Capital.")

Individual investors in Japan, too, have recently discovered a taste for higher returns. Kokusai Asset Management's overseas bond fund, for example, has become Japan's biggest mutual fund, and since 2005, individual Japanese investors have been able to buy, through the country's 24,000 post offices, investment trusts that own foreign stocks.

Still, Risks Abound

It's the shift in strategy by the central banks and pension funds of China and South Korea, rather than any move away from U.S. assets, that explains the December drop in net cash flows into the U.S. According to the U.S. Treasury, net cash flows were a negative $11 billion that month, meaning that U.S. investors bought more foreign assets than overseas investors bought in the U.S.