Malkiel: Don’t Get Buried By Bonds

July 30, 2012

Bond investors need to understand the dangers of what awaits them when low rates run their course, indexing legend Malkiel says.


Burton Malkiel, author of the seminal work “A Random Walk Down Wall Street,” is just about the biggest star the world of index investing has to offer. He’s also associated with AlphaShares, the firm that markets investable indexes based on China. But when Managing Editor Olly Ludwig visited with Malkiel recently, they didn’t talk just about China. Malkiel also shared his skepticism about the eurozone, his unflappable belief in the superiority of indexing and, most tangibly, about the dangers of bonds as the current low-rate environment ends.


Ludwig: A lot of people are talking about slowing growth in China and wondering if the good old days of stellar growth are over. What’s your reaction to that sort of concern?

Malkiel: Well, here you have an economy that is slowing down, there's no question about that. But when the economy slows down from 10 ½ percent real growth to 8 percent—or, let’s say we’re really pessimistic and say 7 to 7 ½ percent—we wring our hands and say, “Oh my God, China is crashing.” It’s the only place in the world where a crash is considered a slowdown in growth. Growth is slowing down. There's no way that China could possibly continue to grow at double-digit rates.

But China is still growing more rapidly than any other major country in the world. What people don’t appreciate is that if growth threatens to slow to low single-digit rates, then China has the wherewithal to do the kind of stimulus that other countries can't do. They have a debt-to-GDP ratio of 16 or 17 percent, and they also have huge foreign reserves.

Ludwig: There are those who say China shouldn’t be loosening now, that they have an inflation problem and that by loosening monetary policy it’s going down the same path as some of the developed countries.

Malkiel: That’s just not true. The inflation rate, which last year had been 6 percent, is now closer to 2 percent, and is in fact now well under control. Inflation is not a problem at the moment. In fact, the place where they did have inflation was in real estate prices. And they have been coming down.

Ludwig: OK. What about China’s water issues? A lot of the country is arid, even outside of the Gobi Desert. What is your view about that being a structural problem that may prove quite difficult to address and work through?

Malkiel: No question about it: China, thus far, is raw-material poor and definitely water-poor. It is a structural problem. China is going to have to import a lot of its food. The Chinese are not going to solve the water problem themselves, just as they're importing a good deal of their raw materials.

You saw that CNOOC bought a Canadian oil company. They have also been making investments in places like Brazil and Africa to assure themselves of the food supplies that they’ll need as well.

So you're absolutely right. They aren't going to solve those things and become self-sufficient in either raw materials or food. But that doesn’t mean that they can't, in a global economy, acquire those things fairly easily.

Ludwig: Now with regard to gold, China has become the biggest gold-producing country in the world. What are they doing with all that gold?

Malkiel: I'm not a gold bull, but if you want to be a gold bull, as China and India become wealthier, their people will demand more gold. That’s how people have saved there.



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