When will inflation take off?

Bill Gross - founder of bond manager PIMCO, and one of the most respected bond investors around - is usually worth listening to.

He doesn't get everything right - who does? - but his monthly overviews always provide plenty of food for thought.

Gross is a realist, which probably explains why he became a bond rather than an equity fund manager. He tries to look at things as they are, rather than being a mindless cheerleader for the long-term prospects of the stock market.

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In his latest piece he claims that the "cult of the equity" is dying. Predictably, it's drawn a lot of attention.

But there's a much more crucial point in his piece. It's about the one thing that could have a more devastating impact on your savings in the future than anything else - inflation

Bad news for savers - bonds and equities are both in for a rough ride

Bill Gross has been arguing for a while that economic growth in the future will be much weaker than we're used to, mainly due to debts the global economyhas racked up.

Under this 'new normal' scenario, you can't expect stocks to perform as well as they did in the 20th century. Indeed, their performance since 2000 has been very poor - hence his view that the 'cult of equity' is dead or dying.

The trouble is, bond yields are so tiny that you can't realistically expect them to perform well in the future either. This is all terrible news for savers and pension funds. You can't build a decent retirement pot on the back of near-zero bond yields and miserly dividend yields.

That means people will probably have to safe a lot more and work a lot longer than they currently think they will. For some, retirement may just be a pipedream.

Worse still, Gross reckons that Western governments are set on a course of action that will make things even more painful for today's investors.

Having run out of money, our politicians seem to believe that cost cutting is a surefire vote loser. Few want to raise taxes either. So for Britain, the USA and now even the eurozone, all hopes rest with the printing presses, and attempts to inflate our debts away.

If inflation takes off, then bond yields would have to go higher, and bond prices would fall sharply. Surging inflation would be bad news for most equities too.

But the big question is: when will it happen?

We should embrace deflation - but we won't

I think Gross is right to be worried about inflation. But for now, as I've discussed here before, the forces of deflation are so big that it's going to take money printing on a huge scale to create the sort of inflation that can get rid of the debts in Western economies.

The UK is in recession with high levels of debt and cash-strapped consumers. America is in a similar boat, as is the eurozone. And now China looks to be in trouble with falling company profits and over-investment.

Asset prices are falling, debts are going bad, and people are trying to cut back. This is not a recipe for a major inflation problem.

One way to heal our economies would be to accept this process of bankruptcy and deflation. If you believe in capitalism, you have to accept both the good and the bad parts of it.

Recessions are sometimes a necessary process. They push bad businesses into bankruptcy, and inflict losses on those who made bad investment decisions.

However, they also provide opportunities. The resources that were being used inefficiently by bad businesses can be bought up cheaply by people who can make better use of them. Lower costs make businesses more competitive. The falling prices that come with this type of correction mean that you can buy more goods with the money in your pocket.

Meanwhile, keeping interest rates above the rate of inflation encourages people to save. These savings supply firms with the funds to invest in more wealth-creating projects.

Getting to this point is usually quite painful, but once an economy has reached this point it can begin to prosper again.

The trouble is, this won't happen. Our central bankers and politicians would rather protect the interests of an insolvent financial system by creating money out of thin air.

They would rather make goods and services more expensive for the general public, and destroy the value of people's savings, than accept that some asset prices are too high, and some debts shouldn't be repaid.

The Bank of England knows that this is the game plan. Why do you think it has stuffed its staff pension fund with inflation-protected bonds?

So what do you do with your money?

So I think that Gross and others who fear inflation will be proved right - eventually.

For inflation to take off, money printing needs to reach a point where people become afraid of rising prices or a collapsing currency, and so start to spend money as quickly as they can.

But the world may have to experience a deflationary shock, and falling prices, before central bankers get desperate enough to act. If this scenario plays out then holding a good chunk of cash in your portfolio would be a good strategy.

This will allow you to wait for investment opportunities (not to mention also buying you more goods and services, if prices fall). Buying bonds with very long maturities - 30 years or more - could also make you money in the short-term, although you'd have to time your exit correctly.

So how do you hedge against inflation erupting? Well, you won't be surprised to hear us recommending gold. With increasing talk of more money printing in America and European Central Bank president Mario Draghi promising to do "whatever it takes" to save the eurozone, gold - at just over $1,600 an ounce - looks interesting right now.

There are other inflation hedges out there but they don't look great value at the moment. Inflation-protected bonds look expensive.

Water and electricity grid companies are allowed to raise their prices in line with inflation but have gone up in price a lot recently. However, these shares may fall in price if the economy experiences deflation. So they belong on your watch list.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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