Burton Malkiel is on the verge of having the 10^th edition of his seminal book, “A Random Walk Down Wall Street,” published next month. Reworking the tome left the Princeton economics professor and adviser to AlphaShares more committed than ever to passive investing. He sees ETFs as the next logical step of the indexing revolution.

In his conversation with IndexUniverse.com’s Managing Editor Olivier Ludwig, Malkiel dismissed talk that ETFs are an “instrument of the devil,” stressed patience as the developed world digs itself out of balance-sheet problems and highlighted a focus on emerging markets, like China.

Ludwig: What’s new in the latest edition of your book?

Malkiel: As you know, I believe in indexing, and every time I do a new edition, I say: “OK, you’ve said that people should buy index funds, so how did it work vs. active management?” And every time I do the book, fortunately, the data are very clear: Indexing works.

Second, I have a big discussion of the housing bubble and the credit crunch. So that’s a whole new section.

The final thing is that I am thoroughly convinced that the old lessons of investing still work, including one thing people say doesn’t work anymore: diversification. And that’s because when the market crashed, everything went down together. But what I point out is that this isn’t true. The correlation of some asset classes is actually lower. Bonds, for example, have had a negative correlation with stocks. Gold has done very well. And what I show is that if you diversified with either index mutual funds or ETFs, you could have doubled your money, even during what was one of the most difficult periods for investors ever.

Ludwig: Is your diversification focused largely on offshore investments, or is there more to it?

Malkiel: Basically, my portfolio is a third U.S. It has bonds, it has REITs and it has a third offshore. And half of the offshore was in the emerging markets. I’m also a big fan of rebalancing, and my portfolio is rebalanced annually.

Ludwig: What do you make of this ongoing sovereign debt crisis in Europe? The focal point seems to have shifted from Greece to Ireland.

Malkiel: Well, anytime there’s instability, anywhere, this isn’t a good thing for markets. I have always been a skeptic of the euro, in that you’ve got one currency but the individual countries don’t have independent monetary authority and there’s no central government to help the losers. So what we’re seeing is the Germans saying, “We’ve given Greece a lot of money, and we’re fed up with doing it.” My own sense—and I don’t particularly want to be a Cassandra on this—is that I am virtually certain that eventually the Greek debt will have to be restructured. The same is true for Ireland, probably Portugal, maybe even Spain.

Ludwig: Are you suggesting that the euro might consolidate around Germany, France and maybe the Benelux countries [Belgium, Netherlands and Luxembourg]?

Malkiel: I think it will be very hard for countries to leave the eurozone. But there could very well be political crises in places like Greece, which certainly did misbehave. But they now have constraints put on them that may not be politically feasible. I don’t know what’s going to happen. Is it possible that the eurozone will consolidate around France and Germany and so forth? Yes, it is.

Ludwig: What about QE2? Are you in favor of it?

Malkiel: I am in favor of QE2. I would agree with comments Alan Blinder made in the Op-Ed he did [Nov. 15] in the Wall Street Journal. I think a lot of the criticisms are simply wrong. I think the Europeans are upset with us because it is leading to a fall in the value of the dollar, and that puts Europe at a competitive disadvantage. But I think that’s kind of a parochial view. Europe doesn’t have to do the tight monetary policy it’s doing. It doesn’t have to go in a different direction than us. I think what we are doing is right. Politically, we’re not going to get any more fiscal stimulus—the Federal Reserve is the only game in town and I think it’s exactly the right thing to do when you’ve got a very sluggish economy and almost 10 percent unemployment.

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