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Bootle: Long Haul to Recovery for Developed World

Interest rates may continue at low levels for quite awhile with deflation being a live risk, says Roger Bootle, author and managing director of Capital Economics.

Holly Cook: Hello. I'm Holly Cook for Morningstar. Joining me today is Roger Bootle. He's managing director of Capital Economics, and he's recently authored a book called "The Troubles with Markets."

Roger, thanks for joining me.

Roger Bootle: Pleasure.

Cook: So let me start first with the developed economies. We're no longer in recession, but we've clearly got a long, hard slog ahead of us. With the Fed recently having announced a second bout of quantitative easing, the U.K. government recently unveiled its austerity plans. What's your outlook in general for the developed areas?

Bootle: I think it's pretty grim actually. I suspect it won't be a double dip recession, but I think it's going to be a long haul to crawl out of the pit that we fell into after the financial crisis. Balance sheets are still very weak for consumers in America, and much of the Anglo-Saxon world. Governments of course are in deep trouble. In a number of countries, they're having to announce and implement austerity programs. I just don't see that these countries are in a position to generate much by way of domestic demand.

If there is to be a strong revival in this part of the world, I think it's got to come on the back of exports, and for that to happen, collectively, then the countries of the emerging market world have got to expand domestic demand, and change their exchange rates. If they do that, then I think you can then start to get quite optimistic about the developed world.

Cook: So you mentioned the emerging markets there. Obviously, they don't have the burden of balance sheet repair that needs to happen in the developed economies. What's your general outlook for that region?

Bootle: On the whole, those countries look as though they are going to grow very rapidly. China, for instance, I think, will probably continue to grow at something like about 9% or 10% for the next several years, unless there is a breakdown in the open international trading system, which I think could happen because American patience is running out, I think, with Chinese authorities. But just putting that to one side, I think the outlook for most of the emerging market world is really extremely good, rapid growth in East Asia, much of Latin America doing pretty well. Just about everywhere, actually, in the emerging market world is a completely different condition from the developed world.


Cook: Then going back to the developed world, and homing in on Europe, we've had a brief rest from headlines about sovereign debt crisis, but recently Ireland has come back home to the headlines. What's your outlook for the future of the Eurozone? Do you think there is a possibility we may go into two-tier system at some point in the future?

Bootle: I think the Eurozone is in fundamental crisis, and I've said this for a long time. The crisis won't go away as a result of some sort of temporary bailout package. It may well be that the panic that's gripped markets recently will subside, but I don't think investors should be fooled by that.

There is a fundamental problem, which is to do with both the heavy indebtedness of some members of the Eurozone, but also the lack of competitiveness of peripheral countries, and dealing with those two together is going to be extremely difficult. It may well be that one or other of the peripheral countries will default in the not-too-distant future. I think there is a pretty good chance of that, but that won't solve the competitiveness problem. How are they going to get back to reasonable rates of economic growth, because without economic growth, they will not be able to solve their financial problems. I think, and I've believed this for some time, that there is a pretty good chance that one or more countries will end up leaving the Eurozone.

Cook: And you mentioned as countries are attempting to get out of this crisis, there's been a lot of talk alongside that about the risk of inflation and how should inflation-proof your portfolio, but then there's also another school of thought that seems to think that the main risk is actually deflation. Which to you is the greater threat?

Bootle: I'm a deflationist. I think that the world is in difficult state with regard to demand, the level of demand. Of course, there has been deflation in much of the developed world in America. There was deflation in the CPI measure last year. Japan, of course, is continuing to experience it. Many countries in Europe have been experiencing deflation. With regard to going forward, I think the people who are really worried about inflation are worried about it primarily because of what has happened with regard to policy. Quantitative easing unnerves them. The idea that central banks can be printing large amount of money, I think, readily leads to the suspicion that this is going to end in inflation. Indeed, inflation is the intention of the policymakers, and I think that view is wrong.

I also think it's wrong that it's bound to lead to inflation in the end, because although if you like the official money supply, the liabilities of the central banks, that's going up quite rapidly as central banks are engineering this policy, but nevertheless the overall money supply is not going up; in fact in some countries in the West, it's static or even falling. Moreover, central banks can reverse the policy of quantitative easing as and when it becomes necessary. So I think that danger is much overblown.

On the other side of the account, the risk that we could end up in a situation very similar to Japan in the 1990s is, I think, this is a live risk. Demand very weak, wage increases, salary increases are extremely low in most of the developed West--difficult to see where the demand comes from. I suspect that as and when commodity prices stop going up rapidly and oil prices stop going up, I think we could readily fall into a deflationary position.

Cook: So you just mentioned commodity prices, and gold recently hit yet another record high. It does seem to be still being used in its traditional role as a safe haven by investors. Do you think that we're set for increasing highs or is that going to level off at some point?

Bootle: I don't understand gold, and I recognize it as a sort of pseudo-currency, and as such I think it has profound psychological characteristics. A lot of people think of it as being something that's terribly safe. I suppose in the long run, it must be some sort of store or protection of real value, but actually it's an extremely risky instrument. The point about gold is, because it has no yield, there is no clear and sound way of establishing fair value. So the same arguments that the gold bugs put forward now for it, you could advance to $2,000, $3,000, $20,000, or $100, and it could go to any of those levels. It could go up an awful long way. It could also go down an awful long way. I think people who are dabbling in this should be aware of potentially how risky it is.

Cook: So apart from the commodity, how about other asset classes? What's your outlook for equities versus fixed income, for example?

Bootle: I think, there's a big difference here between the short term and the long term. I think that interest rates in the developed West are going to remain at these effectively zero levels for a very long time, and given that I think there's going to very low inflation or even the danger of deflation in a number of countries, this adds up to quite a good picture for bond markets, even though in many countries, debt levels are very high. Government debt levels are very high and government borrowing levels are very high. That won't stand in that way, in my view, of bond yields continuing at these very low levels. They may even edge down a bit. I think, it's possible there may be continued falls in bond deals and varying capital gains on bond holders, although surely the bird has mostly flown.

But looking out longer, I think it's a very different picture. I mean, who would want to lend to a government at yields of 3% or so or in many cases less than 3% on 10-year view. Surely, these yields are much too low into medium term. And in that regard, I think equities come into play. Who knows what's going to happen to equities in the short term, if there are further difficulties in the international monetary system, equities may well suffer in the short term, but over the medium term, they look to me to be reasonable value, particularly I'd say in the U.K. The U.S. market continues to look, I think, overvalued, but for Europe as a whole and the U.K., in particular, I don't think equities do look overvalued. They don't look fantastically exciting, I have to say, in my view. It's not as though they're off the scale and ludicrously cheap, but they look reasonable. And I think that means that an investor that has a fair chunk of equities over a run of years, I don't mean, over the next few months, but who's prepared to think long term, I suspect equities will deliver a reasonable return.

Cook: So at the risk of asking you to oversimplify what is clearly a very complex situation, can I ask you to identify what you think are maybe some of the key items that should be on an investor's radar over the next few years?

Bootle: I think investors need to protect themselves against a very long period of very low returns that cash and bond instruments will give very little. That also of course means that those investors who are trying to construct a portfolio to fund retirement and thinking about annuities have to be really very worried about that.

I'm very negative about the outlook for residential property prices in the U.K. and much of Continental Europe--not in the U.S. where it seems to me although things are grim in the residential market at the moment, at least the prices look to me to be--house prices--fair value, so into the medium term they are not too bad. But inflation risk investors have got to worry about. They've got to give some regard to it, but in my view, they should avoid being dragged into an approach to investment which is reliant on the idea that inflation is going to take off, and lastly I think they should be very alive to the possibility of continued turmoil in the Eurozone.

Cook: Well, thank you very much for your time, Roger, and for your insightful comments.

Bootle: Pleasure.

Cook: For Morningstar and, I'm Holly Cook.