The gloom and doom folks must have been pretty annoyed that America was so successful in selling 30-year bonds a couple of weeks ago. After all, if the country’s finances are really in such a mess, who would be lining up to buy such long-term commitments? One could view the sale, which was oversubscribed by a factor of 2, to be a huge vote of confidence.

But, no. There’s always a dark side, and in this case there was almost immediate hand-wringing about the flattening of the yield curve. It is a near-gospel credo that “a flat yield curve is always followed by a recession.” This observation has been oft repeated and seldom explained. Is it possible that the entire economy rests on a “carry”? That the profitability of all of industry depends on borrowing short and lending long? As it turns out, few people seem to know why there is this connection, and fewer still who concede its validity.

First, a definition. According to Jack Lavery, head of Lavery Consulting, “When the Federal Reserve talks about the yield curve, it is referring to the spread between the federal funds rate and the 10-year bond.” An inverted yield curve simply means that the return on short-term instruments is higher than that available on long-term bonds.

Today, for instance, the yield on three-month Treasuries is 4.4%, compared to 4.55% on 30-year bonds. That’s remarkably little premium for such an extended maturity. Normally, people expect to be paid more for locking up their money for a longer period of time and to be compensated for the perceived higher risk of an obligation that will not be repaid for 10 or 20 years.

Ed Hyman, head of ISI Group and Wall Street’s leading economist, observes that the yield curve should be viewed as incremental. That is, a sharply negative curve is much worse than a flattish curve, which is what we have today. On the other hand, a steeply positive curve is indeed bullish. In other words, “the yield curve phenomenon is not like Anthrax, where you have it or you don’t. It’s a matter of degree.”

Today’s flattish curve argues for a slowdown, which is generally anticipated, but not for a recession. Mr. Hyman points out that the new Fed chief, Ben Bernanke, dismissed the flat yield curve as immaterial during his confirmation hearings. That says a lot, since Mr. Bernanke is unquestionably a monetarist.

Having said that, Mr. Hyman suggests two reasons why the flattening or inversion of the yield curve impacts the economy. First, banks don’t do well when rates are higher on the short end than on the long end. Banks typically borrow short to lend long. Consequently, banks are likely to become less aggressive lenders with an inverted curve, and pull in credit.

Second, there is a “mystical” effect, to use Mr. Hyman’s word, having to do with inflation. Long rates are typically viewed as a proxy for consensus inflation expectations. Fifteen years ago, when long rates were more than 10%, investors expected inflation to remain a serious concern.

Today, with long-term rates at 4.5%, investors are recognizing that there are few reasons to be concerned about inflation. “Short-term rates are determined by people,” Mr. Hyman says. “Somehow, long-term rates are thought to be determined by economic gods, who know more than we do.”

Is this cycle typical? Are the economic gods not concerned about our “twin deficits”? Many observers, including Mr. Hyman and Mr. Lavery, think that the impact of globalization is increasingly being felt in long-term credit markets. There is universal acknowledgement that the world is awash in liquidity, and that funds are easily sloshing between markets, seeking to maximize returns.

Astonishingly, our long-term rate of 4.5%, which seems so low, is the highest of any of the G-7 countries. Consider: Our 30-year bond is selling at a higher yield than France (3.8%), Germany (3.8%), or certainly Japan, where the 30-year bond is yielding 2.2%. The average yield spread between Treasuries and the debt of developing countries is at a record low, at 1.85 percentage points. This compares to a spread of 11.2 percentage points in November 2001.

Why is our yield relatively high? Probably because our country has had the highest growth rate, which might bump inflation up a notch or two. Or because the “twin deficits” might mean some currency erosion over time.

What does this mean to investors? In the short term, according to David Coard, head of the fixed income desk at Williams Capital, “The trend is your friend.” He and his clients have been selling short short-term securities such as two-year Treasuries and buying longer-term paper. This has been a workable strategy for some time, and may continue. In his view, even if yields go up they won’t rise as quickly on the long end as in the short side of the market.

Longer term, Mr. Hyman asserts that high liquidity levels worldwide will mean generally lower investment returns. This is a connection most investors have not come to terms with. Buyers willing to be paid 4.5% on 30-year paper are conceding that those returns will be hard to beat. Mr. Coard was not at all surprised by the success of the 30-year bond sale. “We haven’t had one in five years. There’s lots of cash around. Also, there are some natural buyers, such as insurance companies and foreigners looking for a safe haven.”